Wednesday, July 16, 2014

The Morning Call---Yellen's cover you ass forecast

The Morning Call

7/16/14

The Market
           
    Technical

            The indices (DJIA 17060, S&P 1973) meandered about yesterday, finishing with mixed results (Dow up, S&P down).  They remained above their 50 day moving averages and within uptrends across all time frames: short (16185-17664, 1912-2078), intermediate (16514-20872, 1851-2651) and long (5083-18464, 762-1999). 

            Volume was considerably more than has been the recent norm; breadth was mixed.  The VIX rose, closing back above the upper boundary of its very short term downtrend.  I am interpreting this as a re-confirmation of the break above that boundary---though given the recent schizophrenic behavior, I am not sure this is more than a one day call.  In short, the chart at this point is confusing, but seems to be suggesting that volatility is about to pick up (and stock prices weaken).

            The long Treasury declined again and finished below the upper boundary of its former very short term downtrend two days after a confirmation of a break above that boundary.  Like the VIX and GLD, it has vacillated up and down through this boundary---the only difference being that it is one day behind.  It remains above its 50 day moving average and within short and intermediate term trading ranges.  TLT’s chart continues to create uncertainty for me and, judging by the pin action, for many other fixed income investors.

            GLD took in the chops again, negating the break above the upper boundary of a very short term downtrend and confirming the break below the lower boundary of a very short term uptrend.  It closed right on its 50 day moving average and within short and intermediate term downtrends.  Our Portfolios cut their losses in the gold related positions established on Monday.

Bottom line: given Monday’s pin action, I wouldn’t have been surprised if yesterday’s performance was neutral, i.e. any enthusiasm about more dovish cooing from Yellen was already discounted on Monday.  I didn’t expect the slightly more hawkish tone of her comments (see below); and so given that, I thought that stocks might sell off more than they did.   In other words, I thought equity prices acted just fine in light of Yellen’s comments on the market. 

That said, the schizophrenia in the VIX, TLT and GLD markets suggests that investors in other markets are not as certain as the straight stock guys.  Coupled with other divergences, this all suggests that the Averages may have to work very hard to get to the upper boundaries of their long term uptrends

Our strategy remains to do nothing save taking advantage of the current momentum to lighten up on stocks whose prices are pushed into their Sell Half Range or whose underlying company’s fundamentals have deteriorated.

Our gold related investments initiated on Monday are history.

            Institutional versus individual investors.  Who is right? (short):

            Stocks historical trading pattern in years in which they were basically flat the first half of the year (short):

            The impact of Fed interest rate hikes on the economy and the market (medium and a must read):

    Fundamental
    
     Headlines

            Yesterday’s US economic news was mixed: the July NY Fed manufacturing index was better than expected, weekly retail sales were OK, May business inventories and sales were slightly below estimates and May retail sales fell short of consensus.  Nothing here.

            Overseas, the news was centered back on Espirito Santo holding company (major stake holder in that insolvent Portuguese bank) in which another related entity may be filing bankruptcy---emphasizing again how intertwined the EU banks are.

The latest from the Portuguese bank default (it’s getting worse) (medium):

            This article focused on US financial institutions; however, as I constantly emphasize, the problems are worse in Europe.  Financial interconnectedness and systematic risk at our major banks are a big problem (medium and today’s must read):

            ***Overnight, there were rumors that Espirito Santo would do a capital raise.  In addition, Chinese GDP and industrial production beat expectations, retail sales were up but a bit short of estimates and housing prices fell.  It appears that most of the improvement in China came as a result of a return to rising credit levels---a sign that the Chinese government just couldn’t resist the temptation to join the rest of the world in QEInfinity.
            Yesterday’s leading headline was, of course, Yellen’s testimony before congress in which she reiterated most of her past macroeconomic talking points, i.e. the US economy is improving, enough to allow an end to tapering, but not enough to raise interest rates.  The surprise was that she chose to point to certain markets that could be getting frothy; and that came across as a tad more hawkish than investors had expected.

            Goldman’s take on Yellen’s testimony (medium):

            Yellen’s comments on the frothy market (short):

            Bottom line: The US economy remains the bright spot in our outlook, though our Valuation Model shows that corporate earnings flowing from that scenario are very richly valued---and that ignores problems in China, Japan, the EU (Portugal), Ukraine and the Middle East.

Further, Fed policy isn’t exactly helping the outlook.  Absent Yellen’s comments on frothy markets, her testimony was made from the same cloth as prior statements by her and by the FOMC---suggesting that the Fed will remain easy until its hand is forced by the bond market (hence assuring another botched transition from easy to tight money). 

I am not really sure I get the point of that frothy markets statement---something that seems universal, judging by the comments that I am getting from the pundits.  That said, since a number on international banking organizations (notably the Bank of International Settlements) have begun warning of speculative bubbles, it may be that she (the Fed) just wants to be on record as warning of bubbles---since in 2007, the Fed insisted that everything was just hunky dory right up until the crash.  This way, she can say ‘I tol’ you’.   

Further, the import of the remark doesn’t negate the Fed’s strategy to stay easy until the bond market rebels.  Although perhaps Yellen may want to hurry the process along.  

 In short, Yellen’s testimony only muddied the Fed policy waters.

My bottom line is that for current prices to hold, it requires a perfect outcome to the numerous problems facing the US and global economies AND investor willingness to accept the compression of future potential returns into current prices.

 I can’t emphasize strongly enough that I believe that the key investment strategy today is to take advantage of the current high prices to sell any stock that has been a disappointment or no longer fits your investment criteria and to trim the holding of any stock that has doubled or more in price.

            Bear in mind, this is not a recommendation to run for the hills.  Our Portfolios are still 55-60% invested and their cash position is a function of individual stocks either hitting their Sell Half Prices or their underlying company failing to meet the requisite minimum financial criteria needed for inclusion in our Universe.
        
            It is a cautionary note not to chase this rally.

            Revenue and earnings expectations for the third and fourth quarters (medium):

            Conditions for a crash/correction are still missing (medium):

            It has been a tough year for stock picking (short):

            There is a limited supply of ‘greater fools’ (medium):

            A thought from Jeremy Grantham (short):

            The impact of interest rates and debt on cash flow (medium):

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