The Closing Bell
5/9/15
Statistical Summary
Current Economic Forecast
2013
Real
Growth in Gross Domestic Product:
+1.0-+2.0
Inflation
(revised): 1.5-2.5
Growth
in Corporate Profits: 0-7%
2014
estimates
Real
Growth in Gross Domestic Product +1.5-+2.5
Inflation
(revised) 1.5-2.5
Corporate
Profits 5-10%
2015
estimates
Real
Growth in Gross Domestic Product (revised)
0-+2%
Inflation
(revised) 1.0-2.0
Corporate
Profits (revised) -5-+5%
Current Market Forecast
Dow
Jones Industrial Average
Current Trend (revised):
Short
Term Uptrend 17130-19927
Intermediate Term Uptrend 17270-22385
Long Term Uptrend 5369-18973
2014 Year End Fair Value
11800-12000
2015 Year End Fair Value
12200-12400
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Uptrend 2010-2991
Intermediate
Term Uptrend 1814-2585
Long Term Uptrend 797-2132
2014 Year End Fair Value
1470-1490
2015 Year End Fair Value
1515-1535
Percentage Cash in Our Portfolios
Dividend Growth
Portfolio 49%
High
Yield Portfolio 54%
Aggressive
Growth Portfolio 53%
Economics/Politics
The
economy is a neutral for Your Money. This
week’s data was negative, again: positives---weekly purchase applications,
weekly retail chain store sales, weekly jobless claims, the April ISM
nonmanufacturing index; negatives---weekly mortgage applications, the
April/March nonfarm payrolls report, the April ADP private payrolls report, the
April PMI services index, March wholesale inventories and sales, the April US
trade balance, first quarter unit labor costs; neutral---March factory orders,
first quarter productivity.
The April trade
deficit and April nonfarm payrolls were the important numbers; neither very
encouraging. Once again on both a
quantity and quality basis, the trend in economic growth is solidly negative---meaning
fourteen out of the last fifteen weeks have witnessed disappointing data.
Additional
comments:
(1) note that
most of the positives are weekly numbers while the negatives are monthly. I would argue that the latter carries more
weight,
(2) the reason
the trade deficit is important is because it is a component of GDP. Following that negative [trade] report, general
consensus among economists was that it pretty much guarantees a negative first
quarter GDP number.
Counterpoint
(medium):
(3) pundits are terming
the April nonfarm payrolls report as ‘goldilocks’, i.e. good enough to indicate
that the economy is doing just fine but not too good to push the Fed to
accelerate raising rates. Absent the
dramatic downward revision of the March reading, I would agree; however, if you
average the two, you get a jobs growth rate of 150,000 for each of those
months. That is hardly a ‘goldilocks’
number.
More like an ‘ostrich’
number. Whether you agree or not, the
Market’s reaction to the nonfarm payrolls report, answered a big question about
investor sentiment, to wit, good QE news is still good stock news,
A
look at wage growth (short and a must read):
(4) Yellen made
an unusual comment this week in which she characterized stock valuations a
‘quite high’. This from the head of an
agency whose sole purpose the last seven years has been to crank up asset
prices. The question is, was it a slip
of the lip or did she really mean it; because if she meant it, the jobs report
notwithstanding, the odds of a rate hike sooner than later just went up.
To be sure given
the string of poor economic stats, it would hardly make sense for the Fed to
start tightening near term. On the other
hand, the bond market is taking rates up and don’t think the Yellen is not
paying attention. And don’t think that
she doesn’t realize that today like so many times before, the Fed, having totally
f**ked up the timing of a transition to normal monetary policy, will sooner or
later be forced to follow [if it keeps rates low, then foreign capital will
flood to the US to borrow cheap, driving the dollar still higher].
The
international economic data was also mostly negative although the EU continues
to report improving numbers---which keeps alive the hope that it has turned the
corner. Unfortunately, the euros can’t
resolve the Greek bailout situation and that has the potential of banging whatever
progress is being made over the head with a giant monkey wrench. In addition, UK voters just gave a resounding
victory to the conservative party whose campaign platform included major
revisions in its relationship with the EU---another thread in the potential unraveling
of the EU.
Our forecast:
‘a much below average secular rate of recovery,
exacerbated by a declining cyclical pattern of growth, resulting from too much government spending,
too much government debt to service, too much government regulation, a
financial system with an impaired balance sheet, and a business community hesitant
to hire and invest because the aforementioned, the weakening in the global
economic outlook, along with...... the historic inability of the Fed to
properly time the reversal of a vastly over expansive monetary policy.’
The pluses:
(1)
our improving energy picture. Oil production in this country continues to
grow which is a significant geopolitical plus.
However, [a] lower oil prices failed to bring the consumer spending
bonus so many pundits expected and [b] prices now appear to have bottomed and
are moving up.
If energy
prices have stabilized, absent any delayed consumer response, then the lower
prices part of this positive factor no longer applies. On the other hand, my concern about fracking
related junk debt on bank balance sheets may also not apply. It is
not clear to me at this point that we have seen the low in oil prices;
but certainly, the longer they exhibit positive momentum, the more likely that
the bottom has been made.
The
negatives:
(1)
a vulnerable global banking system. No events this week. I did link to a scathing editorial by an SEC
commissioner faulting the SEC for being far too easy on the too big to fail
banks AND their management. Until the
Fed stops funding those banks’ prop trading, their management is held
accountable both financially and legally and their stockholders are forced to
take the financial hit for incurring inappropriate risks, our banking system
will remain on the precipice of another Lehman Brothers like occurrence.
‘My concern here.....that: [a] investors ultimately
lose confidence in our financial institutions and refuse to invest in America and
[b] the recent scandals are simply signs that our banks are not as sound and
well managed as we have been led to believe and, hence, are highly vulnerable
to future shocks, particularly a collapse of the EU financial system.’
(2) fiscal
policy. This week, congress is still trying to get a free trade agreement
passed. As you know, I believe that
free trade is an important component in increasing future economic growth. So while opposition exists, I am hopeful that
it will be approved.
(3) the
potential negative impact of central bank money printing: The
key point here is that [a] the Fed has inflated bank reserves far beyond any
comparable level in history and [b] while this hasn’t been an economic problem
to date, {i} it still has to withdraw all those reserves from the system
without creating any disruptions---a task that I regularly point out it has
proven inept at in the past and {ii} it has created or is creating asset
bubbles in the stock market as well as in the auto, student and mortgage loan
markets.
This week,
[a] the central bank of Australia lowered its key rate for
the fourth time,
[b] a number of major Chinese brokerages raise
margin requirements,
[c] perhaps the most important development
this week was severe whackage experienced in the global bond markets. I have discussed a number of explanations for
this in our Morning Calls. But the one
that is starting to make the most sense to me is that the bond guys have
finally recognized that it makes no economic sense to hold a zero interest rate
{or a zero real interest rate} fixed income instrument. And as I also pointed out, it is not without
precedent for the Markets to lead the central banks in raising rates; indeed,
it has happened more often than not.
If this proves
to be the case {at the moment I am just hypothesizing on the cause (s) for the
rate run up}, then the $64,000 question (s) is, how far will rates have to rise
before the Fed acts? And if it does, what will the impact be on the
economy? In other words, will it lift
rates as the economy slowing? Quite the
conundrum as they say. Unfortunately, I
think the Fed has painted itself into a lose/lose position; and that probably
is not good for either the economy or the Markets.
QE and the
Japanese economy (medium and a must read):
(4) geopolitical
risks: tensions remain in the Middle East as well as in and around Ukraine.
There were no
major incidents this week, though the US and Saudi Arabia have apparently
agreed on a major arms sale to the Saudis---justified or not, that is only
going to add fuel to the fire.
In addition, I
am concerned about radical Islam’s intent to bring the war to our home. If you believe ISIS propaganda [and I can understand
why you might not] this week’s failed massacre attempt in Texas is just the
start of a more intense campaign of mayhem in this country. I have no doubt that the FBI and other
agencies are working hard to prevent such attacks; but you seldom win them all.
(5) economic
difficulties, overly indebted sovereigns and overleveraged banks in Europe and around
the globe. It was a light week for
international data which was largely negative.
Bad news out of Australia, China and Japan. However, Europe again delivered more upbeat stats;
enough so to keep the hope of economic improvement there alive.
However, the
major news centered around:
[a] the
Greek/Troika bailout discussions which didn’t go all that well---at least if
you are a Greek. True, Greece did make
an IMF payment for E200 million this week; but it has a very full schedule of
payments over the next couple of months.
Not the least of which is one for E750 million next Tuesday. Part of the news this week was a statement by
the EU that there was no chance of reaching a bailout agreement on Monday. Oooops.
Not helping
matters, the EC Commission slashed its forecast for Greek economic growth,
disagreement broke out within the Troika over the proper conditions for a
bailout, the ECB reduced the collateral value of Greeks bank assets and foreign
banks lowered their credit lines to Greek banks.
The latest
(medium):
[b] the UK
elections which gave a major victory to the conservatives whose platform
included substantial revisions in its relationship with the EU. This can only raise more concerns about the
sustainability of the EU.
‘Muddling
through’ remains the assumption for the global economy in our Economic Model
with the proviso that if a Greek default/exit occurs, all bets are off. This
remains the biggest risk to forecast.
Bottom line: the US economic news maintained its downward
path; though there is a promise of improvement in the eurozone.
Meanwhile, spiking
interest rates and a confusing comment from Yellen has muddied the global QE theme. While I never believed that QE had much
impact on any economy and what impact it did have was more negative than
positive, those rising rates threaten to potentially turn a plus for asset
prices into a negative, Friday’s pin action notwithstanding.
The geopolitical
hotspots remain unresolved (1) the Greeks and the Troika appeared to make no
progress this week, as the Greeks continued to look for ways to weasel out of
repaying their debts, (2) US/Russia are still facing off in several geographic
areas and (3) the Middle East violence continues and with it the odds of a Sunni/Shi’a
civil war---which almost certainly won’t leave oil supplies unscathed.
This week’s
data:
(1)
housing: weekly mortgage fell while purchase
applications rose,
(2)
consumer: month to date retail chain store sales improved
slightly; April nonfarm payrolls were slightly above consensus, but the March
reading was revised down substantially; the ADP private payrolls survey was
very disappointing; weekly jobless claims rose less that forecast,
(3)
industry: March factory orders were in line; April PMI
services index was a little below expectations while the April ISM
nonmanufacturing index was better than estimates; March wholesale inventories
were up less than consensus, while sales fell [again],
(4)
macroeconomic: the April US trade deficit was much
larger than forecast; first quarter nonfarm productivity was in line while unit
labor costs were higher than anticipated.
The Market-Disciplined Investing
Technical
The indices
(DJIA 18190, S&P 2116) finished the week on a high note as investors got
jiggy with Friday’s nonfarm payroll number.
Both closed above their 100 day moving average and the trend of lower
highs---for the third time. If they end there on Monday, those trends will be
negated.
Longer term, the
indices remained well within their uptrends across all timeframes: short term
(17047-19844, 1993-2974), intermediate term (17168-22294, 1802-2575 and long
term (5369-18873, 797-2132).
Volume rose
slightly, though not nearly as much as I would have expected, given Friday’s
Titan III shot. Breadth improved. The VIX fell back below its 100 day moving
average and is in a very short term downtrend---both positives for stocks. That said, it is creeping closer to the lower
boundaries of its short and long term trading ranges. The closer it gets, the more attractive it
becomes as portfolio insurance.
The following big
declines early in the week, long Treasury moved modestly up on Friday. Still it
remained below its 100 day moving average, within a short term downtrend and below
the lower boundary of its former intermediate term uptrend. In short, the bond community was not nearly
as impressed with Friday’s nonfarm payroll number as the stock boys. I am not sure what that means, since I was
never sure why bonds plummeted in the first place. What I feel reasonably sure of, is that if
bonds continue to decline, stock investors won’t be able to ignore it forever.
GLD continues to
do nothing---suggesting that whatever the cause of the bond market decline, it
wasn’t concerns about inflation. A head
and shoulders pattern is still developing, a break of which would set it up for
a challenge of its long term trading range.
Bottom line: after
a rough couple of days early in the week, the bulls were in charge on Friday, tip
toeing through the tulips following an employment report suggesting that the
Fed can continue to procrastinate raising rates. If there is follow through next week, the
trend of lower highs will be broken and the Averages will be set up to
challenge the upper boundaries of their long term uptrends---although they must
take out their all-time highs before doing so.
I continue to believe that the upper boundaries of their long term
uptrends will strangle any meaningful attempt to move higher.
That said, longer
term, the trends are solidly up and will be so until the short term uptrends,
at the very least, are negated.
The
long Treasury’s recent pin action is causing me a great deal of uncertainty
primarily because I see no clear reason for the substantial price decline. In addition, bonds prices lifted only modestly
amid Friday’s surge in stock prices, suggesting a lack of conviction that the
Fed will continue to delay increases in interest rates. My concern focuses on what might be the
fundamental reasons for this contrary performance. I still have nothing to offer by way of an
explanation; but our ETF Portfolio did lighten its muni bond positions.
Fundamental-A Dividend Growth
Investment Strategy
The DJIA (18190)
finished this week about 50.6% above Fair Value (12073) while the S&P (2116)
closed 41.1% overvalued (1499). Incorporated
in that ‘Fair Value’ judgment is some sort of half assed attempt at getting fiscal
policy under control, a botched Fed transition from easy to tight money, a
historically low long term secular growth rate of the economy and a ‘muddle
through’ scenario in Europe, Japan and China.
This week’s poor
US and international economic stats confirm the economic assumptions in our
Valuation Model. However, as I said
above, there is the hope that the European economy has started to improve. I have not revised our forecast because we
need some good news just to hold the current flat to slightly up outlook.
Questions
(spiking interest rates and Yellen’s comment) arose this week about the
sustainability of QE’s continued capacity to push asset prices higher; although
the Market’s response to Friday’s nonfarm payroll report clearly addressed that
issue, suggesting that stock investor’s love QE as much as ever.
However, given
the very limited response of the bond market to the nonfarm payroll number, I am
not sure that it makes sense to assume that whatever was driving rates up is no
longer valid. So if the bond vigilantes
keep pushing rates higher, it is going to make the Fed’s (transition timing)
problem worse and sooner or later, equity investors will no longer be able to ignore
the changes being wrought in the equity discount factor. I am not saying that bond yields will
continue to rise. I am saying that if it
is unclear what is propelling rates higher, then we can’t be sure it is not
going to continue.
Geopolitical
risks have not declined. There was no progress in the Greek bailout talks as
differences broke out within the Troika as to the terms of the agreement and
the Greek banks incurred additional pressure on their capital structure from
the ECB and foreign banks. These can only have raised the odds of a
default/exit and its consequences---about which I believe no one has a
clue. Clearly, that also ups the
probability of market disruptions.
The
NATO/US/Russia and Middle East standoffs haven’t been resolved though there was
no further deterioration in either this week.
‘As I noted last week, I have no clue how to
quantify the aforementioned geopolitical risks’ impact on our Models even if I
could place decent odds of their outcome because: (1) the outcomes are mostly
binary, i.e. Greece either exists the EU or doesn’t and (2) they all most
likely incorporate potential unintended consequences, which by definition are
unknowable. Better to just say these are
potential risks with conceivably significant costs and then wait to see if we ‘muddle
through’ or have to deal with those costs.
The important investment takeaway, I believe, is to be sure that your
portfolio had at least some protection in the downside.’
Bottom line: the
assumptions in our Economic Model are unchanged but still in danger of being
revised down again. If they are anywhere
near correct, they will almost assuredly result in changes in Street models that
will have to take their consensus Fair Value down.
The assumptions
in our Valuation Model have not changed either; though there are scenarios
listed above that could lower Fair Value. That said, our Model’s current calculated Fair
Values are so far below current valuation that any downward revisions by the
Street will only bring their estimates more in line with our own.
Earnings growth
without sales growth (medium and today’s must read):
Our Portfolios
maintain their above average cash position.
This week, a number of the stocks on our Buy List fell below the lower
boundaries of their respective Buy Value Ranges---not a plus for future price
movement. In addition, our ETF Portfolio
lightened up on its muni bond positions.
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.
DJIA S&P
Current 2015 Year End Fair Value*
12300 1525
Fair Value as of 5/31/15 12073 1499
Close this week 18190
2116
Over Valuation vs. 5/31 Close
5% overvalued 12676 1573
10%
overvalued 13280 1648
15%
overvalued 13883 1723
20%
overvalued 14487 1798
25%
overvalued 15091 1873
30%
overvalued 15694 1948
35%
overvalued 16298 2023
40%
overvalued 16902 2098
45%overvalued 17505 2173
50%overvalued 18109 2248
55%
overvalued 18713 2323
Under Valuation vs. 5/31 Close
5%
undervalued 11434 1420
10%undervalued 10832 1345
15%undervalued 10230 1270
* Just a reminder that the Year
End Fair Value number is based on the long term secular growth of the earning
power of productive capacity of the US
economy not the near term cyclical
influences. The model is now accounting
for somewhat below average secular growth for the next 3 to 5 years.
The Portfolios and Buy Lists are
up to date.
Steve Cook received his education
in investments from Harvard, where he earned an MBA, New York University, where
he did post graduate work in economics and financial analysis and the CFA
Institute, where he earned the Chartered Financial Analysts designation in
1973. His 40 years of investment
experience includes institutional portfolio management at Scudder. Stevens and
Clark and Bear Stearns, managing a risk arbitrage hedge fund and an investment
banking boutique specializing in funding second stage private companies. Through his involvement with Strategic Stock
Investments, Steve hopes that his experience can help other investors build
their wealth while avoiding tough lessons that he learned the hard way.
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