The Closing Bell
4/9/16
My granddaughter arrives this afternoon and will be staying till
Thursday. So I am not sure how much
writing I will do next week. I will be
in town and in touch with the Market.
Statistical
Summary
Current Economic Forecast
2015
estimates
Real
Growth in Gross Domestic Product (revised)
-1.0-+2.0%
Inflation
(revised) 1.0-2.0%
Corporate
Profits (revised) -7-+5%
2016 estimates
Real
Growth in Gross Domestic Product -1.25-+0.5%
Inflation
(revised) 0.5-1.5%
Corporate
Profits (revised) -15-0%
Current Market Forecast
Dow
Jones Industrial Average
Current Trend (revised):
Short
Term Trading Range 15431-17758
Intermediate Term Trading Range 15842-18295
Long Term Uptrend 5471-19343
2015 Year End Fair Value
12200-12400
2016 Year End Fair Value
12600-12800
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Trading Range 1867-2081
Intermediate
Trading Range 1867-2134
Long Term Uptrend 800-2161
2015 Year End Fair Value
1515-1535
2016
Year End Fair Value 1560-1580
Percentage
Cash in Our Portfolios
Dividend Growth
Portfolio 53%
High
Yield Portfolio 54%
Aggressive
Growth Portfolio 53%
Economics/Politics
The
economy maybe providing a temporary upward bias to equity valuations. The
stats this week were somewhat sparse and weighted to the negative: above
estimates: weekly mortgage applications, weekly jobless claims, the March Markit
services PMI and the March ISM nonmanufacturing index; below estimates: weekly purchase
applications, month to date retail chain store sales, March retail chain store
sales, February consumer credit, February factory orders, February wholesale inventories
and sales and the February trade deficit; in line with estimates: none.
The primary
indicators were mixed: the March ISM nonmanufacturing index (+) and February
factory orders (-). Bolstering the
overall negative case for the week were two anecdotal datapoints: (1) the
Atlanta Fed revised its first quarter GDP growth estimate down to 0.4%. This is the fourth downgrade in as many
weeks, and (2) heavy truck orders plunge 37%. In the last 31 weeks, seven have been positive
to upbeat, twenty three negative and one neutral.
On a point that
I made in last week’s Closing Bell, (i.e. that the stats out of the
manufacturing sector had improved markedly over the last two weeks) the ink was
hardly dry on the paper when I discovered a release from the Fed revising industrial
production data downward. That was
followed on Monday by a disappointing February factory orders number.
In the
aforementioned Closing Bell I noted: ‘(1)
two weeks in not enough data to warrant a change in outlook, (2) remember the
government revised its seasonal adjustment factors for the first
quarter---which could, at least partially, explain the improvement, (3) the
international economic numbers have been and remain terrible; if US industry
manages to overcome this enormous headwind, then it will be impressive,
indeed. I am just not sure how probable
that is, and (4) nonetheless, I am impressed with these results and have turned
on the flashing yellow light to indicate that I may have jumped the gun on my
recession call.’
My only revision
to those comments would be that the flashing yellow light is a good deal dimmer;
and, subject to future data flow, a candidate to be turned off.
Recession alert
index (short):
Here is another alert
(medium):
Similar to the
US, the international economic stats were few but negative--- continuing to act
as a headwind to our own economy.
The other big
story of the week was the release of the minutes from the latest FOMC meeting,
the bottom line of which was they generally supported Yellen’s dovish approach
to monetary policy.
In summary, the US
economic stats were negative while the international data remains depressing. Meanwhile, the Fed is doing its utmost to
confuse and confound.
Our forecast:
a recession or a zero economic growth rate, caused
by too much government spending, too much government debt to service, too much
government regulation, a financial system with conflicting profit incentives
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 slowdown that
won’t stop slowing down (medium and a must read):
The
negatives:
(1)
a vulnerable global banking system. Nothing this week----except this (short):
And this (short):
(2) fiscal/regulatory
policy. There were two potentially
significant political events this week that could (indeed one already has]
impact the regulatory environment:
[a] the so
called Panama Papers, a list of shell companies domiciled overseas that were
seemingly used to hide money of the rich, were released. While few Americans were implicated, it
nonetheless plays to the theme of ‘the rich are getting richer’ and not paying
their fair share of taxes. Not helping
matters, immediately following this disclosure there were a number of
accusations {seemingly well founded} that the US was currently the world’s
largest tax haven. To be clear, I am not
condoning tax avoidance. Indeed, I agree
with the notion that our financial system, as it is not constructed, does favor
the rich. What concerns me is that this
is the kind of news that can be seized upon by the politicians and potentially
lead to all kinds of pernicious legislation/regulations that will only make our
complicated, special interest oriented tax code worse.
[b] the US
Treasury markedly changed the tax laws related to tax inversion merger activity
{a US company gets acquired by a foreign company headquartered in a country
with a much lower corporate tax rate than the US}. Politicians have been bellyaching about these
transactions for years; and there is no doubt that many of these transactions
are for tax related purposes. However {i} tax inversions are legal and {ii} the
rationale for doing one is perfectly reasonable---because the US’s tax rates
are high relative to other countries, making it economically uncompetitive as a
domicile for many corporations.
Nonetheless,
there is a big political element to this issue which has the risk of being
solved by legislation/regulations that only makes doing business in the US all
the more difficult.
In addition, {i}
this new regulation had a three year look back on one particularly relevant
aspect of an inversion merger (in other words, the treasury changed the rules
as of three years ago); as a result, Pfizer and Allegan called off their merger
due to this change in regulations, {ii} the US Justice Department filed a
lawsuit to stop Haliburton’s acquisition of Baker Hughes and {iii} the chairman
of the house transportation and infrastructure committee has come out against
the Canadian Pacific/Norfolk Southern merger.
Without
commenting of the goodness or badness of increased government scrutiny of
corporate M&A activity, it will nonetheless likely have an impact on the ability
of corporate America to continue to manufacture margin improvements and
earnings growth.
Pro:
Con:
(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.
Several tidbits
this week:
[a] the minutes
from the last FOMC meeting were released on Wednesday, the bottom line of which
was that the committee supported Yellen’s dovish comments last week as opposed
to the more hawkish messages delivered the prior week by several Fed officials.
On Friday, I
linked to a note that the Fed would hold an expedited meeting on Monday to
review interest rates. I thought that
might be significant. However subsequently, there was no further coverage in
either the live or print media. So
apparently, no one else thinks it important.
[b] a
representative of the Bank of Japan reiterated that more easing measures remain
on the table as potential policy moves, including still more cuts in negative
rates.
[c] the Bank of
India lowered key interest rates.
You know my
bottom line: QE [except QE1] and negative interest rates have done nothing to
improve any economy, anywhere, anytime. What
they have done is lead to asset mispricing and misallocation. Sooner or later,
the price will be paid for that. The longer it takes and the greater the
magnitude of QE, the more the pain.
(4) geopolitical
risks: while all was quiet on the western front this week, that doesn’t mean
that the risks are any less from terrorists’ bombings, turmoil in the EU over
immigration and assimilation policies and adventurist polices by Russia, Iran
and North Korea.
There is a
decent chance of an explosive event stemming from one or more of the
aforementioned, though I have no idea just how big it could be or which one is
more likely to occur.
(5)
economic difficulties in Europe and around the globe. The international economic stats released this
week were quite negative: German factory orders declined, most major EU
countries’ March services PMI declined, the IMF was out talking about slowing
global growth. However, the March
Chinese services PMI was better than expected [remember they lie].
Has the Chinese debt bubble already burst? (medium):
Meanwhile, OPEC members Kuwait and Russia kept
dribbling the freeze/no freeze oil production ball, keeping the rest of world
confused. I have this image of an OPEC
meeting, members with their feet up on their desks, smoking cigars, sipping scotch
and laughing uncontrollably about what their next move will be to jerk the rest
of the world’s chain and how to place their bets on Markets reactions.
The bottom line: the data we got
was not encouraging. And Ms. Yellen
seems to agree that the global economy remains a major headwind.
Bottom line: the US data in aggregate continues to point
toward a recession. The global economy did
nothing to brighten the outlook. OPEC as well as the global central banks are doing
everything possible to confuse and confound the Markets.
A deteriorating
global economy and a counterproductive central bank monetary policy are the biggest
economic risks to our forecast.
This week’s
data:
(1)
housing: weekly mortgage applications rose but purchase
application were down,
(2)
consumer: month to date retail chain store sales were much
weaker than the prior week, and March retail chain store sales slowed from their
pace in February; February consumer credit rose driven by student and auto
loans; weekly jobless claims were down more than projected,
(3)
industry: February factory orders declined more than
forecast; the March Markit services PMI was up versus February’s reading; the
March ISM services index was slightly better than estimates; February wholesale
inventories and sales were down,
(4)
macroeconomic: the February US trade deficit was larger
than expected.
The Market-Disciplined Investing
Technical
The indices
(DJIA 17576, S&P 2047) stumbled last week, failing to successfully
challenge the upper boundaries of their short term trading ranges and voiding
very short term uptrends. Breadth was
poor; and the VIX appears to have found a bottom, mirroring the Averages by bouncing
off the lower boundary of its short term trading range and negating a very
short term downtrend. The only good news
in this picture was that it was all done on anemic volume.
The Dow closed
[a] above its 100 day moving average, now support, [b] above its 200 day moving
average, now support, [c] within a short term trading range {15431-17758}, [c]
in an intermediate term trading range {15842-18295} and [d] in a long term
uptrend {5471-19343}.
The S&P
finished [a] above its 100 day moving average, now support, [b] above its 200
day moving average, now support, [c] within a short term trading range {1867-2081},
[d] in an intermediate term trading range {1867-2134} and [e] in a long term
uptrend {800-2161}.
The long
Treasury had a good week, ending in both very short term and short term uptrends
as well as above its 100 day moving average and above a Fibonacci support
level. However, it is still facing a challenge
of the upper boundary of its intermediate term trading range.
GLD also did
better; but remains in a very short term downtrend. So it has more work to do get back on the
winning track.
Bottom
line: the indices did not have a particularly
good week, though I warned that they were in heavily congested territory and
not to expect the pace of momentum to be sustained. While there were some troubling short term
developments (inability to push out of their short term trading ranges, voiding
their very short term uptrends, weak breadth), it is too soon to count the run
up from February over. So the assumption
remains that they challenge their all-time highs but fail to push above them.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (17576)
finished this week about 41.3% above Fair Value (12432) while the S&P (2047)
closed 33.0% overvalued (1538). 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.
The US economic numbers
were back to the negative side this week.
Further, the bright spot in last week’s data---manufacturing stats--was
almost completely voided by subsequent Fed revisions in industrial releases and
a lousy February factory orders report. In addition, the Atlanta Fed revised
its first quarter GDP growth estimate down for the fourth time in a row. And finally, the international economic
releases remain quite discouraging.
Not helping
matters, OPEC continues to yank the world’s chain with its freeze/no freeze
dialectic, sending oil prices into a drug induced see sawing. At this point, I am not sure who’s on first;
but as I have noted several times, in the absence of a production cut,
there is currently little evidence to support higher oil prices. If that is the
case, then (1) I would expect to see more troubles in the energy sector and
with the banks who serve them and (2) if oil prices continue to affect stock
prices, then the Market will have yet another headwind.
In sum, even if our
forecast of recession is wrong, the economy is still growing at a snail’s pace
and faces a huge headwind from the rest of the world’s economies. That would render most Street forecasts for
the economy, corporate earnings and stock valuations too high.
My favorite
optimist gives a stunningly accurate description of the problems our economy
faces, then makes an Alfred Hitchcock conclusion by stating that his optimism
is based on investors’ pessimism---which he conveniently fails to define. My question is, how can investors be
pessimistic and stocks be at both all-time price and valuation highs?
Fed policy again
made the headlines as the minutes from the last FOMC meeting were released on
Wednesday. Bottom line: after some
confusion over exactly how hawkish/dovish the Fed members were, the doves prevailed. Importantly from the Market’s standpoint,
investors continued their euphoria over easy money. My question remains, how much more return can
they expect when a huge percentage of global fixed income securities are at a
negative yield and stock prices are near all-time highs as corporate earnings
fall?
I have proven
that I don’t have the answer. But when
investors do figure it out, I believe that the cash generated by following our
Price Discipline will be welcome as investors wake up to the Fed’s (and other
central bank) malfeasance. I suspect the
results will not be pretty.
Also worth
mentioning in the list of negatives is the growing anti-business sentiment
found in not only the political rhetoric but also in a newly aggressive
bureaucracy that is changing the law on the fly and a stepped up regulatory
enforcement. This group of clowns love
the bully pulpit to forward their self-aggrandizing agenda to gain fame and
fortune---which historically has not been good for stocks.
Last but not
least, earnings season is upon us. The universe
knows that the numbers are not going to make good reading; so some of this is
also certainly in stock prices. The question
is, how much? If investors are too
pessimistic, then Market reaction could be positive; and, of course, visa
versa.
Net, net, my two
biggest concerns for the Markets are (1) declining profit and valuation
estimates resulting from the economic effects of a slowing global economy and
(2) the unwinding of the gross mispricing and misallocation of assets caused by
the Fed’s wildly unsuccessful, experimental QE policy.
Bottom line: the
assumptions in our Economic Model are unchanged. 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 for equities.
The assumptions
in our Valuation Model have not changed either; though at this moment, there
appears to be more events (greater than expected decline in Chinese economic
activity; turmoil in the emerging markets and commodities; miscalculations by
one or more central banks that would upset markets; a potential escalation of
violence in the Middle East and around the world) that could lower those
assumptions than raise them. That said, our
Model’s current calculated Fair Values under the best assumptions are so far
below current valuations that a simple process of mean reversion is all that is
necessary to bring Market prices down significantly.
I
can’t emphasize strongly enough that I believe that the key investment strategy
today is to take advantage of any further bounce in stock 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; but
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 2016 Year End Fair Value*
12700 1570
Fair Value as of 4/30/16 12432
1538
Close this week 17576
2047
Over Valuation vs. 4/30 Close
5% overvalued 13053 1614
10%
overvalued 13675 1691
15%
overvalued 14296 1768
20%
overvalued 14918 1845
25%
overvalued 15540 1922
30%
overvalued 16161 1999
35%
overvalued 16783 2076
40%
overvalued 17404 2153
45%
overvalued 18026 2230
Under Valuation vs. 4/30 Close
5%
undervalued 11810
1458
10%undervalued 11188 1384
15%undervalued 105678 1307
* 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 47 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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