The Closing Bell
6/4/16
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 17498-18726
Intermediate Term Trading Range 15842-18295
Long Term Uptrend 5541-19413
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 2037-2110
Intermediate
Trading Range 1867-2134
Long Term Uptrend 830-2218
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 provides no upward bias to equity valuations. With an
exceeding negative set of stats on Friday, this week ended up to the downside: above estimates: month to date retail chain
store sales, April personal spending, the March Case Shiller home price index,
the May Markit PMI, the May ISM manufacturing index and the April trade deficit;
below estimates: weekly mortgage and purchase applications, the May ADP private
payroll report, the May nonfarm payrolls report, May consumer confidence, the May
Chicago PMI, the May Markit services PMI, the May ISM services index, the May
Dallas Fed manufacturing index; in line with estimates: the April personal
income and the April core PCE price index, May light vehicle sales, weekly
jobless claims, March/April construction spending and March/April factory
orders.
The primary
indicators were neutral: the March personal spending (+), March personal income
(0), and March/April factory orders (0), March/April construction spending (0)
and May nonfarm payrolls (-). What was
somewhat surprising to me was the volume of not only the overall ‘in line’
estimates but also the ‘in line’ primary indicators. That goes a ways to dampen the negativity of
the week. However, the magnitude of lousy
numbers was simply overwhelming.
That said, there
has been enough upbeat data of late to leave open the question as to whether or
not the US economy is starting to stabilize.
I am staying with our recession forecast but with lower odds than a
couple of weeks ago. The score is now: in
the last 38 weeks, nine have been positive to upbeat, twenty seven negative and
two neutral.
Not helping
matters was yet another lousy week of stats from around the globe. This set of numbers has been much more
consistently bad for longer than our own.
The recent spate of better data in the US may be giving some a ray of
hope that our economy could be stabilizing.
However, it is getting no assistance from the rest of the world, begging
the question that I have raise several times in the recent past: to what extent
can the US economy recover when the rest of the globe is slumping?
The Fed held to
its new theme: everything is awesome, so rates are going up. All seemed to be
going well until that punk Friday jobs report.
Now what will it do? I suspect
that a June hike is off the table; but then I already had a low probability on
that happening. More important, the
question now is, was the jobless number a fluke or will it turn out to be one
of those defining moments when investors suddenly realize that the Fed has
been, is and will forever be, full of s**t.
If the Fed’s credibility gets seriously challenged, then all that
misallocation and mispricing of assets will likely start to unwind. To be clear, it is far too early to make that
a prediction; but if the jobs number turns out not to be aberration, economic
perceptions will likely change dramatically.
On the other hand, other central banks have
been doing the opposite. China is gradually
devaluing the yuan, Japan is delaying the imposition of a second sales tax
increase and the ECB stepped up its bond purchase program. Of course, with their economic stats so dismal
that is hardly surprising.
In summary, the three
week sizz that the US economic stats were on hit a brick wall this week. Plus, the very poor nonfarm payrolls number has
potential implications far beyond just making this a lousy week. Meanwhile the international data remains
moribund. The big issue coming out of
this week is---what happens to Fed policy if that jobs number is real?
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.
JP Morgan
recession indicators move to new highs (short):
The
negatives:
(1)
a vulnerable global banking system. A proposal to end bank alchemy (medium):
US banks are certainly in stronger financial condition than
in 2008. That doesn’t mean that all is
well in ‘too big to fail’ land.
(2) fiscal/regulatory
policy. I expect little to occur on this
factor as the US moves into the presidential campaigning season. On the other hand, who knows what cockamamie scheme
we may be subjected to as our politicians promise the moon to buy votes.
(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.
As I noted
above, the Fed has been pushing a new script---the economy is great so it’s
time to raise rates. However, at least
the economy is awesome part of that routine ran off track on Friday; so God
only knows what this clown circus is thinking now. I still believe it reasonable to assume that a
June rate hike is off the table. On the
other hand, if the Market decides [and as of the close on Friday, it appears
that it has] that it loves the jobs number [poor economy = low rates] and maintains
its upward thrust, Yellen et al may decide to risk it.
A rate hike
amidst declining inflationary expectations? (short):
The Fed is
behind the curve (medium and an absolute must read):
The rest of the
globe continues to battle recession/deflation.
China has been systematically devaluing the yuan while everyone else is seemingly
responding to the US/Chinese threat to stop their own devaluations by focusing on
other means---the Japanese delaying a sales tax hike and the ECB stepping up
its bond buying program. I think this
significant because if it continues, it would stymie the drive towards a trade
war.
You know my
bottom line: QE [except QE1] and negative interest rates have done nothing to
improve any economy, anywhere, anytime; so its absence will do little
harm. What it has 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: the news this week was just more of same dull thud of battles in
Syria/Iraq where the US boots on the ground continue to die and terrorists’
attacks.
The risks from
a step up of terrorists’ bombings, turmoil in the EU over immigration and
assimilation policies and adventurist polices by Russia, Iran and North Korea
all remain. 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 turned in
another poor week:
[a] May EU inflation remained negative; the Markit manufacturing
PMI was flat while the composite PMI was down; the UK second quarter GDP growth
rate is expected to slow from its first quarter pace; and Greece continues to
struggle to earn additional bail out funds,
[b] April Japanese factory output, household spending
and job availability were better than expected while May Japanese manufacturing
PMI declined. In addition an official of
the Bank of Japan said that the economy in 2016 would not grow at the projected
rate,
[c] May Chinese manufacturing PMI was unchanged while
the services PMI slowed in growth and both the Caixin manufacturing and
services PMI fell below forecasts,
[d] Swiss first
quarter GDP was below expectations.
The trend in poor global data seems
endless. It did have one upbeat week
recently but that has turned out to be a flash in the pan. The issue here is, is the global economy
sufficiently weak to thwart what may be a nascent US recovery.
Bottom line: the chances that the US economy has ceased
deteriorating were dealt a blow this week.
At this early stage, we can’t know; but clearly there is some hope that
this could be occurring. There is no
such promise from the rest of the world’s economies. They continue to generate negative growth
comparisons. Meanwhile, the Fed threatens
to tighten while the rest of the globe fights recession/deflation. The good news is that, at least for the
moment, competitive devaluations no longer pose a risk.
Subject to more
data, 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 and purchase applications
fell; the March Case Shiller home price index rose more than anticipated,
(2)
consumer: April personal income was in line, while personal
spending was better than forecast; month to date retail chain store sales were stronger
than the prior week; May light vehicle sales were in line; May consumer
confidence was below projections; the May ADP private payroll report was
slightly below estimates; weekly jobless claims were in line; May nonfarm
payrolls grew much less than expected,
(3)
industry: the May Chicago PMI fell below forecasts; the
May Dallas Fed manufacturing index came in below consensus; the May Markit manufacturing
PMI was above estimates as was the May ISM manufacturing index; the May Markit
services PMI was less than anticipated and the May ISM services index was very
poor; April construction spending was down but the March number was revised up,
making the two months a wash; likewise April factory orders were disappointing
but a March revision offset it,
(4)
macroeconomic: the April core PCE price indicator was
in line; the April trade deficit was less than consensus.
The Market-Disciplined Investing
Technical
The indices
(DJIA 17807, S&P 2099) had a lot of intraday pin action this week but
basically ended up only slightly from last Friday. Volume on Friday increased
fractionally. Breadth was weak. The VIX finished back near the lower boundary
of its short term trading range which it has rebounded off of four times. A break below it would be a plus for stocks.
The Dow closed
[a] above its rising 100 day moving average, now support, [b] above its 200 day
moving average, now support, [c] within a short term trading range {17498-18726},
[c] in an intermediate term trading range {15842-18295} and [d] in a long term
uptrend {5541-19413}.
The S&P
finished [a] above its rising 100 day moving average, now support, [b] above
its 200 day moving average, now support, [c] within a short term trading range {2037-2110},
[d] in an intermediate term trading range {1867-2134} and [e] in a long term
uptrend {830-2218}.
The long
Treasury soared on heavy volume on Friday, reflecting the declining odds of a
June rate increase. In the process, it
negated a very short term downtrend and is now nearing the upper boundary of
its intermediate term trading range. It
remained within a short term uptrend and above its 100 day moving average.
On Friday GLD also
spiked on volume for same reason as bonds.
It is now well above its 100 day moving average and the lower boundary of
its short term trading range; both of which it had been threatening to void.
Bottom
line: the bulls held their ground all
week, making a particularly strong showing on Friday following the
disappointing jobs report. They continue to hold on to their euphoria, having vacillated
from giddiness over the Fed raising rates because the economy was awesome to
excitement over the Fed not raising rates because the economy is weaker than
expected. I am not going to even try to
explain that; and technically speaking, I don’t have to. At the moment, all that matters is that the
Averages are churning slightly below the upper boundaries of the short term
trading ranges. We await a challenge of
those resistance points---or not.
More on the eighth
year of a presidential term (short):
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (17807)
finished this week about 42.3% above Fair Value (12512) while the S&P (2099)
closed 35.6% overvalued (1547). 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 negative this week. But
this one had a cherry on top in the form of an abysmal nonfarm payrolls report. Remember, the most important data on which
the Fed is supposedly ‘data dependent’ are employment and inflation. So this number is likely to tighten a lot of sphincters
in the Eccles Building.
Of course, we
need the proverbial follow through to be sure this report wasn’t just a
fluke. But if it is not, (1) the Fed
watching will get a lot more interesting and (2) the end of asset misallocation
and mispricing could be at hand. That
said, stock investors seem to remain loyal to the Fed. As I noted above, after an initial sell off
early Friday, stocks rallied into the close on the thesis that since the
economy is worse than expected, there will be no rate increase in June. That follows on the earlier strength in equities
based on the thesis that the Fed was raising rates because the economy is so
strong. Confused? Join the crowd. Someday this manic behavior will end; I just
have no clue when. But the bottom line
is that the key to Market at this point is exactly how it interprets that the
jobs report.
The global
economy continues to deteriorate.
Indeed, the poor jobs number may answer the question that I posed above:
can the US economy grow in the face of a weakening global economy?
In sum, I am
sticking with our forecast of recession, though (1) the recent improvement in
data and (2) the more positive pin action in oil prices give me pause. We
just need more data.
Nonetheless, (1)
most Street forecasts for the moment are exceedingly optimistic for the economy
and corporate earnings, even if all these forecasts prove correct, (2) and
stock valuations are priced for perfection.
The current
trend in dividend increases/cuts (medium and a must read):
I continue to 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.
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. Near
term that could be influenced by whether or not the employment data was a fluke
and how the Market interprets the outcome.
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.
Update on
Buffett indicator (short):
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 6/30/16 12512
1547
Close this week 17807
2099
Over Valuation vs. 6/30 Close
5% overvalued 13137 1624
10%
overvalued 13763 1701
15%
overvalued 14388 1779
20%
overvalued 15014 1856
25%
overvalued 15640 1933
30%
overvalued 16265 2004
35%
overvalued 16891 2088
40%
overvalued 17516 2165
45%
overvalued 18142 2243
Under Valuation vs. 6/30 Close
5%
undervalued 11886
1469
10%undervalued 11260 1392
15%undervalued 10635 1314
* 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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