Saturday, August 27, 2011

This Week in Review (8-27)


Statistical Summary
Current Economic Forecast

2010 (revised)

Real Growth in Gross Domestic Product: +2.5- +3.5%
Inflation: 1-2 %
Growth in Corporate Profits: 10-20%

2011

Real Growth in Gross Domestic Product: +1.5- +2.5%
Inflation: 2-3 %
Growth in Corporate Profits: 7-12%


Current Market Forecast
Dow Jones Industrial Average

Current Trend (revised):

Intermediate/Short Term Trading Range 10725-12919
Long Term Trading Range 7148-14180
Very LT Up Trend 4187-14789

2010 Year End Fair Value (revised) 10095-10115

2011 Year End Fair Value 10750-10770

Standard & Poor’s 500

Current Trend (revised):

Intermediate/Short Term Trading Range 1101/1172-1372
Long Term Trading Range 766-1575
Very LT Up Trend 644-2000

2010 Year End Fair Value 1240-1260

2011 Year End Fair Value 1320-1340

Percentage Cash in Our Portfolios

Dividend Growth Portfolio 22%
High Yield Portfolio 22%
Aggressive Growth Portfolio 22%

Economics

The economy is a modest positive for Your Money.
There was not a lot of data this week. Unfortunately, what we got was mostly neutral to negative, though there was one bright spot: July durable goods orders were very strong. While the stats did little to support our outlook neither were they particularly worrisome. That said, a string of disappointing weekly numbers like we just had will have me reassessing the assumptions in our Model.

For the moment, our forecast remains: (1) a below average secular rate of recovery 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 unwilling to hire and invest because the aforementioned, (2) the likelihood a rising and potentially corrosive rate of inflation due to excessive money creation and the historic inability of the Fed to properly time the reversal of that monetary policy.

As dismal as the above sounds, it is reflected in our Economic and Valuation Models. What is not discounted is (1) a ‘double dip’ and (2) the EU sovereign debt crisis spreading beyond Greece and inflicting additional damage to US financial institutions’ balance sheets and to the international earnings of US corporations.

(1) the Three Stooges: our forecast for a below average economic recovery in the US is largely the outcome of poor, ill conceived, mistimed, self serving decisions by our political class. Regrettably, Bernanke’s speech Friday and Obama’s upcoming ‘new jobs’ plan notwithstanding, there is nothing to suggest any meaningful changes in the political dynamics in Washington that would cause me to alter our outlook. It would seem our only hope in November 2012; but in the meantime, expect below average secular growth that could itself be sabotaged by some other numb skull policy designed to allow government to ‘fix’ the problem.

A prime example would be a QEIII. As I am sure you know, the Bernank spoke on Friday. While he expressed concern about the economy and a willingness on the Fed’s part to provide further easing if required, he failed to mention any policy options. Nevertheless, I think that he deliberately left open the possibility of more easing by expanding the length of the FOMC’s September meeting and suggesting that there were weighty matters to discuss. The Markets clearly took heart from that as witnessed by the performance of both the equity and gold markets following the speech. If that is the correct interpretation, then given the results of QEI and II it is not unreasonable to expect little impact on growth and much on inflation. Not what we need.
http://www.capitalspectator.com/archives/2011/08/bernanke_speaks_1.html#more

Indeed what we do need is some pro growth policies from our elected representatives. To date, both parties have shown a remarkable knack for developing and implementing anti-growth, anti capitalist, pro big government boondoggles--which is in no small measure the reason the US economy is in the sorry state that it is in. Yes, we do have Obama’s ‘new plan’ to look forward to; but if this Guy sticks to His pro big government, nanny state agenda, the ‘new plan’ will as useless as tits on boar hog.

Here are just a few examples of our government’s malfeasance:
http://mjperry.blogspot.com/2011/08/gibson-under-attack-by-us-justice.html
http://mjperry.blogspot.com/2011/08/new-civil-right-right-right-to-raise.html

(2) the Three Blind Mice. I wrote last week: ‘As near as I can tell, the euros are simply standing around in a giant circle jerk and praying. I have no clue how the EU sovereign debt problem resolves itself. My guess is that neither does anyone else and hence the current Market panic.’

The only event this week was the second Greek bail out couldn’t get out of the chute. That raises the risks of a Greek default/restructuring and the spread of this disease beyond Greece. That in turn would ‘negatively impact(s) the economic growth in Europe, potentially scaling up the level of political unrest and re-damaging the balance sheets of US banks and reducing revenues and earnings of US companies doing business in Europe.’

As I have said, this is the major risk to our forecast; and such a scenario require me to adjust our Economic Model’s global growth rate down.

Bottom line from last week hasn’t changed: ‘the economy continues to muddle through and, if my low expectations for a budget fix from the current crew in power is correct, it should continue to do so through early to mid 2013. The good news is that both a sluggish economy and a second rate political class are reflected in our Valuation Model.’

‘The bad news is that the EU political class seems incapable of properly dealing with the growing likelihood of multiple country bankruptcies. Until it does, the financial condition of the PIIGS will almost surely continue to deteriorate. If left unaddressed, that will not good for the euros, it will not good for US companies doing business in Europe, it will not be good for the US financial institutions with exposure to EU sovereign debt and it will likely not be good for stocks.’


This week’s data:

(1) housing: weekly mortgage applications and purchase applications fell; new home sales plunged 7.3%,

(2) consumer: weekly retail sales were again mixed; weekly jobless claims increased versus expectations of a decline; the University of Michigan’s final August index of consumer sentiment came in at 55.7 versus estimates of 55.8,

(3) industry: July durable goods orders were strong; one August Fed bank local business conditions index [Chicago] came in better than forecast while another [Richmond] was worse than anticipated,

(4) macroeconomic: second quarter GDP was up in line with expectations while the GDP deflator was hotter than estimates and corporate profits were up 3% on an annualized basis.

A closer look at second quarter profits (short):
http://scottgrannis.blogspot.com/2011/08/corporate-profits-are-fantasticwhats.html

The Economic Risks:

(1)the economy is weaker than expected.

(2) Fed policy (reading the data correctly).

(3) a disruption in global oil supplies (It is not the price of oil but its availability that will cause severe economic dislocation.).

(4) protectionism (Free trade is a major positive for world and US economic growth.).

(5) fiscal profligacy (Government spending as a percent of GDP is too high and the looming explosion in entitlement expenditures will make it worse. There is no good solution save spending discipline.).

(6) a rising tax and regulatory burden (Government has never proven that it could solve economic problems efficiently or satisfactorily.)

Politics

The domestic political environment is a neutral but could be improving for Your Money while the international political environment remains a negative.

The Market-Disciplined Investing

Technical


The Averages (DJIA 11253, S&P 1176) had a good week. The DJIA remains within its intermediate term trading range (10725-12919) while the S&P keeps toying with both 1101 and 1172 as a lower boundaries to its intermediate term trading range (1101/1172-1372). It is not clear which will prevail.

However, short term that is less of an issue. At the moment, a pennant formation is developing (that being a series of both higher lows and lower highs). As long as this pattern persists there is no clear trend; but when one of those trends (i.e. higher lows or lower highs) are broken, that tends to determine the Market direction for a period of time. So technically speaking, I want to sit on my hands to see which way the Market breaks.

If it is to the up side, then it is a pretty good sign that the early August lows were the worst that we are going to see. So I will want to put money back to work; and the good news is that there are still plenty of candidates on our Buy Lists. If equities break to the downside, then I want to watch the 10791, 1120 and 10725, 1101 support levels. If they hold, then again I will want to put some of our cash back to work. If not, then our Sell Discipline becomes much more important.

GLD had a schizophrenic week--first getting whacked very hard, trading all the way down to the lower boundary of its short term up trend, then recovering strongly on Friday. Typically after a pounding like GLD took this week, there is a period of consolidation. If that happens and GLD holds the lower boundary of that short term up trend, our Portfolios will re-purchase the shares Sold early last week. If not, then I may be 0 for 2 on my latest GLD calls.

Bottom line:

(1) the DJIA and S&P are in an intermediate/short term trading range (10725-12919, 1101/1172-1372), though, as noted, the S&P seems to be testing two levels,

(2) long term, the Averages are in a very long term [78 years] up trend defined by the 4187-14789, 644-2000 and a shorter but still long term [13 years] trading range defined by 7148-14198, 766-1575.

Fundamental-A Dividend Growth Investment Strategy

The DJIA (11284) finished this week about 6.9% above Fair Value (10546) while the S&P closed (1176) 9.6% undervalued (1302).

I have nothing new to add to last week’s summary:

‘In my opinion, equity prices are now struggling to properly discount (1) the uncertainties related to potential multiple bankruptcies among the EU countries/the dissolution of the EU and the resulting impact on US bank balance sheets and US corporate profits plus (2) the additional pessimism born of a complete lack of faith in the western political class’ ability/will to address and solve these problems.

Of course, with the S&P priced 13.7% (9.6%) below Fair Value, at least some of this trauma is being reflected. With respect to Europe, until we know how bad the ultimate outcome is, it is tough to know what the correct stock valuations are. That said, the worst outcome today is not likely to be nearly as bad as the worst outcome a year from now if the can gets kicked down the road. The point being that another smoke and mirrors patch is the bad news scenario. If either Germany or some combination of PIIGS withdrew from the euro Monday morning, there may be an initial negative reaction; but I think stock prices would be higher a week later. It’s that week that poses the valuation problem.

As far as the lack of confidence in our elected representatives, I haven’t had any confidence in them for at least 12 years. Yet others seem only now to be waking up to the fact that the electorate has saddled itself with a bunch of self interested, self important parasites. For better or worse, I have no such delusions and have priced in the continuing reign of this group of morons through 2012. However, until the rest of the Market gets that done, prices will likely stay under pressure--the operative word being ‘until’ because it could be happening now.

Through this all volatility and emotion, the constant that I hold on to is our Price Disciplines. Our Model makes plain that stocks, in general, are undervalued and many of our stocks specifically are trading at historically low absolute and relative valuations. That doesn’t mean that those candidates won’t get cheaper or that there aren’t stocks that remain on the high side of Fair Value that have the potential of getting cracked really hard. The good news is that our Disciplines provide us with an unemotional gauge with which to make those ‘cheap’ and ‘high side of Fair Value’ judgments. Staying focused on our Disciplines has always gotten me and our Portfolios through rough times.’


This week our Portfolios Sold a portion of their GLD holding, taking it from circa 9-10% to circa 7-8 %.; that in turn raised their cash position form 20% to 21-22%.

Bottom line:

(1) our Portfolios will carry a higher cash balance than pre-financial crisis but it will be more a function of individual stock valuations and less on macro Market technical trends,

(2) we continue to include gold and foreign ETF’s in our asset mix because we continue to believe that inflation is the major long term risk. An investment in gold is an inflation hedge and holdings in other countries provide [a] a hedge against a weak dollar and [b] exposure to better growth opportunities,

(3) defense is still important.

DJIA S&P

Current 2011 Year End Fair Value* 10760 1330
Fair Value as of 8/31/11 10546 1302
Close this week 11284 1176

Over Valuation vs. 8/31 Close
5% overvalued 11073 1367
10% overvalued 11600 1432
15% overvalued 12127 1497


Under Valuation vs. 8/31 Close
5% undervalued 10018 1236
10%undervalued 9491 1171
15%undervalued 8961 1106

* 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 with somewhat higher inflation.

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.