Statistical Summary
Current Economic Forecast
2011
Real Growth in Gross Domestic Product: +1.5- +2.5%
Inflation: 2-3 %
Growth in Corporate Profits: 7-12%
2012
Real Growth in Gross Domestic Product: +1.5- +2.5%
Inflation: 2-3 %
Growth in Corporate Profits: 0-10%
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
2011 Year End Fair Value 10750-10770
2012 Year End Fair Value 11290-11310
Standard & Poor’s 500
Current Trend (revised):
Intermediate/Short Term Trading Range 1101-1372
Long Term Trading Range 766-1575
Very LT Up Trend 644-2000
2011 Year End Fair Value 1320-1340
2012 Year End Fair Value 1390-1410
Percentage Cash in Our Portfolios
Dividend Growth Portfolio 20%
High Yield Portfolio 17%
Aggressive Growth Portfolio 22%
Economics
The economy is a modest positive for Your Money.
Almost no data this week; and as has been the pattern of late within the stats was some good news (existing home sales and leading economic indicators) and some bad news (housing starts).
In the end, there simply wasn’t enough information to alter our outlook. So, the current dark mood of the Market notwithstanding, the evidence still suggests that our forecast is right on: 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 along with 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.
Nevertheless, it would be foolish to ignore the Street’s current bout with pessimism; and so I have to assume that the risk is increasing that a recession will occur.
All that said, neither the quantity nor quality of this week’s data mattered anyway because Europe, the Fed and to a lesser extent our dysfunctional political class dominated the headlines.
(1) the EU sovereign debt crisis is and will be the biggest risk to our forecast until it gets resolved. I optimistically noted last week that there were some small hopeful signs that the eurocrats were starting to come to grips with the hard realities of past fiscal profligacy and the impaired assets now held by the major EU banks--‘small’ being the operative word. Clearly, a great deal more has to be done and soon to avoid a worse case scenario. Unfortunately, very little additional progress was made this week; although rumors abound that Greece will default this weekend and preparations are afoot to address the resulting liquidity issues that would likely arise in the EU financial system. The bottom line here is that conditions are as dire as they are because eurocrats fiddled while Greece burned; matters will be even worse, if they continue to do nothing.
http://www.nakedcapitalism.com/2011/09/europe-must-choose.html
(2) as you know, the FOMC met this week and following its meeting announced Operation Twist. To say that investors were not impressed would be a gross overstatement. Indeed, following its release, the downward momentum in stock prices went into overdrive. There were two causes [a] its statement that the risks to the economy have increased spooked investors [b] while its focus on lowering long term interest rates confused investors {since lower long term rates suggest less risk}
To be sure both [a] and [b] are more psychological than substantive. In fact, I think that, in terms of its impact on the US economy, Operation Twist is much ado about nothing. However, the damage was still done. Leaving me with this take a way: Mr. Bernanke quit trying so hard; you can’t solve the economic mess facing this country. As much as you may want to do everything possible to improve conditions, the problem is one of governance [or lack thereof]. Fiscal, regulatory, trade policies are what is holding back economic expansion and until they are changed, the Fed can do little. Indeed, as suggested by the Market’s reaction, your actions can be counterproductive.
(3) and speaking of fiscal, regulatory and trade policies [which I wish I wasn’t], November 2012 can’t come soon enough. This group of morons we have elected to manage the ship of state just don’t get it. How many more times do we have to listen of Obama telling us that taxes need to be raise on ‘the rich’ when 50% of the US households don’t even pay income taxes and the top 10% pay 70% of all the taxes? How many more examples of government directed spending gone awry [think Solyndra] do we have to endure? When is congress going to figure out that in a period of extreme financial uncertainty and austerity, the electorate doesn’t need to be burdened with the additional fear that the government can’t work out a budget that ensures the country can meet its short term financial obligations? Is it any wonder, investors are discouraged?
http://www.washingtonpost.com/opinions/return-of-the-real-obama/2011/09/22/gIQAf7dsoK_story.html
Bottom line: the economy continues to stumble along though data suggest that the probability of a ‘double dip’ is increasing. However, I don’t think that the odds have reached 50/50 yet. Further, as irresponsible and ineffective as our ruling class is, I believe that the US economy on its own has the strength to muddle through until November 2012.
Europe, of course, is another story. Its economic problems are worse, its financial institutions weaker and its political class as clueless, inert and ineffective as our own. Unfortunately, it is a large enough trading partner and its financial institutions are intertwined enough with US banks that a chaotic resolution to their sovereign debt problem would adversely affect our already anemic recovery. The only reason that I don’t throw in the towel and join the bears is that necessity seems to be pushing the leadership to take the steps to ring fence Greece and back stop its banks. I am not predicting that it will happen; but until we see how they handle the Greek situation, I don’t how we can predict the endgame.
This week’s data:
(1) housing: weekly mortgage applications were up but purchase applications were down; August housing starts fell more than expected though building permits were stronger than anticipated; August existing home sales came in much better forecast,
(2) consumer: weekly retail sales were mixed; weekly jobless claims fell in line with estimates,
(3) industry: none,
(4) macroeconomic: August leading economic indicators increased more than expected.
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.
An endless stream of incompetence--the latest on Obamacare financing (medium):
http://www.powerlineblog.com/archives/2011/09/no-class.php
The Market-Disciplined Investing
Technical
The Averages (DJIA 10771, S&P 1136) were brutalized last week, but still managed to close within their intermediate term trading ranges (10725-12929, 1101-1372). However, they did break a number of other support levels, not the least of which was the lower boundaries of their respective short term up trends.
The viciousness and swiftness of the decline (circa 70 S&P points in two days) was so sudden that it never gave me a chance to put money to work. That, of course, is the good news--if prices had meandered towards a lower level, our Portfolios likely would have continued the nibbling started the previous week. The challenge now is to be patient through the current testing of the lower boundaries of the indices intermediate term trading ranges (August lows). If successful, we will get a chance to Buy stocks are very attractive levels. If not, I will thank my lucky stars that the Markets moved too fast for an old conservative guy like me to put any money to work (some times luck is better than skill).
Volume was elevated throughout the week; breadth as you might guess was terrible. The VIX was off fractionally but remains well within its current trading range--not a sign that stocks are going to drop (further) off the cliff. Furthermore, as I noted in Friday’s Morning Call, our internal indicator is not signaling any significant downside.
GLD had a near death experience this week, busting through several support levels but closing near the lower boundary of its intermediate term up trend. I got tell you that I played this about as poorly as I could. As I noted, GLD broke several support levels, so I had plenty of chance to reduce our position. My excuse is that every time it broke support it would immediately plunge to yet another support level--so I would wait to see if that level held; and the same thing would happen again. And I am going to do it one more time. The lower boundary of its intermediate term up trend is significant; so I just don’t think that it would be smart to Sell at what could be fractions above the low of this cycle. On the other hand, if it breaks this time, I am movin’ on out.
http://www.zerohedge.com/news/gold-liquidations-open-thread
Bottom line:
(1) the DJIA and S&P are in both an intermediate term trading range (10725-12919, 1101-1372),
(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 (10771) finished this week about 1.7% above Fair Value (10588) while the S&P closed (1136) 13.1% undervalued (1308).
This week, stocks as measured by the S&P got a whole lot more undervalued as calculated by our Valuation Model. As I suggested in the Economics section, it had nothing to do with the performance of the economy. Rather it was a function of indecisiveness in Europe, an out of touch Fed and the insouciance of our political class to the problems that they have created. That said, most of this we already knew--disappointing as it is. As such, it is in the price of stocks.
Not figured into our Model is a ‘double dip’. But as I noted last week, even if we get a recession, with the S&P at ‘circa 15% undervalued; surely that would discount any kind of down turn currently envisioned by Street bears.’
Of course as I noted above, the real risk to our forecast is a multi country default/restructuring in Europe accompanied by an implosion of its financial system. The problem is determining the likelihood of such an occurrence. Reason would suggest that the EU leadership is just as aware of the risks and the consequences of not acting as the rest of the world. Yet they have sat around far too long, yanking themselves off and lying to their electorates by assuming that somehow they are smart enough to pull some unforeseen rabbit out of their hat and avoid the inevitable. That strategy works until it doesn’t; and it generally stops working when Markets precipitate the inevitable. That seems to be happening now. If that is the case, the good news is that most of the experts that I have read and talked to believe that the EU still has the resources and flexibility to allow an orderly default of Greece and salvage the EU financial system. And as I have been suggesting, there are some faint signs of progress to that end. But to avoid a disaster scenario, progress needs to be apparent to the Markets and soon or we are likely in for more pain. I recognize that this bit of rationalizing doesn’t get us any closer to determining the likelihood of the worse case, it simply points out that it is not 100%.
The uncertainty in all this is the reason that our Portfolios own a 10% position in gold (though that is not doing us any good at the moment), 15-18% in cash and follow a well tested Sell Discipline that has served them well in prior difficult times.
This is a great read. Its point is that suppressing daily volatility ultimately leads to Black Swan events. (medium):
http://www.ritholtz.com/blog/2011/09/suppressing-financial-instability-increases-risk-of-market-breakdown/
This week our Portfolios held on for dear life.
Bottom line:
(1) our Portfolios will carry a high cash balance,
(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--although this is becoming problematic as investors flock to the dollar to avoid the EU solvency issue 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 9/30/11 10588 1308
Close this week 10771 1136
Over Valuation vs.9/30 Close
5% overvalued 11117 1373
10% overvalued 11646 1438
15% overvalued 12176 1504
Under Valuation vs. 9/30 Close
5% undervalued 10058 1243
10%undervalued 9529 1177 15%undervalued 8999 1112
* 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.
No comments:
Post a Comment