Saturday, November 12, 2011

The Closing Bell-Europe continues improve; the 'super committee' not so much

Statistical Summary
 Current Economic Forecast


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


Real Growth in Gross Domestic Product (revised): +1.0- +2.0%
Inflation (revised): 2.5-3.5 %
Growth in Corporate Profits (revised): 5-10%

Current Market Forecast

Dow Jones Industrial Average

Current Trend (revised):
Short Term Up Trend 11551-12478
Intermediate 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):
Short Term Up Trend 1225-1339
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 14%
High Yield Portfolio 13%
Aggressive Growth Portfolio 9%*

*includes a 5% position in a market ETF as a trading position.


The economy is a modest positive for Your Money. There was a dearth of stats this week. However, what we got was universally positive. This is generally reflective of the overall trend in the data of late, i.e. growth but sluggish. Indeed, even the ECRI weekly index moved up for the second week in a row (see below). Hence, there is no reason to alter our forecast: 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, I am still concerned that the ECRI weekly data continues to point to a recession (though it improved this week). That along with the potential disaster scenario in the EU remains the two biggest risks to our economic scenario.

The latest ECRI weekly index reading:


Potentially impacting our US long term secular economic growth rate assumption is the budget proposal due out of the ‘super committee’ November 23rd (which you will recall is tasked with reducing the budget deficit by $1.2 trillion over the next ten years). Headlines from the MSM all point to deadlock which, under the current legislation, means that the $1.2 trillion in cuts will perforce come one half from entitlements and one half from defense.

Stop right there. I’ll take it.

There are, however, are two other rumored outcomes now circulating: (1) the committee can’t reach any agreement and congress invents a way to weasel on the mandatory cuts and (2) the committee not only agrees on $600 billion in cuts, but it also proposes major tax reform [flat tax and no deductions] to help cover the remaining $600 billion.

That is quite a spread of potential results. The good news is that two of the three are positive (no agreement, mandatory cuts and agreement plus tax reform); and if we were lucky enough to get the tax reform alternative, that would be a huge benefit to the economy. Enough so that I might have to revise the secular growth rate assumption in our Model.

All that said, keep in mind that the cuts don’t go into effect until 2013 which means nothing substantive will occur until after November 2012--which in turn means, of course, that if the political class wants to again defer doing the right thing today, it can and then wait to see how the elections go to really take action. Then if the dems win, they can weasel on the agreement; and if the GOP wins......well, let’s not get too hopeful.

In any case, the only possible impact on the economy pre 12/31/12 is if the tax reform scenario is enacted and it improves business/consumer psychology sufficiently to stimulate spending and investment. Other than that, any change in our Model has to wait.

Europe, of course, remains on the front burner and commanded the most investor attention this week. The good news is that the wild swings in emotion aside, by week’s end progress was being made to resolve the sovereign debt problems of both Greece and Italy. I spent a lot of time in the Morning Calls reviewing events; so I will just summarize:

(1) Greece got a new technocrat prime minister, a new austerity plan and a tranche of its bail out funds,

(2) Italy is voting on its new austerity plans literally as this is being written. It passed the Senate yesterday and is being voted on by the lower chamber today. Presumably, that means Berlusconi is gone and he will apparently be replaced by a technocrat versus a politician. These steps along with a little assistance from the ECB has brought Italian bond rates down to level where the country can afford to service the debt--which was THE immediate problem for Italy,

Who is buying and who is selling Italian debt (medium):

(3) the above notwithstanding, the outlook from last week has not changed: ‘[a]... the disaster scenario (is) off the table, at least in the short term, [b] however, by not dealing with the underlying causes of the problem {fiscal irresponsibility}, it also removes the good news scenario from consideration, [c] leaving Europe facing an extended period of painful deleveraging likely to result in very slow or negative growth and subject to another possible episode such as we have just lived through {Japan 2.0}.’

As far as what this means for the US economic prospects, the scenario that seems to be playing out is basically following the assumptions in our Economic Model: a Greek default with the rest of Europe muddling through reduces growth in Europe which has some impact on our own rate of growth. But it is not recession inducing. Clearly, should the situation become bleaker, then it would certainly cause me to alter our forecast.

The bottom line to all this is that our recently revised our Economic Model calls for 2012 real GDP growth of 1.5-2%, inflation at 2.5-3.5% and corporate profit increases between 5-10%.

Finally, I reiterate my hope for a more positive outcome: ‘I think that our only way of fighting off the negative implications of the above scenario(s) is to throw out enough of bums now inhabiting Washington, to start moving this country toward a fairer tax system, a more fiscally responsible budget, fewer regulations on all of our lives and enact election and lobbying reform to break the link between the political class and rent seeking special interests.’

This is a must read summary of the week from Goldman’s Jim O’Neill:

This week’s data:

(1) housing: both weekly mortgage and purchase applications were up considerably,

(2) consumer: weekly retail sales were universally up for the first time in several weeks; weekly jobless claims declined more than anticipated; the University of Michigan’s preliminary November index was much stronger than expected,

(3) industry: September wholesale inventories declined but sales were quite strong; October small business sentiment improved,

(4) macroeconomic: both the August trade deficit and the October budget deficit were smaller than estimates.

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.)


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


The Averages (DJIA 12153, S&P 1263) had another stomach churning week but ended on a high note. All’s well that ends well, I suppose. The indices closed within their intermediate term trading ranges (10725-12929, 1101-1372) and their short term up trends (11551-12478, 1225-1339) as well as safely above 11719/1230 support levels. They are now in a position to challenge some upside resistance levels, the most notable being the S&P 200 day moving average (circa 1275). So I will be watching that along with current support at 1230.

Volume declined on Friday; breadth continued to improve and, as I have noted several times, the flow of funds is quite strong. The VIX closed right on the edge of the upper zone of its trading range. Additional down side would be a good harbinger for stocks.

GLD continues to be my hero; it finished the week well within its intermediate term up trend.

All in all, the technical outlook seems OK, though the gut wrenching volatility is enough to drive anyone batty. I continue to believe that 12919, 1372 is as good as it is going to get for a while; so any drive to that level will likely prompt some trading sales. I also believe that 10725, 1101 is as bad as it is going to get. However, a sharp decline from present levels probably wouldn’t generate any Buys, simply because our Portfolios have already Bought at lower levels and their present cash position is about as low as I want to go.

Bottom line:

(1) the DJIA and S&P are in an intermediate term trading range (10725-12919, 1101-1372) and a short term up trend (11551-12478, 1225-1339),

(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 (12153) finished this week about 13.5% above Fair Value (10702) while the S&P closed (1263) 4.4% undervalued (1322).

Equities (as defined by the S&P) are approaching Fair Value (as defined by our Model). Incorporated in that ‘Fair Value’ judgment is a zero economic growth rate in Europe, a Greek default and a sluggish recovery at home that isn’t likely to improve until we change the personnel in Washington.

The good news is that a collapse in the EU seems to have been taken off the table, at least in the short term. The bad news is that the odds of a ‘double dip’ remains high enough to be worrisome and that is not helped by what is likely to be a slowing rate of growth in Europe.

In the end, I see little reason to assume that stocks won’t continue to trade around their Fair Value. However, since our Portfolios are about as fully invested as I want to be in the current economic/political environment, I am much less concerned about what may be attractively priced and much more focused on risk.

As I noted in the Technical section, any move by the S&P towards 1372 and either overvaluation will likely generate sales from individual stock prices hitting their Sell Half Range or trading sales will be made in those stocks that appear technically overextended.

Thoughts from Barry Ritholtz (short):

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.


Current 2011 Year End Fair Value* 10760 1330
Fair Value as of 11/30/11 10702 1322
Close this week 12153 1263

Over Valuation vs. 11/30 Close
5% overvalued 11237 1388
10% overvalued 11772 1454
15% overvalued 12307 1520

Under Valuation vs. 11/30 Close
5% undervalued 10167 1255
10%undervalued 9631 1189 15%undervalued 9096 1123

* 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.