Saturday, December 03, 2011

The Closing Bell, Much more needs to be done

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):
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):
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 12%
High Yield Portfolio 11%
Aggressive Growth Portfolio 17%


The economy is a modest positive for Your Money. Lots of data points this week and for the first time in a while we got some negative numbers: weekly jobless claims were a disappointment and November retail sales and third quarter GDP was slightly below expectations. However, the preponderance of stats continued to portray a (sluggishly) growing economy with few signs of recession.

That said, the ECRI weekly leading index turned down this week. Not by much mind you; but down nonetheless. As you know, this indicator is the biggest source of cognitive dissonance for me with respect to the US economy. It along with a potential EU disaster scenario are the two biggest flies in our economic forecast ointment.

The latest ECRI weekly index reading:

Nevertheless, I don’t’ think these risks are sufficient reasons at the moment 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.

As far as the political economy goes, since the last Closing Bell, our elected representatives were unable to reach any kind of agreement on reducing the budget deficit (the super committee) so we will get the mandatory $1.2 trillion in reductions spread over ten years starting in 2013. While this decrease is a drop in the bucket relative to what we need, it is better than a sharp stick in the eye.

More recently, they are now arguing over extending the holiday for the payroll tax for another year. The outcome of this latest bit of wrangling will have an even smaller impact than the budget reduction issue on a return to fiscal responsibility. So it the broader scheme of things, it is meaningless. As you know, all this nonsense is built into our Economic Model, so nothing here impacts our forecast. The only good news is that the European political class is comprised of an even great collection of fools and their machinations over their own fiscal policies have diverted the attention of the electorate off the moronic behavior in Washington.

Europe, of course, remains on the front burner. This week’s primary development was the coordinated global central bank liquidity assistance to the EU financial system. I covered this subject pretty thoroughly through my own analysis as well as numerous links from guys who have much better background in international finance than I. So I am not going to be repetitious. I simply repeat my conclusion: the central bank aid is not a game changer, the heavy lifting is yet to be done, but it does buy some limited time for the eurocrats to do what is needed to prevent multiple country/bank defaults.

Another framework for a deal (short):

And some cognitive dissonance (medium):

This keeps Europe on track with the assumptions in our Economic Model: a Greek default with the rest of Europe muddling through. This process will likely lead to a zero to slightly negative economic growth rate in Europe, which while impacting our growth rate unfavorably, is not recession inducing. Clearly, if the eurocrats can’t find the political will to address the underlying fiscal profligacy issue sufficiently to sustain the EU, then the situation becomes bleaker and our forecast too optimistic.

P.S. in a previous post I noted that one way out of the funding difficulty the EU countries are now facing was for the ECB to lend money to the IMF which would then lend it to the individual countries with tough fiscal policy strings attached. Yesterday, the GOP began an attempt to block any such action by the IMF:

Bill Gross’ take (medium):

This week’s data:

(1) housing: both weekly mortgage and purchase applications fell due to seasonal factors; October new home sales were up; October pending home sales soared; the September Case Shiller home price index fell much more than anticipated,

(2) consumer: weekly retail sales were strong; November retail sales were slightly less than forecast; October auto sales were better than expected; weekly jobless claims rose more than estimates though the ADP private payroll report showed marked improvement; November nonfarm payrolls were modestly better than anticipated while the prior two months were revised up; consumer debt and credit card delinquencies continued to decline; the Conference Board’s November index of consumer confidence spiked well above its October reading,

(3) industry: the November ISM manufacturing index came in above estimates as did the November Chicago PMI and October construction spending number was a blowout,

(4) macroeconomic: revised third quarter GDP came in slightly below expectations; the latest Fed Beige Book was generally up beat.

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.

This is an absolute must read--it is a history of the role of debt in an economy and how it can undermine the best interests of the population:

The Market-Disciplined Investing


The Averages (DJIA 12019, S&P 1244) had one of their best weeks in history. Wednesday, in particular, changed a lot technically speaking; the most important thing being a halt to a rather precipitous short term decline.

At the moment, the most we can say is that the indices remain within their intermediate term trading ranges (10725-12929, 1101-1372). They are attempting to break a very short term down trend which now intersects at 12048, 1240 (so clearly the S&P is in its time and distance phase); if successful, it should set the stage for a further advance. Near term resistance is found at the late October highs (12300, 1292. Initial support now exists at 11719/1230. Current valuations, seasonal factors as well as struggling progress in Europe suggest that the bias is now to the upside.

Volume was flat on Friday; breadth mixed. The VIX rose fractionally but remained below the upper zone of its current trading range for the third day--a positive for stocks.

GLD was up, finishing the week well within its intermediate term up trend.

All in all, the technical outlook seems OK; although I continue to believe that stock prices will remain bound by the limits of their current intermediate term trading ranges for at least another six months barring either a catastrophe in Europe or the sudden assured end of the Obama administration. As long as equities are in this range, my emphasis will focus on both sides of our Price Disciplines.

Bottom line:

(1) the DJIA and S&P are in 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 (12019) finished this week about 11.7% above Fair Value (10760) while the S&P closed (1244) 6.4% undervalued (1330).

Equities (as defined by the S&P) are below Fair Value (as defined by our Model). As you know, 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.

Europe continues to be the center of the investment world. Given the ugliness of a worse case scenario along with its binary nature (i.e. it either will or won’t happen), volatility will probably continue to be the chief characteristic of this Market until an endgame is in view. That makes investing difficult and trading even worse.

What we can do to help ourselves is to own a decent position in gold (our Portfolios are now at 11-12%) and be brutal in following our Price Disciplines, particularly our Sell Discipline. Hence, the sales of a number of stocks that had violated a clear technical support level AND had no visible support for at least another 15% to the down side.

Of course, as long as stocks remain in their current trading range, our Buy Discipline will come into play when stocks trade into the Buy Value Range. That said, our Portfolios already have full positions in every stock on our Buy Lists. Thus barring the addition of new names, there is little to do on Market weakness.

Since the last Closing Bell, our Portfolios have Sold shares of stocks that have broken their up trends in a material way, Added to their GLD position and instituted a small trading position in VIG.

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 12/31/11 10760 1330
Close this week 12153 1263

Over Valuation vs. 12/31 Close
5% overvalued 11298 1396
10% overvalued 11836 1463
15% overvalued 12374 1529

Under Valuation vs. 12/31 Close
5% undervalued 10222 1263
10%undervalued 9684 1197 15%undervalued 9146 1130

* 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.