Thursday, January 19, 2012

The Morning Call Big changes potentially coming to the leading economic indicators

The Market

The indices (DJIA 12578, S&P 1308) had a great day, leaving them within their intermediate term trading ranges (10725-12919, 1101-1372) and above the lower boundary of a short term up trends (12026, 1242). Both of the Averages have multiple support levels that are close in. Furthermore, the S&P 50 day moving average continues to close the gap with the 200 day moving average; if that ‘cross’ is made, then the technical picture will improve even more.

Volume was flat; breadth improved. The VIX got whacked by 6% and closed near the developing base which I mentioned yesterday. If this level holds, that could potentially become a mild negative for stocks.

GLD (161) rose again and continues its short term recovery. However, resistance exists at the down trend off its September 2011 high (164.8).

Bottom line: the Market looks healthy; I still have no reason to believe that anything technical will obstruct its move to the 12919, 1372 level. Aggressive traders may want to play this move. However, at the moment, I am building a list of stock positions to be reduced as prices approach the upper boundary of the current trading ranges.

The latest read on the Barron’s confidence index (short):


Yesterday’s economic news was mostly positive: weekly mortgage applications were a blow out, but seasonality factored in, weekly retail sales were up, December PPI was down and December industrial production was up though a tad less than anticipated. As always, I am encouraged by any data that is supportive of our forecast.

The only other news worth mentioning was the conditional rejection by the administration of the Keystone pipeline project. The developers have the option of re-routing the pipeline around a supposedly environmentally sensitive in Nebraska and re-applying.

Most analysts agree that this initial rejection was an election year ploy to appease the environmental lobby; and hopefully it will ultimately get approved post election. Not doing so, in my opinion, would be so wrong on so many levels (jobs, energy independence and prices being the most important). Unfortunately, we have to live with the risk that long term this project could be rejected and in the meantime of having to endure a completely dysfunctional political system that will only further discourage business investment and individual consumption.

Bottom line: investor sentiment seems to coalescing around the assumptions that the US economy will continue to grow in 2012 and that the resolution of the EU sovereign debt problem will not be too painful; and that seems to be the driving force behind rising stock prices. The above assumptions, of course, sound very similar to those in our own forecast; the difference is that I can’t get equity valuations materially higher than they are today.

We have been through this kind of drill before; that is, without any changes, our forecast relative to the Street expectations goes from too optimistic to too pessimistic and back again. Today, our forecast seems to be traversing to the too pessimistic camp; and to be sure, it may be. But (1) while our economy is improving, it still has huge internal headwinds: a debilitating debt to GDP ratio with no effort being made to correct it, a banking system that still hesitant to lend money to anyone other than AAA corporate giants and a business community unwilling to make domestic investments because of fear of a government more interested in social ideals than economic growth [see above] and (2) while the new ECB funding program alleviates short term fears of a liquidity collapse, the longer term solvency issue that is a function of decades irresponsible fiscal policy has not been adequately addressed and until it is, will pose the risk not only of a more severe recession than anticipated but an implosion of the EU banking system if investors become unwilling to hold EU sovereign debt.

Another take on the outlook for Europe this year (medium):

Which is a long winded way of saying that I don’t buy this current optimism, I see too many impediments to transitioning to a more positive growth scenario and I can’t get Valuations much higher than present levels. Hence, my focus right now is on those holdings that have the greatest downside vulnerability with an eye to making sales as prices advance.

As a footnote: One of my worries about our economic forecast is the recent ECRI weekly index readings which point to a recession. One of the reasons for holding this bit of dissonance at bay was the strength shown by the leading economic indicators. Well, it seems that the Conference Board, which computes the LED, has decided that to revise the make up of this index.

While the Conference Board itself has not yet released any new stats, Lance Roberts has taken the computational revisions that were announced and imputed the new series of data--and the answer is, the ECRI seems to have it correct. I am going to await the Conference Board’s official release; however, in the meantime, I will be working on potential changes to our own forecast that reflect a weaker economy. If the Conference Board’s revision has a similar impact on 2012 growth assumptions from widely followed Street economists, this rally may stop dead in its tracks. In any case, here is Lance’s analysis of the changes and the results. (medium):

Who is buying? Check out Goldman’s take (short):

To date this quarter’s earnings ‘beat’ rate is about 50% versus over 70% in prior quarters.

Subscriber Alert

The stock prices of Staples (SPLS-$15) and Oracle (ORCL-$28) traded above the upper boundary of their respective Buy Value Ranges. Accordingly, they are being Removed from the Aggressive Growth Buy List. The Aggressive Growth Portfolio will continue to Hold these stocks.

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. Steve's goal at Strategic Stock Investments is to help other investors build wealth and benefit from the investing lessons he learned the hard way.