Thursday, January 26, 2012

The Morning Call--We are Adding to GLD

The Market

The indices (DJIA 12758, S&P 1326) picked up momentum to the upside yesterday, closing within their intermediate term trading ranges (10725-12919, 1101-1372) and above the lower boundary of their short term up trends (12155, 1255). The 12919, 1372 level is clearly within striking distance; and as I have said repeatedly, prices are likely to get there.

Volume was up marginally; breadth improved. The VIX declined and remains within a firm down trend.

GLD soared, rebounding off its 50 day moving average and finished decidedly above the down trend off its September highs. At the Market open, our Portfolios will Add to their positions, taking them above 5%.

Bottom line: 12919, 1372 here we come. However, I have opined that these boundaries will hold. I am sticking with that, though with the news out of the Fed yesterday, the likelihood of me being wrong has increased.

The percentage of stocks above their 50 day moving average (charts):

Stock prices are up but so are earnings downgrades (short):


The great earnings news from Apple Tuesday night had little impact on stocks at yesterday’s opening because all the early Wednesday news was negative: (1) economic news: December pending home sales [down] and mortgage applications [also down] (2) news from Europe: the UK economy is slowing more than anticipated and Portuguese interest rates are blowing out to the upside. The latter points are particularly concerning viz a viz our forecast in that they could be signs that our ‘muddle through’ scenario could be too optimistic. However, this was all soon forgotten.

First Greece, then Portugal (medium):

Over night rates are again up (short):

The big news was the change in policy coming out of the FOMC meeting--extending the period of accommodative monetary policy out to at least mid 2014; in other words, low rates and easy money for as far as the eye can see. Let’s call this move QE 2.5 and basically parallels the recent loosening in EU monetary policy (which not coincidentally is also a three year program).

The good news is that (1) it will provide additional help to the European financial system in dealing with its liquidity problem, (2) it potentially lessens the risk associated with my biggest fear--a bankruptcy that could lead to a chain reaction in the EU sovereign debt credit default swap market in which counterparties are unable to meet their obligations, and (3) based on investor reaction to QE 1, QE 2 and operation twist, this should be a plus for stock prices.

The bad news is that it makes Fed’s ultimate task of removing all the excess liquidity on bank balance sheets that much harder. Think inflation.

Surprisingly enough, except for the aforementioned extension of easy money, the rest of FOMC statement read almost identically to the statement from the last FOMC meeting: rates were left unchanged, the economy is expanding moderately (though slightly less so than previously forecast) and unemployment unlikely to improve materially anytime soon. In other words, even though nothing has changed, the Fed is doubling down on easy money. Obama to the Ber-nank, thank you.

Bottom line: the Fed is doing everything in its power to mitigate any global liquidity risk. While that may be helpful short term in avoiding a freeze up in our banking system should we get a disorderly default in Europe, it doesn’t address the real problems either here or abroad--which are solvency risks (fiscal irresponsibility). And it is the solvency issues that are the more important determinants of the pace (or lack thereof) of economic recovery.

My point here is that while the Fed’s new policy may be reducing the magnitude of the downside IF our forecast is too optimistic; but it does nothing to improve the upside because it isn’t going to induce banks to lend or businesses to borrow any more than QE1, QE2 or operation twist did--because the banks and businesses are scared sh**tless of fiscal/regulatory policies (and who could blame them after Tuesday night’s speech?) not monetary policy. In short, it raises the probability that our outlook will be spot on; and if that is the case, then nothing has changed with respect to valuations.

And (short):

On the other hand, the old saw to ‘not fight the Fed’ has to have increased as a price determining factor at this point; and that suggests that the odds that prices could overshoot the 12919, 1372 boundary have gone up. Nevertheless, with no change in the fundamentals, i.e. Fair Value at S&P 1336, my strategy is to force the Market to prove me wrong. In the meantime, I can’t ignore our Discipline to Sell stocks that move into their Sell Half Range.

A corollary of not fighting the Fed when there is already trillions of dollars on bank balance sheets is that the risk of inflation/currency debasement has gone up, strengthening the case for owning gold.

Thoughts from David Rosenberg (medium):

Subscriber Alert

The stock price of CR Bard (BCR-$90) has traded above the upper boundary of its Buy Value Range. Accordingly, it is being Removed from the Dividend Growth Buy List. The Dividend Growth Portfolio will continue to Hold BCR.

The stock price of Sigma Aldrich (SIAL-70) has traded above the upper boundary of its Buy Value Range. Accordingly, it is being Removed from the Dividend Growth and Aggressive Growth Buy Lists. The Dividend Growth and Aggressive Growth Portfolios will continue to Hold SIAL.

The stock price of Cato Corp (CATO-$27) has traded above the upper boundary of its Buy Value Range. Accordingly, it is being Removed from the High Yield Buy List. The High Yield Portfolio will continue to CATO.

As noted above, our Portfolios are Adding to their GLD positions at the Market open.

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.