Saturday, April 21, 2012

The Closing Bell-Europe is still the 900 lb gorilla

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 Trading Range 12919(?)-13302
Intermediate Up Trend 11429-16429
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 Trading Range 1372(?)-1422
Intermediate/Short Term Up Trend 1200-1767
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 28%
High Yield Portfolio 34%
Aggressive Growth Portfolio 32%


The economy is a modest positive for Your Money. Another week, another series of mixed data; though this time the emphasis was on the negative side. Disappointing were weekly mortgage purchase applications, March housing starts as well as existing home sales, weekly jobless claims, March industrial production and both the April New York and Philadelphia Fed manufacturing indices. Mortgage applications, building permits, March retail sales and March leading economic indicators beat expectations.

While nobody likes the stats weighed to the negative side, especially in an already sluggish recovery, this is all part of the expected pattern of the slow, erratic economic progress reflected our forecast. We would have to get multiple weeks of this kind of data flow before I would be concerned. In addition, one could argue that it finally helps put to rest the notion that the economy will advance at a higher rate than our outlook.

On the other hand, one could also argue that with this quarter’s earnings reports to date coming in well ahead of analysts’ estimates, there is still reason to believe (hope?) that the economy is in better shape than our Model predicts. While it is too early in the earnings season to have confidence that this positive earnings trend will continue, it is pronounced enough that I clearly need to keep the more robust economic growth scenario in mind a bit longer.

Our forecast remains:

‘a below average secular rate of recovery resulting from too much government spending, too much government debt to service, too much government regulation,.... 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.’

The risks to our outlook haven’t changed:

(1) oil prices are still at elevated levels and as such pose some risk to the pace of the current economic recovery. That said, as I noted last week, my concerns are somewhat assuaged by the corresponding decline in natural gas prices and their impact on total energy costs; though I recognize that it will take time to gain the full benefit. In addition, the legislation introduced this week that includes a provision authorizing the construction of the Keystone pipeline would provide some psychological reinforcement to keeping oil prices under control. Unfortunately, this measure is as much political posturing as anything else; and even if it weren’t, it would still not have an influence short term.

On the other hand, making matters worse is the president’s current campaign to stigmatize ‘speculators’ as the cause of high oil prices rather than admit His own complicity in restraining supplies. That, of course, is not likely to change.

So when already high oil prices and a lack of sensible political action to address them are coupled with the existing tensions in the Middle East, unstable oil prices have to stay on our list of potential risks.

(2) this week’s data flow did nothing to temper the ECRI recession call. Putting an exclamation point on it, the ECRI weekly index declined for the first time since early January. As you know, what makes this indicator troublesome for me is [a] its track record for calling economic downturns and [b] the adamancy of its founder regarding this particular call. Net, net, while the immediate facts on the ground don’t give much support to this forecast, I leave it as a risk to our outlook.

(3) of course, the sovereign and bank debt problems in Europe remain the 900 pound gorilla of potential risks. This week, Spain held the spotlight as its economy continues to deteriorate and its funding needs remain high. Not to be outdone, Italy announced that it is delaying the implementation of its balanced budget plan. Meanwhile, there is no sign of measures to improve either solvency or liquidity from anywhere else in the EU. On top of that, French elections are next week, the socialist candidate leads and he is promising to raise taxes and push the ECB to fund even more country/bank deficits--not exactly a prescription for growth and fiscal responsibility.

At this point, I make my usual disclaimer: I am not saying that the Europeans won’t act to prevent additional bankruptcies. But the longer they procrastinate, the greater the risk of either a major recession in the EU and/or another country follows Greece into default but with much graver consequences [dislocations in the global financial derivatives market].

Bottom line: despite a less than stellar week of data, there is no reason to assume that the economy is going off track.

Our political class is busy defining the issues for the November election (proposing the ‘Buffett Rule’, punishing oil speculators, cutting small business taxes, building the Keystone pipeline). That may ultimately benefit us if (1) the cut spending, cut taxes, cut regulation crowd wins and (2) they actually do what they promise [which is not a given]. In the meantime, the investors/electorate continue to get hosed; and it will only get worse unless these morons do something to mitigate the tax increases coming 1/1/13.

‘Across the pond, the eurocrats are doing what they do best--smoking cigars, drinking wine, chasing skirts and laying on the beach; in other words, doing everything possible to ignore their problem. My obvious concern is that this strategy is not a formula for correcting an acute case insolvency. They may ultimately solve it but it appears that it will take an emergency to generate the necessary action; and given the progressive worsening of the situation, the risk is that conditions will simply deteriorate to the point where the problem is unfixable. In any case, it appears that a crisis is needed to prod action. We just don’t know when and the extent of the economic fallout’.

This week’s data:

(1) housing: weekly mortgage applications rose but purchase applications plunged; March housing starts fell though building permits rose; March existing home sales declined versus expectations of a slight increase,

(2) consumer: weekly retail sales were mixed; however, March retail sales were strong; weekly jobless claims were a disappointment--again,

(3) industry: March industrial production was below estimates; February business inventories and sales were strong; both the April New York and Philadelphia Fed’s manufacturing indices came in well below forecasts,

(4) macroeconomic: March leading economic indicators advanced more than anticipated.

The Economic Risks:

(1) the economy is weaker [stronger] 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 indices (DJIA 13029, S&P 1378) closed above the 12919, 1372 support level, the Dow for the fifth day, the S&P for the fourth. That should be sufficient to confirm 12919, 1372 as the lower boundary of the recently re-set short term trading range (13302, 1422 are the upper boundaries). However, the S&P once again fell below its 50 day moving average (1379); so I am a bit uneasy assuming that we have a new defined trading range. I want to wait and see how the S&P trades next week. Implicitedly, that means 12744, 1332 remains a distant candidate for the lower boundary.

That said there is no question about the intermediate term uptrends of both index (11489-16489, 1203-1772).

As you know, our Valuation Model would suggest that a new trading range set at 12919-13302, 1372-1422 would be at an elevated level; so even if 12919, 1372 are confirmed, I would not be surprised by their successful challenge and a second re-set. That said, I am not arguing that this Market is going to roll over and re-enter a bear market. As I have noted many times, there are a number of support levels that could hold any decline within reasonable bounds. In addition to the lower boundaries of the intermediate term up trends, these support levels include (1) their 200 day moving averages [12138, 1272], (3) the neckline of the reverse head and shoulders pattern [12287, 1266] and (4) the old resistance/support level [11741, 1230].

Volume on Friday was up; breadth improved. The VIX declined but stayed well above the lower boundaries of (1) its short term trading range [though it is still seeking the upper boundary] and (2) its very short term uptrend.

GLD inched up again for the second day while the upper boundary of its very short term downtrend continued to decline--which is somewhat promising. It also remains above the lower boundary of its short term trading range; and as long as it does, the reverse head and shoulders formation will continue to develop (a positive).

Bottom line:

(1) the DJIA and the S&P is on the cusp of setting the lower boundaries of their new short term trading ranges (12929[?]-13302, 1372[?]-1422) and remain in their intermediate term up trends (11489-16489, 1205-1772),

(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 (13029) finished this week about 19.0% above Fair Value (10940) while the S&P closed (1378) 1.9% over valued (1352). Incorporated in that ‘Fair Value’ judgment is a ‘muddle through’ scenario in Europe and a sluggish recovery at home that isn’t likely to improve until we change the personnel in Washington.

This week’s somewhat disappointing economic data notwithstanding, the sluggish recovery forecasted by our Economic Model remains in tact, meaning that the price estimations in our Valuation Model do likewise.

Our political class’ behavior is still unremarkable. Collectively, they are now driving to the (election) hoop with every action calculated to frame the issues. That may not necessarily be bad on a longer term basis if the good guys win and follow through on their rhetoric; but short term, it does nothing to ease the spending, taxing, regulatory burden on the electorate. So until something changes....well, nothing changes; and that is all reflected in our Models

The solvency/liquidity of the European states and their financial institutions continue to pose the greatest risk to our Valuation Model. The problem is not that we don’t understand the size and scope of this crisis, the problem is that no one seemingly has the balls to do anything about it--which clearly threatens our ‘muddle through’ scenario. To be sure, the eurocrats have acted to pull back from the brink on prior occasions. However, the risk is that because Spain and Italy are so much larger than Greece, the momentum towards default may be impossible to stop once it gathers speed. That raises the probability that either a misstep will lead to a very severe recession and/or a counterparty default in the CDS market snowballs out of control throughout the global financial system.

In sum, the US economy continues to make slow progress in its recovery in spite of the best efforts of our ruling class and their even less effective European counterparts. With this fundamental background, at current prices, investors appear to be a bit generous in their valuation of US equities; so a drift to lower prices would not be a surprise. The kink in armor is eurocratic intransigence that could ultimately negatively impact US economic growth and/or the stability of our financial institutions. That is not factored into our Models and remains the biggest risk. As a result, I think that the proper strategy is to stay hedged with plenty of cash and gold and focus on individual stocks, mindful of our trading stops and our Buy Lists on any weakness and our Sell Half Discipline on any strength.

Our Portfolios took no action this week.

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 a major long term risk. An investment in gold is an inflation hedge and holdings in other countries provide exposure to better growth opportunities. However, the likelihood of a continued strengthening in the dollar argues for less emphasis on these investment alternatives over the intermediate term.

(3) defense is still important.


Current 2012 Year End Fair Value* 11300 1400
Fair Value as of 4/30/12 10940 1352
Close this week 13029 1378

Over Valuation vs. 4/30 Close
5% overvalued 11487 1419
10% overvalued 12034 1487
15% overvalued 12581 1554
20% overvalued 13128 1622

Under Valuation vs. 4/30 Close
5% undervalued 10393 1284
10%undervalued 9846 1216 15%undervalued 9299 1149

* 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.