Note: I am heading for the beach again next week. No Morning Calls or Closing Bell. Back on 7/9. As always, if action is needed, I will be in touch via Subscriber Alerts. Have a great 4th of July.
Statistical Summary
Current Economic Forecast
2012
Real Growth in Gross Domestic Product (revised): +1.0- +2.0%
Inflation (revised): 2.5-3.5 %
Growth in Corporate Profits (revised): 5-10%
2013
Real Growth in Gross Domestic Product +1.0-+2.0
Inflation 2.0-2.5
Corporate Profits 0-7%
Current Market Forecast
Dow Jones Industrial Average
Current Trend (revised):
Short Term Trading Range 12022-13302
Intermediate Up Trend 11900-16900
Long Term Trading Range 7148-14180
Very LT Up Trend 4546-15148
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 1266-1422
Intermediate Term Up Trend 1251-1831
Long Term Trading Range 766-1575
Very LT Up Trend 651-2007
2011 Year End Fair Value 1320-1340
2012 Year End Fair Value 1390-1410
Percentage Cash in Our Portfolios
Dividend Growth Portfolio 30%
High Yield Portfolio 32%
Aggressive Growth Portfolio 33%
Economics
The economy is a modest positive for Your Money. The data flow this week was mixed: positives---May new home and pending home sales, the April home price index, weekly retail sales, the Dallas Fed’s manufacturing index; negatives---mortgage/purchase applications, personal income, the Richmond Fed index, Chicago PMI and the June indices of consumer confidence and consumer sentiment; neutral---durable goods orders, weekly jobless claims, personal spending and the revised first quarter GDP number.
The stats seem to be drifting to a less negative view of the economy than was true a month ago. That is not to say the risk of a recession has been eliminated---that has been a risk to our forecast for as long as I can remember. But it does suggest the risk is somewhat less than it was two weeks back.
So for the moment, our economic outlook remains unchanged:
‘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.’
On the positive side, there are reasons to be optimistic:
(1) the seasonal pattern of economic data for the prior two years was strong in the first and fourth quarters sandwiching weaker second and third quarters; given the positive impact of unseasonably warm weather in the first quarter, there are reasons to think that a repeat of this model is accounting for the recent weakness in the numbers,
(2) the continuing decline in oil prices
http://mjperry.blogspot.com/2012/06/natual-gas-windfall-is-one-of-most.html
(3) the Supreme Court decision on Obamacare notwithstanding, the potential psychological benefit of the electorate seemingly embracing fiscal responsibility.
As for the risks facing this forecast:
(1) a vulnerable banking system. Thursday, rumors swirled that the potential loss from the JP Morgan derivatives trading error could reach $9 billion. If that doesn’t make the case that our banking system is woefully incapable of the risk management of complex financial products, I don’t know what does. As I have repeatedly warned: if Jamie Dimon doesn’t know the magnitude of his bank’s risk exposure, how much risk is on the balance sheets of less effectively managed banks and how much greater will be the risk if Europe tanks,
http://www.zerohedge.com/news/bruno-iksils-guide-surviving-status-quo-baffle-them-bullshit
(2) a blow up in the Middle East could change everything in an instant.
(3) the ECRI weekly index turned positive [again] this week. As you know, the recent trend in the readings of this indicator has been quite erratic; so I remain somewhat skeptical of the validity of its prediction. Nevertheless, it remains on our list of risks because of [a] its track record for calling economic downturns and [b] the adamancy of its founder regarding this particular call.
http://advisorperspectives.com/dshort/updates/ECRI-Weekly-Leading-Index.php
(4) every week that goes by, the closer we get to the 1/1/13 so-called ‘fiscal cliff’. As you know, I believe that in the end, the scheduled tax increases and spending cuts will not occur; or if they do, they will be quickly reversed. Whoever wins in November will do something in January to alter this outcome---we just don’t what that will be.
In the meantime, businesses and consumers remain fearful of what could happen and, therefore, unwilling spend/invest/hire at least in the very short term,
Exacerbating this problem is the knowledge that absent a major rollover in the composition of our elective institutions, Obamacare with all its tax increases and regulatory costs is now going to be loaded on top of the ‘fiscal cliff’ burden,
The problem with our healthcare analysis and how to fix the system (this is a great article and an absolute must read):
http://american.com/archive/2012/june/the-healthcare-myths-we-must-confront
More on the Robert’s decision (medium):
http://www.nationalreview.com/author/56454/latest
And this from Charles Krauthammer (medium):
http://www.washingtonpost.com/opinions/charles-krauthammer-why-roberts-did-it/2012/06/28/gJQA4X0g9V_story.html
(5) finally, the sovereign and bank debt crisis in Europe remains the biggest risk to our forecast. The main event this week was the EU summit; the results of which were [a] banks will be allowed to apply directly for bail out funds, [b] any funds lent from the ESM/EFSF will not be senior to other outstanding debt, [c] there will be no additional austerity provisions to gain additional bail out funds, [d] no new money was added the current bail out funds.
Frankly that is more than I expected; although it still is a mere baby step forward in solving the EU’s bank and sovereign debt problems. In the end, making it easier for the banks to borrow money is not what fixes the problem of too much money already borrowed. Nonetheless, it keeps all the balls in the air for another week/month---which is clearly better than nothing.
To be sure, as long as the Markets allow the eurocrats to move forward an inch at a time, the disaster scenario [at some point investors will run out of patience, refuse to accept another half baked ‘management by crisis’ miniscule step toward a solution and precipitate crisis that the eurocrats can’t get in front of] will be avoided; although I don’t think that it necessarily lessens its probability.
Meanwhile, stats reveal the extent of the run on Greek banks (medium):
http://www.zerohedge.com/news/greek-bank-deposits-have-biggest-one-month-outflow-ever-may
Bottom line: the US economy is on track to maintain its sluggish below average growth path. Unfortunately, that path was made all the more difficult by the Obamacare decision which will simply add another layer of taxes and regulations on already overburdened business and consumer sectors. While the direct impact won’t be felt until after 2013, it nonetheless extends the period in which government usurpation of private resources throttles the economy’s capacity for growth. That, of course, assumes that healthcare won’t rise to the top of list of campaign issues, won’t have an impact on the elections and won’t be repealed---all of which could happen. It is just too soon to make that bet. For the moment then our forecast remains unchanged.
Eurocrat procrastination in dealing with their most critical problems remains the biggest risk to our forecast. Certainly, the recently announced steps keep our ‘muddle through‘ scenario alive and well, But, in my opinion, it most likely doesn’t lower the odds that a misstep could lead to a disaster scenario which almost surely lead to a recession in the US and quite possibly another banking crisis.
The latest from Charles Biderman (4 minute video):
http://www.zerohedge.com/news/bidermans-disbelief-markets-unending-belief-something-nothing
This week’s data:
(1) housing: weekly mortgage and purchase applications fell; May new home sales soared as did pending existing home sales; the April Case Shiller home price index rose more than expected,
(2) consumer: weekly retail sales were up; weekly jobless claims were basically flat; May personal income was reported up but lower than estimated while consumer spending was flat as expected; the June index of consumer confidence came in slightly below forecasts as did the consumer sentiment index,
(3) industry: May durable goods orders were mixed; the Richmond Fed’s June manufacturing index dropped considerably more than anticipated while the Dallas Fed’s index was better than expected; the June Chicago PMI was lower than estimates,
(4) macroeconomic: revised first quarter GDP was reported in line though the price index was hotter than forecast.
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.)
Politics
The domestic political environment is a neutral but could be improving for Your Money while the international political environment remains a negative.
The economic burden of our ruling class (medium and also a must read):
http://spectator.org/archives/2012/06/02/the-one-percenters-fortress-ci
The Market-Disciplined Investing
Technical
The indices (DJIA 12880, S&P 1367) closed within their intermediate term uptrends (11900-16900, 1251-1831) and their short term trading ranges (12022-13302, 1266-1422).
On a very short term basis, both of the Averages blew through the 12744, 1338 intermediate resistance level (the former neckline of the reverse head and shoulders). The Dow also took out the upper boundary of a downtrend off the April 2012 high (12813), while the S&P failed to do so (1372). Just to take this even deeper into the technical weeds, both index closed right on their mid June 2012 highs (12888, 1364).
I checked our internal indicator with the following results:
(1) with respect to the 12744, 1338 resistance level: in a 158 stock Universe, 75 closed above their comparable level, 75 did not and 8 were too close to call,
(2) with respect to the mid June high [12888, 1364]: in a 158 stock Universe, 66 closed above their comparable level, 77 did not and 15 were too close to call.
So the above suggests that the Averages continue to do better than stocks in general. Unless you think that equity prices are off to the races and, therefore, that the indices will pull the rest of the Market along with them, my opinion is that these results give a negative bias to the coming pin action. You may recall that I ran the same study in mid June when prices spiked, received similar results and stock prices immediately fell back. That doesn’t mean that it will happen this time; however, historically this indicator has been reliable.
The close Friday puts the Averages about midway between the boundaries of their short term trading ranges---not a zone that, technically speaking, I think attractive for either buying or selling.
Volume on Friday was up; breadth improved. The VIX plunged, closing below the lower boundary of its short term uptrend for the third day. A confirmed break would be good for stocks. In the meantime, it remains above the lower boundary of its intermediate term trading range.
http://www.bespokeinvest.com/thinkbig/2012/6/29/sp-500-sector-breadth.html
GLD popped, finishing above the lower boundary of its intermediate term trading range,
From Barclays: lots of unwarranted optimism and short covering (medium):
http://www.zerohedge.com/news/barclays-rally-fade-it-because-summit-not-game-changer-eur
And:
http://www.zerohedge.com/news/and-reason-todays-bathsalts-rally
Update on ‘the best stock market indicator ever’:
http://advisorperspectives.com/dshort/guest/John-Carlucci-Best-Indicator-Ever-Update.php
Technically speaking, the rest of the world doesn’t look so hot (medium):
http://advisorperspectives.com/dshort/guest/Dominic-Cimino-120629-Trouble-Ahead.php
Bottom line:
(1) the indices are in short term trading ranges [12022-13302, 1266-1422] and remain well within their intermediate term up trends (11900-16900, 1251-1831],
(2) long term, the Averages are in a very long term [78 years] up trend defined by the 4546-15148, 651-2007 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 (12880) finished this week about 16.7% above Fair Value (11030) while the S&P (1367) closed right on Fair Value (1364). 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.
Every point in the above statement received emphasis this week:
(1) ‘a slow sluggish recovery at home’. The economic data continues to track our forecast. At the beginning of June, it appeared that the numbers were starting to roll over; however, the last two weeks have returned to being more ‘mixed’ in nature. Weak data from overseas are being offset by declining oil and commodity prices [Friday notwithstanding]. Every week that the stats come in mixed, I get a little more confident that the economic assumptions in our Valuation Model are on track,
(2) [the economy] ‘isn’t likely to improve until we change the personnel in Washington’. While this week’s Obamacare decision is on the surface a major negative, in my opinion, the decision has simply been shifted from the judicial to the legislative branch; and, therefore, it increases the importance and necessity of a wholesale rollover of our political class in November. In the meantime, the specter of rising healthcare costs and regulations is not apt to improve business/consumer sentiment and therefore the odds of increased investment, hiring and spending. My hope is that the recent message delivered by the Wisconsin voters is echoed through the entire electorate in November and beyond. Unfortunately, hope is not an investment strategy.
(3) ‘muddle through scenario in Europe’. As you know, this assumption includes [a] Greece leaving the euro, [b] the eurocrats taking sufficient steps to ring fence the remaining PIIGS, [c] resulting in a slow, painful process of correcting the fiscal imbalances that the most likely means zero overall growth for approximately the next decade.
The results of Friday’s EU summit was a positive move toward dealing with Europe’s banking and sovereign debt problems. Regrettably, it only marginally got Europe closer to a real solution. To be sure, it did demonstrate that when their collective backs are against the wall, the eurocrats could move the ball forward; hence, ‘muddling through’. However, the risk is that they fiddle until an extreme shock occurs, it will be too late to salvage the eurozone and a financial panic ensues.
From a valuation standpoint, this all fits the assumptions in our Model. The nagging question is at what price levels is a European disaster scenario discounted? Unfortunately, as I have said several times, I have no idea what the answer is because we don’t have a model for the dismise/shrinking of a monetary union---but it almost certainly lies at lower levels.
My investment conclusion: ‘stocks (as defined by the S&P) are right on Fair Value (as defined by our Model). Under less stressful circumstances, that would leave room for our Portfolios to ‘nibble’ at stocks on our Buy Lists. However, this is not exactly a normal time with an unquantifiable risk on the immediate horizon that is impossible to reflect in our Model. Hence, our Portfolios’ large cash and GLD positions. That said, because I don’t know the magnitude or probability of any downside move, the best strategy is to ‘nibble’ through any Market declines which our Portfolios will do but starting at lower levels’.
This week, our Portfolios took no action.
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.
DJIA S&P
Current 2012 Year End Fair Value* 11300 1400
Fair Value as of 6/30/12 11030 1364
Close this week 12880 1367
Over Valuation vs. 6/30 Close
5% overvalued 11581 1432
10% overvalued 12133 1500
15% overvalued 12684 1568
Under Valuation vs. 6/30 Close
5% undervalued 10478 1295
10%undervalued 9927 1227 15%undervalued 9375 1159
* 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.
No comments:
Post a Comment