Friday, June 29, 2012

The Morning Call-Another small step for mankind

The Market


After another roller coaster day, the indices (DJIA) 12602, S&P 1329), finished (1) within their short term trading ranges [12022-13302, 1266-1422], (2) within those short term ranges, fairly close to the initial 12744, 1338 resistance levels, and (3) within their intermediate term uptrends [11900-16900, 1249-1829].

Volume rose; breadth faltered. The VIX was up, closing right on the lower boundary of its short term uptrend. Since it broke that boundary Wednesday, under our time and distance discipline, the move back to the boundary does not negate the break. Net, net, the VIX has now completed its second day in confirmation process of the break. If confirmed, it would be a positive for stocks. Meanwhile, it stayed above the lower boundary of its intermediate term trading range.

GLD got whacked but remains above the lower boundary of its intermediate term trading range.

Bottom line: as long as the intraday gyrations in stock prices are in the middle quartiles of the Averages short term trading ranges, there is not much to do except for the most nimble of traders---which I am not. However, as I have noted previously, when, as and if equity prices trade into the lower quartiles of those short term trading ranges, our Portfolios will be open to spending cash.

Investor sentiment drops (short):



Yesterday’s economic data (weekly jobless claims, revised first quarter GDP) came in pretty much as expected. As usual, investors could have cared less; much larger issues were being dealt with.

First, unless you were asleep all day, you know that the Supreme Court upheld Obamacare. Who wudda thunk? I think it safe to say that a majority of investors/the electorate thought that at least some portion of the act would be reversed. And judging by the Market reactions, clearly investors aren’t happy now that the worst possible outcome is enshrined in law.

A number of pundits were quoted as saying the decision was a positive because we now have certainty. What do think those guys were smoking? Unless I am completely nuts, all the ruling did was move the uncertainty to the November elections. Indeed, the tone of this battle will likely get even more intense as it moves back into the political arena and that may simply add to uncertainty (volatility). For sure, it is not going to make businesses and consumers more confident and, hence, more willing to invest, hire and spend.

Worse, it adds the onus of higher taxes and increased regulation to the looming ‘fiscal cliff’. Finally, it at least partially offsets the psychological boost delivered by Wisconsin voters to notion that this country is moving back to the political center. Small wonder the Dow was off 180 points in early trading.

The flaws in Obamacare (medium):

A constitutional lawyer’s review of Justice Roberts brief on Obamacare (medium)

Did congress just acquire a new funding tool? (medium):

Later in the day, the Market experienced another infusion of the ‘hope springs eternal’ trade as stocks rallied hard on rumors/hope that somehow the eurocrats would produce something useful in their current summit.

Two of the most quoted ‘hopes’ were that:

(1) a new 120 billion euro ‘growth’ fund would be initiated. Of course, that is less than the 130 billion euro fund rumored just last week. Plus the Italians said that they would oppose it unless it was accompanied by a new bond buying program. That is very close to Monti’s similar ultimatum last week in which he threatened to resign (and later said ‘just kidding’),

(2) agreement could be reached on ‘short term’ measures, meaning the aforementioned bond buying program as well as deposit insurance industry wide in Europe.

Why the latest plan was DOA (medium):

Europe has few levers for growth (medium):

***overnight, they did reach an outline of an agreement. The key provisions:

(1) banks can now apply directly for bail out funds. This allows these new funds not to be counted as part of the sovereign debt. This is important because the debt/GDP ratio is a key metric in the sovereigns receiving funds,

(2) the terms of the ESM and EFSF rescue funds will be changed to remove the seniority provisions. This is important because originally any bail out funds would immediately assume seniority status, subordinating all other debt and thereby making it difficult for the banks to raise money anywhere but the ESM/EFSF.

(3) all funds will be available without any new austerity provisions.

Of course, none of the details have been agreed to most especially how the rescue funds will operate. And as they say, the devil is always in the details. In addition, it was revealed in the press conference following the agreement that there would be no additions to the current bail out funds---which if history is any guide, we know can’t possibly be adhered to. And if it is not, then what? Here is the full announcement (it is fairly short):

Bottom line: the US economy is limping along as we had forecast. The Obamacare decision yesterday did nothing to help our cause; and to the extent that it depresses businesses’ hope for a more manageable cost structure, it could make things worse.

Europe continues to do only what is absolutely necessary to get from falling off a cliff. Last night’ agreement being a perfect example. The eurocrats possibly took another teeny, tiny step to maintain the solvency of the banking system and the PIIGS; but we won’t even know that until the ESM is established and its governing rules are in place. Even if this works, the cost in growth potential will be huge and we are still left with the risk that investors will tire of this slow motion process and precipitate a crisis.

All of this (except the crisis) is built into the assumptions in our Valuation Model---which computes stock prices (as defined by the S&P) at current level as slightly undervalued. If the risk associated with the resolution of the EU solvency problems wasn’t as indefinable as it is, I would be reasonably upbeat. But it is not and therefore neither am I.

I recognize the imperative to spend cash when stocks are down even if the level of risk appears high. In my opinion, prices are just not down far enough for me to initiate that effort.

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.