Saturday, August 11, 2012
The Closing Bell-the Paul Ryan selection
Current Economic Forecast
Real Growth in Gross Domestic Product (revised): +1.0- +2.0%
Inflation (revised): 2.5-3.5 %
Growth in Corporate Profits (revised): 5-10%
Real Growth in Gross Domestic Product +1.0-+2.0
Corporate Profits 0-7%
Current Market Forecast
Dow Jones Industrial Average
Current Trend (revised):
Short Term Trading Range 12022-13302
Intermediate Up Trend 12145-17145
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 1278-1858
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%
The economy is a modest positive for Your Money. It was a paltry week for economic data. Positives: weekly retail sales and jobless claims second quarter productivity and the July budget deficit. Negatives: mortgage and purchase applications, wholesale inventories and sales, second quarter unit labor costs. Neutral: June consumer credit.
In other words a snoozer accompanied by the entire global political class going on vacation---and what better time to do it what with the potential collapse of the euro and the impending ‘fiscal cliff’ staring the rest of humanity in the face. But our own ruling class, God bless them, did manage to stay in the headlines by reaching a nadir in political discourse.
In sum, a very dull week unless you thrive on name calling and mud slinging. Fortunately enough, our forecast incorporates both a boring economy and boorish politicians:
‘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.’
(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 is reason to think that a repeat of this model is accounting for the earlier weakness in the numbers,
(2) with the exception of retail sales, the ‘big four’ measures of the economy show little sign of recession,
(3) the seeming move of the electorate towards embracing fiscal responsibility. ***This morning Romney announced Paul Ryan as his VP pick. I believe that the Ryan selection is important because of his close association with the House attempt at a balanced budget. Not that the Ryan plan was the end all and be all; but (1) it is symbolically significant. By picking Ryan, I believe [hope?] Romney has finally clearly defined the central campaign theme for his own candidacy: too much government spending, too high taxes, too much government intrusiveness into our lives, (2) if I am correct in this belief, Ryan will be used to punctuate a stark contrast between the two parties and in doing so, the outcome of the election will in my mind reveal a directional choice regarding how the American people envision the future---a return to less government, more individual liberties or France.
I am not suggesting which side will win; but I am saying that Romney appears to be defining the differences in political philosophies of the two parties in such simple, easily understood terms, whichever side wins we will have an idea on how to makes our bets for the future. If Obama wins, then preservation of wealth has to be our principal objective; if Romney wins, then we have at least a shot at a recovery and growth scenario (there are a lot of factors here: who controls the senate, the influence of the Tea Party, etc).
(1) a vulnerable banking system. I keep thinking that one of these weeks, I won’t have anything to comment on in this section. So far, no such luck. This week it was Standard Chartered’s $250 billion Iranian money laundering scheme. I have ceased being amazed not only about the banksters’ audacity but by the regulators not holding them accountable. So far, no one in any of the multitude of banking scandals perpetrated on US electorate, starting with Jamie Dimon, has gone to jail or been fined in a meaningful way.
The risks here are two fold: [a] investors lose confidence in our financial institutions and refuse to invest in America and [b] these scandals are simply signs that our banks are not as sound as we have been led to believe and, hence, are highly vulnerable to future shocks, particularly a collapse of the EU financial system.
(2) a blow up in the Middle East. The Syrian civil war continues unabated while the rest of the world is choosing up sides. In the end, nothing may happen other than tens of thousands of Syrian dead and untold property damage. However, when all the big boys [US, China, Russia, Iran] are posturing, the risks that the conflict widens are there.
Pardon my lack of concern; but frankly, deadly internecine Muslim conflicts bother me little [better that they busy themselves killing each other as opposed to driving airplanes into our buildings] except to the extent that one of the consequences is $150 a barrel oil---that worries me.
(3) the drought persists in the Midwest, though there was some rain relief this week. Nonetheless, the damage to the corn crop appears irreversible; and while the US soybean crop may be salvageable, worldwide weather problems will likely limit the global harvest. As a result, prices across the entire food complex [grains and meats] rose again this week. To the extent that these are passed on to consumers, higher food [and energy] prices act as a tax on income and hence restrain economic growth. Combine this with the fear of the ‘fiscal cliff’ and you have a formula for lower confidence and a threat of a serious slowdown in consumption and investment.
(4) continuing its schizophrenic behavior, the ECRI weekly index was up last week [it was down the week before]. As you know, this indicator’s ongoing erratic performance sustains my skepticism regarding the validity of its recession prediction. Nevertheless, it remains on our list of risks because of [a] its track record for calling economic downturns, [b] the adamancy of its founder regarding this particular call and [c] perhaps more importantly, he has been joined recently in his recession call by several economists for whom I have great respect.
(5) another week and nothing done on the ‘fiscal cliff’; and since congress will be campaigning full time for re-election until mid September, there is nothing to expect anytime soon.
As you know, my position on this issue is 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, the inability of our political class to address this potentially devastating threat to the economy contributes to the fear and uncertainty among businesses and consumers and by extension their willingness to spend, invest and hire.
Complete guide to the ‘fiscal cliff’ (medium/long):
(6) finally, the sovereign and bank debt crisis in Europe remains the biggest risk to our forecast. There were no real developments this week other than some jawboning back and forth between Draghi, Rojay and Monti and the Germans and the continent’s continued slide into recession.
Nevertheless, investors kept on their happy face. As you know, my concern is that their patience wears thin and they trash the eurobond/eurocurrency markets, creating a crisis that is beyond the eurocrats’ capability to resolve---a likely outcome of which is a freezing up of the entire financial system which infects our own.
Bottom line is unchanged: ‘the US economy remains on its sluggish growth track and unfortunately is getting no help from the political class, the financial system, the weather or the yahoos in charge of avoiding a financial catastrophe in Europe. Yet the inherent strength of what is left of our capitalist system has, at least to date, managed to move the economy forward in spite of these headwinds. So for the moment our forecast remains unchanged.
Nevertheless, I can’t overstate my concern that the financial markets will tire of watching the exceptionally slow motion pace of the current ‘muddle through’ eurocrat strategy, start pricing European debt for a worse case scenario which in turn overwhelms the EU bureaucracy and creates enormous problems for our own less than perfect banking system.’
This week’s data:
(1) housing: weekly mortgage and purchase applications were both down,
(2) consumer: weekly retail sales were slightly to the positive; June consumer credit rose though less than anticipated; weekly jobless claims fell,
(3) industry: June wholesale inventories were down 0.2%; however, wholesale sales plunged 1.4%, driving up the inventory to sales ratio,
(4) macroeconomic: second quarter nonfarm productivity rose more than expected as did unit labor costs; the June trade deficit was less than estimates, while the July budget deficit was lower than forecast.
The Market-Disciplined Investing
This week, the indices (DJIA 13207, S&P 1405) stalled as they approached the resistance offered by the upper boundaries of their short term trading ranges [12022-13302, 1266-1422]. They remained well within their intermediate term uptrends [12145-17145, 1278-1858].
The primary characteristics of this week’s Market were low volatility and low volume---typical of late summer when the universe is on vacation. Nevertheless, the overall bias to stock prices remains positive. My guess is that these conditions will prevail through the end of the month; meaning that we probably ought to join those on vacation because the next two weeks will likely be boring (***the Ryan nomination may change that).
That leaves the Averages in the upper quadrant of their short term trading ranges---a level at which I see no compelling technical reason to initiate any buying. Indeed, my focus now is on the Sell side---monitoring those holdings that are near to either their Sell Half Ranges or trading highs (***this may change too. I just have to think about it some more).
Volume on Friday remained abysmal; breadth was mixed. The VIX was down sharply. This represents the third day of the challenge of the lower boundary of its intermediate term trading range under our time and distance discipline. A confirmation of this break would be a positive for stocks. However, as I noted in Friday’s Morning Call, I am a bit uncertain about whether to count the first two days of the challenge in that on both days, the penetration of the VIX was a mere $.12.
GLD was up, finishing above the lower boundary of its intermediate term trading range and once again nearing the level of the last in a long series of lower highs.
(1) the indices are in short term trading ranges [12022-13302, 1266-1422] and remain well within their intermediate term up trends (12145-17145, 1278-1858],
(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 (13207) finished this week about 18.7% above Fair Value (11120) while the S&P (1405) closed 2.1% overvalued (1376). 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.
The dearth of economic data this week notwithstanding, the economy continues to limp along despite the headwinds created by our worthless, do-nothing political class (although they are quite adept at lies and talking trash), a widening drought in the country’s bread basket (exacerbated by poor weather patterns globally) and a corrupt financial system (which just keeps getting worse). That, of course, is our forecast; so nothing in the economic/political environment warrants altering the assumptions in our Models.
Europe is still managing to ‘muddle through’; although (1) virtually nothing is happening at present since the entire continental political class is on vacation until September and (2) the investment community continues to maintain its faith in the eurocrats in face of overwhelming evidence to the contrary.
That really means that this part of our forecast is being sustained basically by default---which is why I am so concerned. Clearly, investors can cut the EU political class slack as long as they want. But that doesn’t obviate the risk that at some point they could tire of the eurocrats’ lack of ability or will to enact/enforce the measures needed to solve the bank/sovereign insolvencies, then crush the Eurobond market and force an EU banking crisis that spills over into our own financial system which is not nearly as clean and healthy as we thought two months ago.
My investment conclusion: stocks (as defined by the S&P) are slightly above Fair Value (as defined by our Model). Under less stressful circumstances, that would dictate a cash position of around 15%. Our Portfolio’s are at double that level primarily because of the large risk of failure in the EU and the even larger downside to our economy and in particular our financial institutions if that occurs. That said, because I can’t quantify either, I believe that the best strategy is to ‘nibble’ through any Market declines which our Portfolios will do but starting at much lower levels.
This week, our Portfolios took no action.
(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 8/31/12 11120 1376
Close this week 13207 1405
Over Valuation vs. 8/31 Close
5% overvalued 11676 1444
10% overvalued 12232 1513
15% overvalued 12788 1582
20%overvalued 13344 1651
Under Valuation vs. 8/31 Close
5% undervalued 10564 1307
10%undervalued 10008 1238 15%undervalued 9452 1169
* 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.