Steve Cook on Disciplined Investing

The data was OK; but the outlook is getting worse

Steve Cook — Fri, 30 Sep 2011 12:52:00 GMT

The Market

    Technical

    The Averages (DJIA 11153, S&P 1160) rebounded yesterday though it was another roller coaster day; this kept them within their respective intermediate term trading ranges (10725-12919, 1101-1372).

    Volume rose; breadth improved, the flow of funds especially so. The VIX remains at an elevated level within its current trading range--that suggests that fear is the dominant emotion right now; so caution is still the word.

    This piece of Citi’s technical staff is a bit concerning (short):
    http://www.zerohedge.com/news/will-dreaded-double-bottom-within-triangle-push-sp-down-triple-digits

    GLD bounced off the lower boundary of its intermediate term up trend on low volume. I am nervous about this holding but our Portfolios are holding on and could Buy on any sign of real strength.

    Bottom line: volatility laced with fear (VIX) continues to dominate this Market. That said, with stocks having mounted four unsuccessful attempts to bust the lower boundary of the current trading range, our Portfolios are cautious buyers of stocks on our Buy Lists but to also uncompromising sellers of those stocks that have violated our trading stops.

    The AAII sentiment indicator (chart):
    http://www.bespokeinvest.com/thinkbig/2011/9/29/bullish-sentiment-back-above-30.html

   Fundamental

    Headlines

    Surprise, surprise. US economic data actually had an impact on yesterday’s pin action. Jobless claims were down more than expected, GDP numbers were passable as were pending home sales. Those stats got the Market off to a decent start. More important, they provide support for those of us that still don’t think the global economy is about to fall off a cliff.

    More on jobless claims and GDP (medium):
    http://www.capitalspectator.com/archives/2011/09/jobless_claims_28.html#more

    This analysis suggests that the US economy is still moving toward recession (short):
    http://advisorperspectives.com/dshort/updates/Real-GDP-Per-Capita.php

    This is more pessimistic: ECRI weekly leading index creator says US tipping into recession (short & must read):
    http://www.zerohedge.com/news/ecris-achutan-says-us-entering-new-recession

    And the outlook for inflation isn’t so rosy either (short):
    http://scottgrannis.blogspot.com/2011/09/thoughts-on-gdp-and-inflation.html

    Of course, Europe wasn’t completely out of the picture. As I noted in yesterday’s Morning Call, overnight the German parliament had approved the expansion of the EFSF (bail out fund) which was a huge relief to most observers. However, initially the European bourses were down--I am assuming on a ‘sell the news’ response. Later they rallied and appeared to add to the initial upside momentum on this side of the pond.

    But what’s a day without a 3-4% intraday swing, right? So the sellers took over driving the Averages into loss territory, before a last hour rally saved the day. Is there any informative value to this kind pin action? According to some of my trader buddies, there was some month (quarter) end window dressing. In truth, however, other than a reflection of the heightened level of fear and confusion I talk about constantly, I think not.

    The IMF is now considering joining the bailout crowd (short):
    http://www.zerohedge.com/news/imf-scrambles-double-bail-out-capacity-13-trillion-may-issue-bonds-0

    Meanwhile back in the banana republic, the Troika can’t inspect Greek books because of sit ins (short):
    http://www.zerohedge.com/news/greek-banana-republic-status-upgraded-aaa-after-sit-ins-eight-ministries-prevent-troika-inspect

    Bottom line: the eurocrats continue to inch toward some resolution of their financial crisis; but judging by the array of experts whose opinions have been included in these pages, they are a day late and a dollar short. As you know, I think any lack of success the biggest risk to our forecast.

    Satyajit Das on how to survive the global restructuring (medium):
    http://www.marketwatch.com/story/5-money-moves-one-debt-crisis-expert-is-making-now-2011-09-29

    More on the EU problem (medium):
    http://www.nakedcapitalism.com/2011/09/randy-wray-euro-toast-anyone-the-meltdown-picks-up-speed.html

    Following on my comments in yesterday’s Morning Call on the significance of the recent decline in copper prices, here is a history of the S&P after copper prices decline by 20% (bear market):
    http://www.minyanville.com/businessmarkets/articles/copper-price-price-of-copper-copper/9/29/2011/id/37129

    More on investment strategy from Pimco (medium):
    http://advisorperspectives.com/commentaries/pimco_92811.php

    This is only for the real pessimists amongst you (medium):
    http://www.zerohedge.com/news/muddle-through-has-failed-bcg-says-there-may-be-only-painful-ways-out-crisis

    And if you really want to get depressed (long):
    http://www.zerohedge.com/news/guest-post-politics-consistently-bad-legislation

     Thoughts on Investing—from Steve Cohen

“Leverage, concentration and illiquidity are the three things that can kill you”

These are words to live by in the investing world.

Leverage gets more traders in trouble than probably any other single factor.   Uncontrolled (unhedged) leverage can be a sure way to the poor house. Using leverage is the equivalent of stepping off of a pony and jumping onto the back of a wild bull. Most people can’t control it and the few who do still tend to get hurt at some point in their career. Gambling with money you don’t have is a great way to lose your shirt. Only the uber experienced should attempt it. If you’re utilizing leverage you need an edge and if you don’t have an edge you need a hedge.

Concentration (meaning a portfolio with few positions) can be a double edged sword. It will help generate your biggest winners (think Warren Buffett with Geico, AmEx, etc) and it will cause your biggest losers (think Amaranth or LTCM). The key is knowing your market. Don’t go all-in on a position if you don’t have an exit strategy and don’t have an edge. Most people don’t have either and therefore have no business investing with a concentrated portfolio.

Illiquidity is a traders worst nightmare. There is nothing worse than wanting out of a position with no buyers. If you can’t find a buyer or seller you’re not in a market and if you’re not in a market you might as well have never gotten into the position in the first place. Invest in liquid positions. You can’t have an exit strategy if you’re trapped in a position.

Economics

   This Week’s Data

    August personal income fell 0.1% versus expectations of a rise of 0.1%; personal spending increased 0.2%, in line with estimates; core PCE deflator was up 0.1% versus forecasts of up 0.2%.

   Other

    Weekly rail traffic (short):
    http://mjperry.blogspot.com/2011/09/weekly-north-america-intermodal-volume.html

Politics

Domestic

    George Will on Barney Frank and the Fed (medium):
    http://www.jewishworldreview.com/cols/will092911.php3

Germany says yes, Bernanke says maybe, the Three Stooges say no

Steve Cook — Thu, 29 Sep 2011 12:58:00 GMT

The Market

    Technical

    Volatility yesterday was to the downside with the indices finishing at DJIA 11010, S&P 1151. However, they remain well within their intermediate term trading ranges (10725-12919, 1101-1372).

    Volume declined; breadth plunged. The VIX rose 9% but still closed in that upper zone of its current trading range. I observed in yesterday’s Morning Call that many of the stocks in our Universe had gap openings in their near term charts that, technically speaking, had to be closed and that it looked like it would happen soon. Well, ‘soon’ was yesterday. With the necessity of closing the gap now satisfied, the key is whether stocks now stabilize or they follow through to the downside.

    GLD sold off and closed right on the lower boundary of its intermediate term up trend--so that trend remains in tact, at least for another day.

    Bottom line: one of the most disturbing aspects of yesterday’s pin action was that the stocks of several of our holdings closed the day on the verge of breaking below our trading stops. As I have noted, the current high level of volatility makes for a schizophrenic Market. So if equities trade down today, it is conceivable that our Portfolios could be Buying some stocks while getting Stopped out on others.

    A look at margin debt versus Market performance (short):
    http://advisorperspectives.com/dshort/guest/Lance-Roberts-110928-Margin-Debt-Clue-to-Market-Direction.php

    Fundamental

    Headlines

    The economic data yesterday was OK: mortgage and purchase applications were up; the headline number for August durable goods orders was disappointing, but inside the data, it was not a bad report (see below). Again, no one cared.

    Three items held investor attention and created the pressure on stock prices:

(1)    copper prices are collapsing. Since copper prices are correlated to stock prices, it raised investor concerns regarding the Market in general. In addition the Shanghai Composite [stock index] is hitting two year lows sparking worries about a larger than anticipated decline in Chinese [and by extension Asian] economic activity. And since China is a major consumer of copper, the apprehension over the two individually [copper/the Market, copper/China] simply got magnified for both. Clearly, these factors exacerbated current anxiety over recession. Not good for stocks.
http://www.ritholtz.com/blog/2011/09/cruel-king-copper-and-a-low-in-the-shanghai-index/

But never fear, the Ber-nank is here. Last night, he suggested that QEIII is waiting in the wings.

(2)    there is still plenty of attention on the ongoing drama in Europe. Yesterday, the Finnish parliament approved the expansion of the EFSF [a necessary component of the new EU financial stability plan]--that should seemingly be interpreted as a positive. However, the German parliament has its vote today; and as you know if you have been following this soap opera, there are serious doubts as to whether the German will approve the new plan. Without Germany, there is no plan. So remembering our own experience with TARP [our beloved ruling class voted against it before they voted for it], some investors decided that discretion is the better part of valor and adios-ed the Market.

P.S. or were they just anticipating ‘selling the news’? The German parliament approved the EFSF expansion by an overwhelming majority. Stocks are selling off.

Ireland versus Greece as candidates for default (short):
http://scottgrannis.blogspot.com/2011/09/tale-of-two-piigs-cont.html

(3) and just to be sure that we haven’t forgot just how stupid they are, the Three        Stooges are at it again. This time their intent is to again try to label China a ‘currency manipulator’. I included a chart in yesterday’s Morning Call [and repeat below] just to demonstrate how far off base these yokels are. They say that history repeats itself [think Smoot Hawley], so we know what the endgame looks like. Lest you think me Sinophile, I do believe that, China is screwing us; but their evil deeds are in theft of intellectual property. So once again, these guys can’t get it right--if they were only as funny as the real Three Stooges.

I can find no improvement to yesterday’s Bottom line: ‘stocks remain undervalued, at least as calculated by our Model. The economy continues to struggle along versus slipping into a recession. But we are stuck with the above mentioned gut wrenching volatility in stock prices which is a function of the volatility in the political economy that has been introduced by the political classes in both the EU and US. Unfortunately, that is not apt to change in the US given the entire ruling class is now in full re-election mode or in Europe because of the difficulty in getting 17 countries to agree on the resolution of a self inflicted wound. In the end, that means we use our Price Disciplines to Buy great companies that are Sold down to extreme levels and, in this kind of Market, to maintain trading stops to insure our principal is protected.’

    More on the EU crisis (medium):
    http://blogs.telegraph.co.uk/finance/ambroseevans-pritchard/100012223/frau-merkel-it-really-is-a-euro-crisis/

Economics

   This Week’s Data

    Weekly jobless claims fell by a whopping 42,000 versus estimates of down 4,000.

    The second revision of second quarter GDP came in at +1.3% in line with estimates; the GDP deflator was +2.5% versus forecasts of +2.4%.

   Other

    More on yesterday’s durable goods order number (short):
    http://www.capitalspectator.com/archives/2011/09/durable_goods_o_4.html#more

    Taking losses (short):
    http://www.ritholtz.com/blog/2011/09/take-the-loss/

Politics

Domestic

White House ‘questions’ Ford about ‘anti bail out’ ad (medium):
http://www.detnews.com/article/20110927/OPINION03/109270322/Howes--Ford-pulls-its-ad-on-bailouts

    More on Solyndra and other eco projects (medium):
    http://michellemalkin.com/2011/09/28/solyndra-watch/

International

    Tony Blankley on US foreign policy (medium):
    http://townhall.com/columnists/tonyblankley/2011/09/28/presidents_foreign_policy_failures_increase

    Another look at the parallels between the Japanese and the US debt crisis (medium):
    http://pragcap.com/more-on-japan-in-fast-forward

Price Discipline

Steve Cook — Wed, 28 Sep 2011 12:59:00 GMT

The Market

    Technical

    The Averages (DJIA 11190, S&P 1175) had another roller coaster day yesterday with prices being up strong early in the day and giving up about one half those gains by the close. Nonetheless, both index closed within its intermediate term trading range (10725-12919, 1101-1372).

    Volume was above average; breadth remained good. The VIX traded down but still closed at an elevated level within its current trading range. Reviewing all the charts in our Universe last night, the most distinctive thing that I noticed was that many stocks gap opened (they opened well above the prior day’s high), traded higher then late in the day closed near their low for the day. Technicians believe that gaps always get filled (meaning that the stock will trade down to at least the high from the prior day). The gap doesn’t have to be filled immediately; but combining the ‘gap filling’ phenomena with the incredible two day intraday advance suggests that stocks may be ahead of themselves, at least on a short term basis.

    GLD rose on decent volume. It remained above the lower boundary of its intermediate term up trend, appearing to confirm support at that trend line.

    Bottom line: we have had a couple of good days, but the volatility remains. So as good as Monday and Tuesday felt, we are likely still faced with some gut wrenching days. So don’t get too jiggy. I certainly want to continue to nibble at these levels but it will be in small incremental pieces versus a more aggressive approach.

    Historical look at the Market’s performance in October (short):
    http://marketsci.wordpress.com/2011/09/26/october-mostly-normal-2/

    Has this been a short covering rally? (short):
    http://www.bespokeinvest.com/thinkbig/2011/9/27/just-a-short-covering-rally.html

    Fundamental

      Headlines

    Yesterday’s economic news was just so, so: retail sales were mixed, consumer confidence was up but not as much as expected and July home prices were a little better than anticipated.

    Once again, this wasn’t investor focus. Early on, the follow through from Monday’s pin action coupled with the Greek parliament passing a property tax (one of the austerity measures that conditioned the receipt of Greece’s second bailout) provided the fuel for soaring prices. Later in the day, the Financial Times reported the EU leaders were not in agreement on the terms of the aforementioned bailout and that led to stocks cutting the gains in half.

    How the new EU plan will work (3 minute video):
    http://www.zerohedge.com/news/eurofail-video-explaining-eurotalf-dealer-last-resort

    Why it ‘might’ work (medium):
    http://pragcap.com/more-details-on-euro-tarp

    Why it won’t work (medium):
    http://www.zerohedge.com/news/guest-post-euro-tarp-why-it-will-be-screaming-failure

    Bottom line: stocks remain undervalued, at least as calculated by our Model. The economy continues to struggle along versus slipping into a recession. But we are stuck with the above mentioned gut wrenching volatility in stock prices which is a function of the volatility in the political economy that has been introduced by the political classes in both the EU and US. Unfortunately, that is not apt to change in the US given the entire ruling class is now in full re-election mode or in Europe because of the difficulty in getting 17 countries to agree on the resolution of a self inflicted wound. In the end, that means we use our Price Disciplines to Buy great companies that are Sold down to extreme levels and, in this kind of Market, to maintain trading stops to insure our principal is protected.

    The latest from David Rosenberg (long):
    http://www.zerohedge.com/news/rosenberg-explains-what-if-anything-has-changed

Economics

   This Week’s Data

    The International Council of Shopping Centers reported weekly sales of major retailers fell 0.2% versus the prior week but rose 2.7% versus the comparable period a year ago; Redbook Research reported month to date retail chain store sales down 0.1% versus the similar timeframe last month but up 4.2% on a year over year basis.

    The Case Shiller July home price index improved modestly.

    The September Conference Board’s index of consumer confidence came in at 45.4 versus estimates of 47.0 and August’s reading of 44.5.

    Weekly mortgage applications rose 9.3%, while purchase applications were up 2.1%.
    http://www.calculatedriskblog.com/2011/09/mba-mortgage-purchase-application-index_28.html

    August durable goods orders fell 0.1% versus expectations of a 0.2% increase.

   Other

    Martin Feldstein on the EU’s problems (medium):
    http://www.project-syndicate.org/commentary/feldstein40/English

    ASA weekly staffing index (short):
    http://mjperry.blogspot.com/2011/09/asa-staffing-index-reaches-ytd-high.html

    For the pessimists. This is long but a very good read.
    http://www.zerohedge.com/news/guest-post-its-long-hard-road

Politics

Domestic

    Senator Pat Toomey on tax reform and the super committee (4 minute video):
    http://www.clubforgrowth.org/perm/?postID=15572

    Solyndra up date (short):
    http://www.powerlineblog.com/archives/2011/09/solyndra-update.php

International

    Is China really a currency manipulator? (short):
    http://scottgrannis.blogspot.com/2011/09/china-is-not-currency-manipulator.html

Another small step for mankind

Steve Cook — Tue, 27 Sep 2011 12:47:00 GMT

The Market

    Technical

    The Averages (DJIA 11042, S&P 1162) had a good day and closed within the boundaries of their intermediate term trading ranges (10725-12919, 1101-1372).

    Volume was flat; breadth improved considerably, especially the flow of funds. The VIX was down but remains at elevated levels in the upper zone of its current trading range.

    Gold was down. Intraday it was quite volatile and traded well below the lower boundary of its intermediate term up trend. However, it finished the day above that boundary. I think the aforementioned intraday plunge had all the looks of a selling climax which is supported by the GLD’s overnight performance. I want to be careful but it is time to Add to this holding.
    http://www.minyanville.com/businessmarkets/articles/precious-metals-precious-metals-investing-gold/9/26/2011/id/37059

    Bottom line: the indices’ follow through yesterday from Friday’s positive performance was a plus, in my opinion, primarily because it makes last Thursday’s challenge to the lower boundary of their intermediate term trading ranges unsuccessful, adding further strength to this support level. I don’t think that it will be the last test but our Portfolios will nibble again this morning.

    A look at the current Markets through the Fibonacci prism (medium):
    http://blog.afraidtotrade.com/triple-us-equity-index-confluence-fibonacci-support-reference-chart/

    Global equity markets are in a bear market by some people’s definition. Forgetting that tell me the chart in this link doesn’t look like a developing head and shoulders? (short):
    http://tickersense.typepad.com/ticker_sense/2011/09/global-equity-index-enters-a-20-decline.html

    Fundamental

      Headlines

    August new home sales was the only data point yesterday--it was a little better than expected. In addition, our beloved ruling class appears to have come up with a budget compromise that will keep the government’s doors open until mid-November--that also is a little better than expected.

    But not to sound like a broken record, Europe continued to be the focus of investor attention. And surprise, surprise, this time we got some good news. It appears that the eurocrats having been doing something useful besides sitting in cafes, sipping wine and watching the skirts. At this point, nothing is confirmed but the generally accepted rumor is that the EU will employ a much expanded ($400 billion) the EFSF (bail out fund). It will use the proceeds to (1) shore up bank capital and (2) provide seed money to the European Investment Bank [owned by all the EU countries] that will in turn create a Special Purpose Vehicle that can leverage the seed money 8-10 times by issuing bonds, the proceeds of which will be used to buy sovereign debt from the EU banks. It sounds more complicated than need be but there are some legal/political issues that require that it be done this way. In the end, this is just a euro version of TARP which worked reasonably well for us.

    Bottom line: the Market was clearly encouraged by the EU rumor; as was I. But let’s be clear. (1) this plan may never be implemented [see below], (2) if it is, it has its shortcomings [see below], (3) it doesn’t address the austerity required to make the EU solvent in the long run and (4) it says nothing about the upcoming Greek debt payment. Nevertheless, it does continue the progress that I argued two weeks ago was the first hopeful sign that the eurocrats weren’t going to let the EU financial system implode.

    This: http://www.zerohedge.com/news/germanys-fdp-merkel-should-make-clear-immediately-there-no-change-business-model-efsf

    And this http://www.nakedcapitalism.com/2011/09/can-european-politicians-beat-the-clock-and-stave-off-a-crisis.html

    So it is way too soon to be tip toeing through the tulips. On the other hand, this plan, if implemented, is better than a sharp stick in the eye. As a result, the likelihood of the disaster scenario declines a bit further. That suggests that more nibbling makes some sense.

    The latest from John Hussman (long):
    http://advisorperspectives.com/commentaries/hussman_92611.php

    Speaking of which, this analysis is similar to the work that Hussman does. It is a bit long but is today’s must read:
    http://advisorperspectives.com/dshort/guest/Estimating-Future-Returns-Update-110926.php

    For the bears amongst you (3 minute video):
    http://www.zerohedge.com/news/bbc-speechless-trader-tells-truth-collapse-comingand-goldman-rules-world

Economics

   This Week’s Data

    August new home sales fell .1%, slightly better than expected.

   Other

    How the EPA creates new jobs (short):
    http://michellemalkin.com/2011/09/26/epa-regulations-jobs/

    The Chicago Fed’s national activity report is weak but no recession (medium):
    http://advisorperspectives.com/dshort/updates/Chicago-Fed-National-Activity-Index.php

    Money supply update (medium, also a must read):
    http://scottgrannis.blogspot.com/2011/09/money-supply-update.html

Monday Morning Chartology 9/26/11

Steve Cook — Mon, 26 Sep 2011 12:48:00 GMT

The Market

    Technical

     Monday Morning Chartology

    Last week was brutal for stocks. Nevertheless the S&P held above the August low (1101); so the intermediate term trading range remains in tact. However, given the power of Wednesday and Thursday’s decline, caution is the word, but a Buying opportunity is being created.

    GLD is last week’s biggest frustration for me. Specifically, one day it closed on a support level, then next plunge right to the next support level. Friday’s action is a great example: Thursday it closed on an identifiable support level then collapsed to near the lower boundary of its intermediate term up trend. Let’s hope my investment decisions are better this coming week.

    The VIX remains in the upper zone of its current trading range. At the moment, it has little informative value.

    Fundamental

    The latest on investment strategy from Pimco (long):
    http://advisorperspectives.com/commentaries/pimco_92211.php

    Doug Kass’ current thoughts on the Market (medium):
    http://www.thestreet.com/story/11257277/1/kass-low-rates-dont-hold-the-answer.html

    A close look at ‘cash on the sidelines’ (medium):
    http://www.ritholtz.com/blog/2011/09/the-myth-of-cash-on-the-sidelines/

    If you really want to get beared up (medium):
    http://www.zerohedge.com/news/five-banks-account-96-250-trillion-outstanding-derivative-exposure-morgan-stanley-sitting-fx-de

    Equity valuation update (short):
    http://scottgrannis.blogspot.com/2011/09/equity-valuation-update.html

Economics

   This Week’s Data

   Other

    This is a very good article discussing the fallacy of the US ‘exporting’ high paying jobs (medium):
    http://cafehayek.com/2011/09/artificial-scarcities-are-not-wealth.html

    Update on the ECRI weekly leading index (short):
    http://advisorperspectives.com/dshort/updates/ECRI-Weekly-Leading-Index.php

The Closing Bell 9/24/11

Steve Cook — Sat, 24 Sep 2011 16:41:00 GMT

In the last month in conjunction with a long time friend, I have been working on developing a blogspot of my own. That has now come to fruition and starting this coming week I will be posting on our new site, The All American Investor. http://allamericaninvestor.blogspot.com/. I will post for another week here; but this coming Friday will be my last. Join me there.

Statistical Summary

   Current Economic Forecast

    2011

     Real Growth in Gross Domestic Product:        +1.5- +2.5%
     Inflation:                                      2-3 %
    Growth in Corporate Profits:                                    7-12%

2012

   Real Growth in Gross Domestic Product:        +1.5- +2.5%
   Inflation:                                   2-3 %
Growth in Corporate Profits:                                     0-10%

Current Market Forecast

   Dow Jones Industrial Average

     Current Trend (revised):
        Intermediate/Short Term Trading Range 10725-12919
        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):
       Intermediate/Short Term Trading Range    1101-1372
       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                  20%
    High Yield Portfolio                     17%
    Aggressive Growth Portfolio             22%

Economics

The economy is a modest positive for Your Money. Almost no data this week; and as has been the pattern of late within the stats was some good news (existing home sales and leading economic indicators) and some bad news (housing starts). In the end, there simply wasn’t enough information to alter our outlook. So, the current dark mood of the Market notwithstanding, the evidence still suggests that our forecast is right on: 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. Nevertheless, it would be foolish to ignore the Street’s current bout with pessimism; and so I have to assume that the risk is increasing that a recession will occur.

All that said, neither the quantity nor quality of this week’s data mattered anyway because Europe, the Fed and to a lesser extent our dysfunctional political class dominated the headlines.

(1)    the EU sovereign debt crisis is and will be the biggest risk to our forecast until it gets resolved. I optimistically noted last week that there were some small hopeful signs that the eurocrats were starting to come to grips with the hard realities of past fiscal profligacy and the impaired assets now held by the major EU banks--‘small’ being the operative word. Clearly, a great deal more has to be done and soon to avoid a worse case scenario. Unfortunately, very little additional progress was made this week; although rumors abound that Greece will default this weekend and preparations are afoot to address the resulting liquidity issues that would likely arise in the EU financial system. The bottom line here is that conditions are as dire as they are because eurocrats fiddled while Greece burned; matters will be even worse, if they continue to do nothing.
http://www.nakedcapitalism.com/2011/09/europe-must-choose.html

(2)    as you know, the FOMC met this week and following its meeting announced Operation Twist. To say that investors were not impressed would be a gross overstatement. Indeed, following its release, the downward momentum in stock prices went into overdrive. There were two causes its statement that the risks to the economy have increased spooked investors while its focus on lowering long term interest rates confused investors {since lower long term rates suggest less risk}

To be sure both and are more psychological than substantive.    In fact, I think that, in terms of its impact on the US economy, Operation Twist is much ado about nothing. However, the damage was still done. Leaving me with this take a way: Mr. Bernanke quit trying so hard; you can’t solve the economic mess facing this country. As much as you may want to do everything possible to improve conditions, the problem is one of governance [or lack thereof].   Fiscal, regulatory, trade policies are what is holding back economic expansion and until they are changed, the Fed can do little. Indeed, as suggested by the Market’s reaction, your actions can be counterproductive.

(3)    and speaking of fiscal, regulatory and trade policies [which I wish I wasn’t], November 2012 can’t come soon enough. This group of morons we have elected to manage the ship of state just don’t get it. How many more times do we have to listen of Obama telling us that taxes need to be raise on ‘the rich’ when 50% of the US households don’t even pay income taxes and the top 10% pay 70% of all the taxes? How many more examples of government directed spending gone awry [think Solyndra] do we have to endure? When is congress going to figure out that in a period of extreme financial uncertainty and austerity, the electorate doesn’t need to be burdened with the additional fear that the government can’t work out a budget that ensures the country can meet its short term financial obligations? Is it any wonder, investors are discouraged?
            http://www.washingtonpost.com/opinions/return-of-the-real-obama/2011/09/22/gIQAf7dsoK_story.html

    Bottom line: the economy continues to stumble along though data suggest that the probability of a ‘double dip’ is increasing. However, I don’t think that the odds have reached 50/50 yet. Further, as irresponsible and ineffective as our ruling class is, I believe that the US economy on its own has the strength to muddle through until November 2012.

    Europe, of course, is another story. Its economic problems are worse, its financial institutions weaker and its political class as clueless, inert and ineffective as our own. Unfortunately, it is a large enough trading partner and its financial institutions are intertwined enough with US banks that a chaotic resolution to their sovereign debt problem would adversely affect our already anemic recovery. The only reason that I don’t throw in the towel and join the bears is that necessity seems to be pushing the leadership to take the steps to ring fence Greece and back stop its banks.     I am not predicting that it will happen; but until we see how they handle the Greek situation, I don’t how we can predict the endgame.

This week’s data:

(1)    housing: weekly mortgage applications were up but purchase applications were down; August housing starts fell more than expected though building permits were stronger than anticipated; August existing home sales came in much better forecast,

(2)    consumer: weekly retail sales were mixed; weekly jobless claims fell in line with estimates,

(3)    industry: none,

(4)    macroeconomic: August leading economic indicators increased more than expected.

The Economic Risks:

(1)    the economy is weaker 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.

    An endless stream of incompetence--the latest on Obamacare financing (medium):
    http://www.powerlineblog.com/archives/2011/09/no-class.php

The Market-Disciplined Investing

Technical

The Averages (DJIA 10771, S&P 1136) were brutalized last week, but still managed to close within their intermediate term trading ranges (10725-12929, 1101-1372). However, they did break a number of other support levels, not the least of which was the lower boundaries of their respective short term up trends.

The viciousness and swiftness of the decline (circa 70 S&P points in two days) was so sudden that it never gave me a chance to put money to work. That, of course, is the good news--if prices had meandered towards a lower level, our Portfolios likely would have continued the nibbling started the previous week. The challenge now is to be patient through the current testing of the lower boundaries of the indices intermediate term trading ranges (August lows). If successful, we will get a chance to Buy stocks are very attractive levels. If not, I will thank my lucky stars that the Markets moved too fast for an old conservative guy like me to put any money to work (some times luck is better than skill).

Volume was elevated throughout the week; breadth as you might guess was terrible. The VIX was off fractionally but remains well within its current trading range--not a sign that stocks are going to drop (further) off the cliff. Furthermore, as I noted in Friday’s Morning Call, our internal indicator is not signaling any significant downside.

GLD had a near death experience this week, busting through several support levels but closing near the lower boundary of its intermediate term up trend. I got tell you that I played this about as poorly as I could. As I noted, GLD broke several support levels, so I had plenty of chance to reduce our position. My excuse is that every time it broke support it would immediately plunge to yet another support level--so I would wait to see if that level held; and the same thing would happen again. And I am going to do it one more time. The lower boundary of its intermediate term up trend is significant; so I just don’t think that it would be smart to Sell at what could be fractions above the low of this cycle. On the other hand, if it breaks this time, I am movin’ on out.
    http://www.zerohedge.com/news/gold-liquidations-open-thread

Bottom line:

(1) the DJIA and S&P are in both an intermediate term trading range (10725-12919, 1101-1372),

(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 (10771) finished this week about 1.7% above Fair Value (10588) while the S&P closed (1136) 13.1% undervalued (1308).

This week, stocks as measured by the S&P got a whole lot more undervalued as calculated by our Valuation Model. As I suggested in the Economics section, it had nothing to do with the performance of the economy. Rather it was a function of indecisiveness in Europe, an out of touch Fed and the insouciance of our political class to the problems that they have created. That said, most of this we already knew--disappointing as it is. As such, it is in the price of stocks.

Not figured into our Model is a ‘double dip’. But as I noted last week, even if we get a recession, with the S&P at ‘circa 15% undervalued; surely that would discount any kind of down turn currently envisioned by Street bears.’

Of course as I noted above, the real risk to our forecast is a multi country default/restructuring in Europe accompanied by an implosion of its financial system. The problem is determining the likelihood of such an occurrence. Reason would suggest that the EU leadership is just as aware of the risks and the consequences of not acting as the rest of the world. Yet they have sat around far too long, yanking themselves off and lying to their electorates by assuming that somehow they are smart enough to pull some unforeseen rabbit out of their hat and avoid the inevitable. That strategy works until it doesn’t; and it generally stops working when Markets precipitate the inevitable. That seems to be happening now. If that is the case, the good news is that most of the experts that I have read and talked to believe that the EU still has the resources and flexibility to allow an orderly default of Greece and salvage the EU financial system. And as I have been suggesting, there are some faint signs of progress to that end. But to avoid a disaster scenario, progress needs to be apparent to the Markets and soon or we are likely in for more pain. I recognize that this bit of rationalizing doesn’t get us any closer to determining the likelihood of the worse case, it simply points out that it is not 100%.

The uncertainty in all this is the reason that our Portfolios own a 10% position in gold (though that is not doing us any good at the moment), 15-18% in cash and follow a well tested Sell Discipline that has served them well in prior difficult times.

This is a great read. Its point is that suppressing daily volatility ultimately leads to Black Swan events. (medium):
http://www.ritholtz.com/blog/2011/09/suppressing-financial-instability-increases-risk-of-market-breakdown/

This week our Portfolios held on for dear life.

           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 the major long term risk. An investment in gold is an inflation hedge and holdings in other countries provide a hedge against a weak dollar--although this is becoming problematic as investors flock to the dollar to avoid the EU solvency issue and exposure to better growth opportunities,

(3)    defense is still important.

                                                                              DJIA                    S&P

Current 2011 Year End Fair Value*               10760                   1330
Fair Value as of 9/30/11           10588                    1308
Close this week               10771                 1136

Over Valuation vs.9/30 Close
    5% overvalued                  11117                    1373
    10% overvalued               11646                    1438
    15% overvalued                               12176                    1504


Under Valuation vs. 9/30 Close
    5% undervalued                               10058                       1243
10%undervalued              9529                     1177
15%undervalued                            8999                        1112

* 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.

Europe and the incompetency of our political class

Steve Cook — Fri, 23 Sep 2011 12:50:00 GMT

The Market

    Technical

    Are we having fun yet? I don’t need to tell you that yesterday was brutal with the Averages (DJIA 10733, S&P 1129) down big. Nevertheless, both closed within their intermediate term trading ranges (10725-12929, 1101-1372). In other words, they held the August lows, though the DJIA closed perilously close to its low. Further the S&P followed the DJIA below the lower boundary of its short term up trend; and did so with such force that the distance element of our time and distance discipline confirms the break of the short term up trend.

    Volume increased; breadth was abysmal. The VIX rose 11% but remains within the upper zone of its current trading range. I also checked our internal indicator again. I noted in yesterday’s Morning Call that Tuesday’s carnage within our Universe was worse than reflected in the indices.   However, yesterday the opposite occurred. Not that there wasn’t some serious whackage. It just appears that the Averages caught up with our stocks.
    http://www.bespokeinvest.com/thinkbig/2011/9/22/sp-500-breadth.html

With that as a preface, here are the results as of the close last night: in a Universe of 163 stocks (1) with regard to the short term up trend, 123 stocks have broken that trend, 33 have not, 7 are too close to call, (2) with regard to the August lows, 121 stocks have NOT broken that level, 37 have and five are too close to call. What does that tell us? (1) forget about the short term up trend, (2) despite the DJIA holding narrowly above its August low, there is little indication that this low is going to be taken out. The latter is important because our indicator tends to lead the broader Averages (as it did Tuesday); so, at least by this measure, there is a decent chance the 10725, 1101 level will hold. Let me caution that its record is not perfect; but after reviewing yesterday’s results, I feel better than I did at 2PM yesterday afternoon.

    GLD got busted along with everything else. As with stocks, the magnitude of the move below the short term up trend is sufficient to confirm its break. Ditto the initial support level. I know that I said that if GLD broke that initial support level, I would likely sell some. But its price drop was so large that it closed right on another level; so I am going to see how it trades today before acting.

    Here is an interesting theory as to what drives gold prices (medium):
    http://www.crossingwallstreet.com/archives/2011/09/what-operation-twist-means-for-gold.html

    Bottom line: after the thrashing equities have taken over the two days, clearly it is a time for caution. However, technically speaking the August lows are simply being tested for a fourth time. If stocks bounce here, our Portfolios will be a careful buyer.

    P.S. futures are pointing to a big down opening; so the relief bounce I had expected is not happening. At this moment, it makes no sense to be standing in the front of this oncoming train.

    Margin debt is down (short):
    http://www.zerohedge.com/news/nyse-margin-debt-plunges-mid-2010-levels-still-60-higher-may-2009-lows

    Fundamental

      Headlines

(1)    US economic news was OK: jobless claims in line, leading economic indicators were down by less than expected,

(2)    however, the global economic news was not so hot. The manufacturing and service sector data out of Europe was weak. Plus an editorial by Mohamed El Erian suggesting that the French banks were not in good shape and needed help, pushed the bourses down before our open; and that in turn it spilled over into our early morning trading,

(3)    after thinking over night about the Fed’s latest policy moves, investors apparently decided that they were even worse than originally thought,
http://www.zerohedge.com/news/rosenberg-presents-three-ways-bernanke-disappointed-market-and-why-it-dumping

(4)    congress is once again dicking around with the debt ceiling while Obama is on the campaign trail talking up His new [$400 billion] jobs bill, deepening the depression investors feel about the inadequacy of our political leadership.

Bottom line: almost everything that could potentially go wrong with the world was in the headlines yesterday. And to be sure, they could all go wrong. But the US economy continues to hang in there despite the onslaught of irresponsible, self serving, third rate policies foisted upon by our moronic political class. More important, this is reflected in our Valuation Model.

The EU economic condition is worse than our own; but there are signs (small to be sure) that the eurocrats have realized that they have reached the point of no return and that they have one last chance at developing a rational solution to their problem (s). The questions, of course, are (1) will they succeed and (2) if they fail, how much of that is in the price of eggs.

I still have no clue; but with stocks 15% below Fair Value (as calculated by our Model) some lack of success is in there. I do believe that our condition is not as bad as was in 2009. But there is a big gap between now (1129) and the March 2009 low (666); so there is still plenty of downside even assuming that I am correct. My only solution to this kind of dilemma is to rely on our Price Disciplines and to recognize that when everybody hates stocks that is the time to Buy them.

    Here is a must watch interview with Satyajit Das on the EU crisis (5 minutes):
    http://www.minyanville.com/businessmarkets/articles/euro-european-financial-crisis-satyajit-das/9/22/2011/id/37014

    Why Operation Twist won’t work (medium):
    http://www.investors.com/NewsAndAnalysis/Article/585596/201109211832/New-Fed-Policy-A-Twist-On-Old.htm

    And (medium):
    http://www.nakedcapitalism.com/2011/09/how-markets-interpreted-the-feds-operation-twist-as-a-sign-of-double-dip.html

    And this thoughtful piece on the damage wrought by Fed policy (medium):
    http://pragcap.com/misunderstanding-the-effects-of-qe2-was-a-grave-mistake

     CNBC $1 million Challenge

    As you know, I sold the VXX going into the close last night on the thesis that stocks would likely bounce at the open this morning, if only for a brief time. Of course, that ain’t happenin’. How smart am I?

    The International Fund is selling the India ETF (EPI) at the open.

    Dividend Growth: GLD, TGT, CME, IBM, SIAL,

    High Yield: GLD, CATO, SNY, FII,

    Aggressive Growth Portfolio: GLD, SEIC, LOW, APH,

    International; GLD, EWC, EPI,

    All In: GLD, CME, APH, MDVN (Medivation),

     Thoughts on Investing--from Lance Paddock

A good article on dividends and their importance in the Wall Street Journal. Two quotes stuck out for me:
First, stock returns don’t typically consist of exciting price gains with dinky dividends tacked on. Over the eight decades ended September 2010, dividends contributed 44% of S&P 500 total returns, according to research by Fidelity Investments. And that includes a long, anomalous stretch during the 1980s and 1990s, when valuations bloated and yields shrank. During the 1970s, when returns averaged 5.9% a year, dividends contributed 71% of that figure.

That is all true, but it actually understates the importance of dividends. If you take out inflation dividends have over the long term contributed more than 80% of the real return (return above inflation) and over 100% of the real return during the seventies.

At the end of the day this is as it should be. Investors often talk as if dividends don’t matter as long as we get capital appreciation, but that is extremely short sighted.

Certainly we want fast growing companies who can reinvest their earnings at high rates of return to do so. However, the bar should be high since management and analysts are overoptimistic about their ability to do so. More fundamentally remember what the point of owning stocks is ultimately. It is to receive dividends. What is the point of owning a company if you never receive any of their earnings?

Casual readers might reply that people have made fortunes investing in companies that do not pay dividends, but they would be missing the point. Why do they make a fortune? Why do investors (at least over time) reward growing companies with a higher stock price? If it is just because earnings are going up, we have to ask the question, “how does that help the investor?” They receive no cash from that growth. Is it just a game? We all just sit around bidding up companies that grow even though it does not benefit us directly for the price to go up? Are we all just making side bets because we know everyone else will want the stock because they know everyone else will want the stock ad infinitum? Often investors do act that way. They think that way and the market becomes divorced from dividends, free cash flow or any relationship with any tangible benefit for the investor. That leads to bubbles and busts and investor irrationality.

It should not be that way though, because there are only two reasons we should allow a company not to pay us its earnings.

1.    Because some of those earnings are needed just to keep the company going. All companies need to maintain and replace existing equipment and other assets.

2.    Because we want them to grow (accrete to book value) and be able to pay a larger dividend in the future. Warren Buffet’s Berkshire Hathaway is an example of a company that has focused entirely on that since Warren still believes Berkshire can earn a high enough return on retained earnings to justify doing so.

That is it. Number two being the key. If a company can retain a dollar and reinvest it to grow future income at a rate of 15% per annum for example it would make more sense for them to do so than give it to us. However, investors need some cash at times in the meantime, and we can sell shares (which appreciate due to growth.) Without that promise that at some point in the future a dividend will be paid owning stocks would be silly, akin to betting on horses. They would not go up!

Wonderfully, over time investors do earn a return that equates to the dividends distributed over time as the charts above illustrate. It does get out of whack from time to time. When it does the market eventually corrects that discrepancy, which is what the awful returns of the last 11 years has been all about at the end of the day. JJ Abodeeley calls it The Value Restoration Project. We call it a secular bear.

We use trend growth in both the Real (after inflation) price of stocks and the real growth of dividends. Trend Real Growth in Earnings has been somewhere around 1.5%.

Trend real growth in the index has been 1.7% a year, which is far lower than people realize. The rest of the return from stocks has been inflation and dividends as discussed earlier. Growth has been a minor component. We want to emphasize this quite carefully. The return of stocks is defined by the dividend yield, the growth in real earnings, inflation and a rise in P/E ratios. One could argue for real dividends as a better guide than reported earnings, but over time those should even out. There is nothing else. If someone argues for higher returns than implied by estimating each of those numbers they are wrong. It is not a difference of opinion, they are wrong. If they argue for faster growth than the 1-2% above inflation mentioned above, remember they are saying things will be much better than the past. Maybe so, but it is certainly unlikely.

Since 1870 a gap has grown between the two numbers in the graph above, which should track, to about 64%! Almost all of which is accounted for by the period since 1982. In all fairness some of this is because dividend payouts have shrunk, and possibly that will result in larger payouts in the future. Some of it is that the price since 1982 has gone way too high. This gap will likely shrink both by payouts from stocks increasing and prices coming down.

Of course Wall Street has been busy disguising the lack of cash actually returned to investors through accretion to book value and dividends by getting us to focus on forward operating earnings. How has that worked out?

Historically, the actual reported net earnings of the S&P 500 have averaged only about 72% of one-year forward operating earnings estimates by Wall Street analysts. The sum of dividends and increments to book value have been even lower, averaging just 60% of forward earnings estimates (and representing only about 84% of the net earnings reported to investors). The remaining portion of “earnings” reported to investors goes the way of the Dodo.

Not too well.

Since dividends have been given short shrift in recent decades it would be wrong to say that stocks were as overvalued in July as the 64% gap in the graph on Real Price and Real Dividend’s would lead one to believe (since with the market price well above trend the overvaluation would have been a lot more that 64% without that caveat.)

However, we should acknowledge that stocks using normal assumptions of growth of 1-2% above inflation plus dividends (about 2.12% today) are priced to deliver over the long-term only about 3-4% above inflation. Not exactly inspiring. Throw in about .5% to account for a low payout today (assuming the retained earnings are not squandered, a big if) and we get 3.5% to 4.5% above inflation. If we set fair value at a projected return of 6% above inflation stocks would need to fall by about 58% at a 1% real growth rate and 25% assuming a 2% real growth rate.

Note that a 2% real growth rate is not only above long-term averages, it is also unlikely since we are already at peak profit margins. From peak profit margins long-term real growth rates have generally averaged between 0% and 1%. Because companies are loath to cut dividends, barring a major financial crisis we should expect the floor to be closer to 1% on dividend growth (and that rate possibly higher as payouts increase) though earnings would likely be much more volatile.

This leads me to the second quote that stuck out:

Second, from here, broad-market returns might be smaller than investors are accustomed to. Bradford Cornell, a finance professor at the California Institute of Technology who specializes in valuation, argued in a paper published last year in the Financial Analysts Journal that stock returns are inextricably tied to economic growth, which is necessarily slowing around the developed world. Stock investors, he says, should expect to collect their dividend yields plus about 1% a year in price gains after inflation.

The connection between dividends, long term economic growth and the growth in earnings and dividends we have been discussing is exactly why Bradford Cornell’s paper is mentioned in the article. Growth is lower than we think and not nearly as important as dividends in explaining your long-term return. You can find his paper here.

What about stock buybacks? Yes, they do count, though their worth is highly exaggerated and are not equal on a dollar for dollar basis to dividends. However, it is a way for companies to return cash to shareholders. What it doesn’t do is increase the value of the S&P 500 as a whole.

First of all the index is already adjusted for share buybacks. So adding them into the index numbers to assume a higher return is double counting.

Second, the value of share buybacks is they reduce the share count, meaning each individual share can receive more of the dividend, even if delivered far in the future.

If dividends are not high then returns are low once speculative mania has reversed. The positive side of that is negative overreaction will eventually arrive and stocks will be yielding 4-6% at some point in time, usually because of financial disorder or inflation. When it does long-term returns can be far above 6% real (such as in 1982 or 1974.)

At that point the Value Restoration Project will be finished as well as the secular bear. Then we can actually be long-term investors again in the US stock market and not speculators hoping for historically unusual outcomes to bail us out.


Economics

   This Week’s Data

    The August leading economic indicators rose 0.3% versus expectations of an increase of 0.2%.

Politics

Domestic

Social security draws ever nearer to insolvency. What our political class hath wrought:
http://advisorperspectives.com/dshort/guest/110922-Blown-Off-Course.php

I've changed my mind. We have a third rate political class

Steve Cook — Thu, 22 Sep 2011 12:50:00 GMT

The Market

    Technical

    The indices (DJIA 11124, S&P 1166) continued their manic depressive performance yesterday, although they remained within their intermediate term trading ranges (10725-12919, 1101-1372). However, the DJIA once again traded below the lower boundary of its short term up trend (11343) while the S&P remained above its comparable trend (1159). That (1) re-starts our time and distance discipline for the DJIA’s break and (2) puts the Averages out of sync.

    Volume increased; breadth cratered. The VIX rose but remains in the upper zone of its current trading range.

    Bottom line: looking through the charts of the companies in our Universe, yesterday’s carnage was even worse than reflected in the indices. A majority of our stocks were driven to either the lower boundary of their short term up trend or to the lower boundary of their intermediate term trading range (the August lows)--the point being that a down close again today will likely mean at least a test of the August lows and raises the odds of something worse. On the other hand, a bounce will just mean another successful test of the short term up trend. So today’s pin action could be potentially critical to the technical outlook; but till we know, patience.

    Fundamental

    The economic data yesterday was mixed to positive: weekly mortgage applications were up but purchase applications were down; more important, August existing home sales were much stronger than anticipated. Once again, no one cared; though Europe was relatively quiet.

Rather this time, the Market spent the day waiting for the release of the Fed statement following its regularly scheduled two day meeting. I frankly thought that there was a decent chance that Bernanke & Co. would, in addition to or instead of Operation Twist, propose some sort of QEIII. Didn’t happen. Instead in addition to leaving interest rates unchanged, they did do Operation Twist (selling short term Treasuries on the balance sheet and reinvesting the funds in long Treasuries with the intent to drive down long rates) in about the size that was expected ($400 billion).

The rest of the statement read about the same as recent statements (the economy is sluggish, most sectors are weak, inflation is moderating, yak, yak, yak) EXCEPT it altered its characterization of the downside risk to the economy to include the word ‘significant’--which it attributed to its growing concern about financial viability of Europe.

    Investors were clearly not happy with Bernanke. First, their already heightened fears over Europe were made worse.   Second, there was consternation that (1) the Fed would state that the risk in the system had increased [EU sovereign debt risk], (2) but it also stated that the purpose of Operation Twist was to lower long term interest rates [the lower the long term interest rates, the less the reward for taking risk]. In other words, it says there is more risk but it reduces the returns for taking it. Finally, Moody’s lowered its rating on US banks (who just took a hit to their income statements as the Fed lowers long interest rates--remember they borrow short and lend long). Stocks rolled over and the S&P lost 3% in the last hour.

    Bottom line: once again, Bernanke et al just made matters worse. Frankly, I am not so concerned about their worry with Europe--they were stating the obvious. But I just don’t get them fretting about more risk and then adopting a policy that encourages investors not to take it. Plus they screwed the banks which are the weak link in the system right now. Although I am not yet sure by how much, this moves the needle closer to a recession scenario. The assumptions is our Model may be too optimistic--we may be dealing with a third rate political class.

    The problem with exiting the euro (medium):
    http://www.ft.com/intl/cms/s/0/f2133a2e-e2e0-11e0-903d-00144feabdc0.html#ixzz1Ya5BHlSx



Economics

   This Week’s Data

    August existing home sales jumped 7.7% versus expectations of a 1.7% increase.
    http://www.calculatedriskblog.com/2011/09/existing-home-sales-comments-and-nsa.html

    Weekly jobless claims fell 5,000 in line with estimates.
    http://www.calculatedriskblog.com/2011/09/weekly-initial-unemployment-claims_22.html

   Other

    Bad news out of Europe (medium):
    http://www.zerohedge.com/news/european-service-activity-contracts-first-time-two-years-global-recession-now-ensured

    And China (medium):
    http://www.zerohedge.com/news/china-cds-spikes-highest-mar09-pmi-disappoints

Will Bernanke matter?

Steve Cook — Wed, 21 Sep 2011 12:55:00 GMT

The Market

    Technical

    The Averages (DJIA 11408, S&P 1202) had another volatile day, though they closed above the lower boundary of their short term up trends (11316, 1161) and within their respective intermediate term trading ranges (10725-12919, 1101-1372).

    Volume declined; breadth improved including the flow of funds turning positive. The VIX was up fractionally and remains in the upper zone of its trading range.

    GLD rebounded above the initial support level after confirming the break of its short term up trend yesterday. This level now becomes the lower boundary of a new short term trading range. As long as GLD holds above this new support level, our Portfolios will hold their current position in GLD.

    Bottom line: if the volatility and schizophrenia of the current Market isn’t driving you crazy, I need some of stuff that you are taking. There is no real solution except patience and carefully monitoring our holdings in the context of our Price Disciplines. The Market’s bias appears to be positive; so given current valuation levels, our Portfolios are buyers of stocks on dips, if they just stay there long enough to get a trade done.

    What high yield funds may be telling us (short):
    http://advisorperspectives.com/dshort/guest/Chris-Kimble-110920-High-Yield-Indicator.php

    The 50 day moving average barrier (short):
    http://www.bespokeinvest.com/thinkbig/2011/9/20/stymied-by-the-50-day.html

    Fundamental

    The economic news yesterday was mixed: housing starts were off more than expected though building permits were above estimates; weekly retail sales were down week over week but still strong year over year.

    Once again, it didn’t matter as all eyes remain on the Punch and Judy show in Europe. Over night S&P lowered the rating on Italian government bonds, but Greece made a circa $700 million interest payment. The relief over the latter coupled with some optimistic statements from EU officials regarding a resolution of the Greek problem out weighted the negative implications of the former.

    Then late afternoon, stories circulated that (1) a deal with Greece was in fact not eminent, (2) the Troika (ECB, EU and IMF) would meet this weekend to further discuss the steps needed for a permanent solution to the Greek problem, (3) no decision was likely to be made till October and (4) Papandreou might hold a referendum on austerity measures sent investors back to the exits. Stocks rolled over and ended basically flat on the day--which all things considered, I think a minor victory.

    Bottom line: stocks are undervalued as calculated by our Model. Explicit in that is, that the latest yakking about jobs and a balancing budget notwithstanding, the US economy isn’t going to improve from its current state of near moribund growth and the political class will do nothing more than they are currently doing--in other words nothing.

    Not to be ignored is the current Fed meeting in which many Market participants are assuming more easing. The GOP leadership just made that a bit more difficult (see below)--thank heavens. The last thing this economy needs is more free money, which incidentally is also in our Model.
    http://www.zerohedge.com/news/eve-critical-fomc-decision-republicans-resend-letter-bernanke-demanding-no-more-qe

    And:
    http://www.zerohedge.com/news/shadow-banking-system-imploded-q2-bernankes-choice-tomorrow-has-been-made-him

    Bernanke’s choices (short):
    http://www.zerohedge.com/news/shadow-banking-system-imploded-q2-bernankes-choice-tomorrow-has-been-made-him

Further, a default/restructuring of Greek debt is also in our assumptions. The problem as exemplified by the spastic performance of equities is that the eurocrats are no better than our own and necessity is dragging them kicking and screaming toward an endgame, whatever its form. The risk is that the endgame occurs before they wise up and take the necessary steps to ring fence Greece and provide for the liquidity demands of the EU financial system. As you know for me the trip wire as to whether they will be successful is whether Greece’s default/restructuring (and I believe that there is virtually a 100% probability of that) is orderly.

    On the other hand, I speculated last week that there were some very small but hopeful signs that the Three Blind Mice are moving toward the steps needed to avoid a disaster scenario. I have no idea what the odds are that this will happen, which is why our Portfolios have 10% position in gold, 15-20% in cash and why I am focused on our trading Sell Discipline. In addition, the lower stock prices go, the more the disaster scenario gets priced in which is why our Portfolios on weakness will continue to nibble on those stocks on our Buy Lists (i.e. stocks that are at or near their historical low absolute and relative valuations).

    A strategy for dealing with a bear market (medium):
    http://www.minyanville.com/businessmarkets/articles/bear-market-obama-jobs-bill-bernanke/9/20/2011/id/36967

    A different look at S&P valuation (short):
    http://blog.yardeni.com/2011/09/s-500-valuation.html


Economics

   This Week’s Data

    The International Council of Shopping Centers reported weekly sales of major retailers down 2.1% versus the prior week but up 3.4% versus the comparable period last year; Redbook Research reported month to date retail chain store sales up 4.1% on a year over year basis.

    Weekly mortgage applications rose 0.6%; unfortunately, purchase applications fell 4.7%.
    http://www.calculatedriskblog.com/2011/09/mba-mortgage-purchase-application-index_21.html

   Other

    The fallacy of the ‘Buffett rule’ (short):
    http://mjperry.blogspot.com/2011/09/omaha-hokum-entire-buffett-rule-is.html

    Business loans and unemployment (short):
    http://www.capitalspectator.com/archives/2011/09/business_loans.html#more

Politics

Domestic

A thought on the war on drugs (short):
http://mjperry.blogspot.com/2011/09/new-fbi-numbers-reveal-failure-of-war.html

    Mark Steyn on Obama’s jobs bill (medium):
    http://www.nationalreview.com/articles/277492/pass-jobs-bill-mark-steyn

    My favorite liberal blogger on Obama’s veto threat (short):
    http://dailycaller.com/2011/09/20/obamas-hollow-gauntlet/

    The latest on Solyndra (short):
    http://www.zerohedge.com/news/solargate-meets-enron-solyndra-ceo-and-cfo-plead-fifth

International

    15 demands on Greece by the EU (short):
    http://bbcjoelynam.wordpress.com/2011/09/18/15-demands-from-the-imfecbeu-troika-which-could-be-the-greek-default-trigger/

    Thoughts on China (medium):
    http://www.zerohedge.com/news/jim-chanos-debunks-myth-china-worlds-white-knight

It could have been worse

Steve Cook — Tue, 20 Sep 2011 12:52:00 GMT

The Market

    Technical

    The indices (DJIA 11401, S&P 1204) sold off yesterday but closed above the lower boundaries (11290, 1156) of their respective short term up trends and well within their intermediate term trading ranges (10725-12919, 1101-1372).

    Volume and breadth were both down. As you might expect, the VIX rose and remains near the upper level of its current trading range.

    GLD got whacked and closed below (1) not only the lower boundary of its short term up trend for the fourth trading day and hence, confirming the break of that trend, (2) but also below the initial support level. A further decline would prompt the sale of a portion of this position.

    Bottom line: as ugly as the first hour of yesterday’s pin action was, the Averages finished the day in sound technical shape. Intraday, the DJIA actually touched the lower boundary of its short term up trend and bounced which I consider a good sign (the S&P never got close). Additional weakness down to the lower boundary of the short term up trend would likely prompt buying by our Portfolios.

    Stocks above/below their 50 day moving average (charts):
    http://www.bespokeinvest.com/thinkbig/2011/9/19/sp-500-and-sector-percentage-of-stocks-above-50-day-moving-a.html

    Fundamental

    There was no economic data reported yesterday. However, my guess is that even if there was, it wouldn’t have mattered. The Greek/EU financial crisis monopolized investor attention as once again the EU financial ministers in a weekend meeting couldn’t agree on the terms of a Greek bailout beyond the steps that were taken last week (a short term bridge loan for Greece and the dollar funding facility) and Greece continued to scramble to develop an austerity plan that is acceptable in those countries (Germany and France) providing that bridge loan. Those developments put stocks into a water fall formation in the first hour of trading.

    Then later in the day, rumors swirled that Greece and the EU finance ministers were close to terms on the bail out of Greece. That got stocks moving higher. While they still ended down for the day, much of the initial damaged was mitigated.
    http://www.hussman.net/wmc/wmc110919.htm

    As a side show, Obama presented His ‘new budget’ which was not new; it was simply the same old sh** with some lipstick on it. It is DOA and everyone knows; just like they know it is a political not an economic agenda that sets the stage for the 2012 debate. To which I say, bring it on.

    Yawn. Another new plan.
    http://www.powerlineblog.com/archives/2011/09/1-5-trillion-in-new-taxes-ho-hum.php

    Bottom line: look I said last week that the Greek/EU sovereign debt problem was not going away and that we were in for plenty of volatility even if the ‘wet dream’ scenario occurs. So we got some of that volatility yesterday. The good news is that (1) tiny steps continue to move resolution of Greek solvency forward, even if that means an orderly default [indeed I have argued that the bullish case is an orderly Greek default sooner rather than later], (2) gold was down big yesterday which suggests to me that somebody out there is getting more positive on the EU financial crisis and (3) lower stock prices equal better value. Our Portfolios will be Buying more soon.

    Finally, Obama’s new budget proposal is meaningless blather. It has nothing to do with stock prices because, as you know, a sluggish economy and a second rate political class are the basic assumptions of our Valuation Model.

Economics

   This Week’s Data

    August starts fell 5.6% versus expectations of a decrease of 2.3%; on a more positive note, building permits increased slightly versus estimates of a small decline.

   Other

    The Fed is over shooting its inflation target (medium):
    http://www.realclearmarkets.com/articles/2011/09/19/weve_overshot_the_feds_upper_inflation_limit_99263.html

    A look at household net worth (medium):
    http://advisorperspectives.com/dshort/commentaries/Household-Net-Worth.php

    Earnings estimates and Market direction (short):
    http://advisorperspectives.com/dshort/guest/Chris-Turner-Earnings-Estimates-110919.php

    No need for an Operation Twist from the Fed (medium):
    http://scottgrannis.blogspot.com/2011/09/no-need-for-operation-twist.html

Politics

Domestic

More on the Solyndra fraud (long):
http://www.nationalreview.com/articles/277512/solyndra-fraud-andrew-c-mccarthy

    And (medium):
    http://www.zerohedge.com/news/why-was-congress-forced-subpoena-head-obamas-budget-office-get-info-solyndra

Monday Morning Chartology 9/19/11

Steve Cook — Mon, 19 Sep 2011 13:23:00 GMT

The Market

    Technical

      Monday Morning Chartology

    This is a great looking chart. The S&P has bounced off the lower boundary of its rising short term up trend three (four?) times. A move above 1229 will put in a third higher high.

    The GLD chart is a bit more worrisome. GLD is now three days below the lower boundary of its short term up trend; one more day below that trend line will confirm its break--clearly a sign of waning momentum. That said, Thursday the ETF closed right on an initial support level and then Friday bounced off of it. So it would appear that there is still a bid near current levels.

    The rising demand for gold (medium):
    http://www.investmentpostcards.com/2011/09/19/perfect-storm-creates-tidal-wave-of-gold-demand/?utm_source=feedburner&utm_medium=email&utm_campaign=Feed%3A+wordpress%2FVYxj+%28Investment+Postcards+from+Cape+Town%29

    The VIX is still trading in the upper zone of its current trading range (not good); but notice that there is a series of three lower highs which is a positive.

    Here is a great look at the VIX, how it works and what it means (long):
    http://www.investmentpostcards.com/2011/09/19/volatility-%e2%80%93-pulse-of-the-stock-market/?utm_source=feedburner&utm_medium=email&utm_campaign=Feed%3A+wordpress%2FVYxj+%28Investment+Postcards+from+Cape+Town%29


    Fundamental

    David Rosenberg on what is driving this rally (long, but if you are a trader, it is a must read):
    http://www.zerohedge.com/news/forget-operation-twist-rosenberg-says-bernanke-about-shock-everyone-what-about-come

    Update on the Q ratio and market valuation (short):
    http://advisorperspectives.com/dshort/updates/Q-Ratio-and-Market-Valuation.php

    Earnings estimates are coming down (short):
    http://www.bespokeinvest.com/thinkbig/2011/9/16/estimated-sp-500-q3-earnings-growth-drifts-lower.html

Economics

   This Week’s Data

   Other

    Positive news from the oil industry (short):
    http://mjperry.blogspot.com/2011/09/new-report-oil-and-gas-in-united-states.html

    Industrial production, yield spreads and recession (short):
    http://www.capitalspectator.com/archives/2011/09/industrial_prod.html#more

    Household balance sheets continue to improve (short):
    http://scottgrannis.blogspot.com/2011/09/households-balance-sheets-continue-to.html

Politics

Domestic

Charles Krauthammer on social security (medium):
http://www.washingtonpost.com/opinions/a-ponzi-scheme-that-should-be-fixed/2011/09/15/gIQAn6EfVK_story.html

This is as balanced an account on what has occurred at Splendora as I have seen (medium):
http://www.minyanville.com/businessmarkets/articles/solyndra-scandal-solyndra-bankruptcy-solyndra-ipo/9/15/2011/id/36909

International

    Geithner gets a rough reception from the EU finance ministers (short):
    http://www.zerohedge.com/news/europes-response-geithners-advice-id-hear-how-united-states-will-reduce-its-deficits-and-its-de

The Closing Bell 9/17/11

Steve Cook — Sat, 17 Sep 2011 15:27:00 GMT

Statistical Summary

   Current Economic Forecast

    2011

     Real Growth in Gross Domestic Product:        +1.5- +2.5%
    Inflation:                                2-3 %
     Growth in Corporate Profits:                                     7-12%

2012

   Real Growth in Gross Domestic Product:        +1.5- +2.5%
   Inflation:                                   2-3 %
   Growth in Corporate Profits:                                    0-10%

Current Market Forecast

    Dow Jones Industrial Average

      Current Trend (revised):
        Intermediate/Short Term Trading Range 10725-12919
        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):
        Intermediate/Short Term Trading Range    1101-1372
        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                  18%
    High Yield Portfolio                     16%
    Aggressive Growth Portfolio              19%

Economics

The economy is a modest positive for Your Money. The data this week was basically mixed--some good news (mortgage applications, industrial production, consumer sentiment), some bad news (employment, inflation). As you know, this has been the general pattern for the last couple of months. That in itself is not a matter of particular concern to me because it is reflective of our forecast: 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.

As you also know, this is not just our forecast for the next 12 to 24 months but is a scenario that I fear will prevail for at least another five to seven years. Given such a dismal outlook, the risks in this scenario are more heavily weighted to the down side (recession). A primary cause of the prolonged period of sluggish growth and the higher risk of recession is the economic ineptitude of the western world’s political class.

This, of course, is not a new theme for me. Hence, both an extended period of below average secular growth and a second rate political class are reflected in our Economic and Valuation Models. What is not discounted is (1) a ‘double dip’ which I think more probable today than I did a month ago and (2) the EU sovereign debt crisis spreading beyond Greece and inflicting additional damage to US financial institutions’ balance sheets and to the international earnings of US corporations.

The latest ECRI weekly leading index data (short):
http://advisorperspectives.com/commentaries/dshort_91611.php

(1)    I hammer away every week that the administration is completely clueless on economics which is only made worse by its focus on ideology versus results. The GOP isn’t much better. While their rhetoric is more to my liking, their actions in general are as self serving as the dems. Until the voting public stops electing career politicians whose sole objective is to get re-elected and starts to focus on leaders with experience solving problems, I see no way out of the current malaise.

    Manifesting all this is the fact that the economy is as lousy as it is, and yet Obama’s jobs plan is a political not an economic document that has zero chance of enactment while the congress is so dominated by two camps of such ideological purity that no help is likely to come out of this group. Charles Krauthammer argues that this is the workings of democracy at its finest in that each day two theories of how government should be managed are becoming more clearly defined however negative the short term consequences; and this circumstance sets up November 2012 as a pivotal moment in our political history. As a citizen, I may hope that his proposition is true; but as a Market participant, I wonder how much more pain businesses, consumers and investors can endure before throwing in the towel [a recession occurs].

(2)    on a somewhat brighter note, we did get some signs of hope out of the EU this week. On Wednesday, France and Germany basically pledged to back stop the Greek economy for a couple more months IF that country continued to enact austerity measures. Then on Thursday, the ECB along other central banks created a facility to assist EU banks that were having dollar funding problems.

Both of these measures are very short term fixes and in no way address the real issue in the EU--the solvency of several countries and the entire EU banking system. However, there were hints that they were established to get the EU through the autumn vote by the EU member countries to expand the EFSF stability fund and, Angela Merkel’s current resistance notwithstanding, create some form of a Eurobond. These measures would act as a back stop of liquidity, improve the quality of bank liabilities [the TARP like purchase of bad loans] and give the banks a chance to raise equity capital.

In the first paragraph of this section, I referred to ‘some signs of hope’ and at the moment, that is all that the above are [the wet dream scenario]. I would never underestimate the ability of the political class to f*** things up; but at the moment, at least they appear to be headed in the right direction.

Here is another opinion (medium):
http://www.nakedcapitalism.com/2011/09/more-on-the-european-bank-bailout.html

Euro TALF rumors (short):
http://pragcap.com/euro-talf-rumors

Bottom line: the Three Stooges aren’t going to change until the electorate does it for them. Hence, in my opinion, we are stuck with another 12-18 months of a sluggish economy overseen by a second rate political class. The good news is that this is well reflected in our Models. What is not in our Models is a recession. As I have noted, while I believe the odds of such an occurrence are increasing, at present, I think them below 50/50 and hence have made no changes to our forecast.

The other problem that is not properly built into our Models is a multiple country default/restructuring in Europe accompanied by an implosion of their financial system. Until this week, the probability of such a scenario seemed to climb with every passing day. But we did get some positive developments addressing Greek and the EU banking systems liquidity. They by no means will solve the problem; but they were steps and we have to be thankful for that. So to be clear, this risk is not off the table and remains the biggest threat to our forecast. But at the moment, it just isn’t increasing.

This week’s data:

(1)    housing: both weekly mortgage and purchase applications were strong,

(2)    consumer: weekly retail sales were up, while August sales were soft; weekly jobless claims increased versus expectations of a decline [again]; the University of Michigan preliminary September consumer sentiment index was reported at 57.8 versus estimates of 56.5 and August’s final reading of 55.7,

(3)    industry: August industrial production came in above expectations; July business inventories and sales were positive; two regional Fed [New York and Philadelphia] bank September business indices were disappointing,

(4)    macroeconomic: August producer prices were up less than estimates while consumer prices were ‘hotter’ than anticipated; the second quarter budget deficit was less than forecast and the trade deficit improved.

The Economic Risks:

(1)    the economy is weaker 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 Market-Disciplined Investing

Technical

The Averages (DJIA 11509, S&P 1216) had their best week since mid summer and closed within their intermediate term trading ranges (10725-12929, 1101-1372). You will recall that the indices were out of sync coming into the week with the DJIA having broken the lower boundary of its short term up trend while the S&P had not. That nonconfirmation was corrected and both of the Averages are now trading above the lower boundaries of their short term up trends (11289, 1155). As you know, our Portfolios nibbled a bit on Friday and will continue to so in the absence of any meaningful break in trend.

Volume soared on Friday--not unusual for a quadruple witching. Breadth declined a bit, though the flow of funds indicator has started to turn up. The VIX was down again but remains at elevated levels.

GLD had another wild week, closing below the lower boundary of its short term up trend. If it doesn’t recover that level on Monday, our time and distance discipline will confirm it as a break. Nevertheless, GLD following its penetration of the short term up trend lower boundary found support almost immediately and on Friday bounced off of that level. That, of course, is encouraging; but if it doesn’t re-gain its short term up trend and breaks the initial support level, our Portfolios will likely lighten up.

Bottom line:

(1) the DJIA and S&P are in both an intermediate term trading range (10725-12919, 1101-1372) and a short term up trend,

(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 (11509) finished this week about 8.6% above Fair Value (10588) while the S&P closed (1216) 7.0% undervalued (1308).

Stocks as measured by the S&P are undervalued as calculated by our Valuation Model which, as you know, assumes that the economy will only stumble along and that our political class will do nothing but campaign for their re-election from now till November 2012. Not figured into our Model is a ‘double dip’. However, at 7% undervalued, certainly some of the risk of recession is reflected in current prices. Furthermore, were the S&P to return to its August low (and hence remain in the current intermediate term trading range) that would put it circa 15% undervalued; surely that would discount any kind of down turn currently envisioned by Street bears.

Also not included in our Models is a multi country default/restructuring in Europe accompanied by an implosion of its financial system.   As you know, I consider this the biggest risk to our forecast. That is the reason that our Portfolios own a 10% position in gold and 15-18% in cash. Clearly, it could be argued that this is insufficient insurance against the worse case scenario; but my judgment is that when augmented by our trading sell discipline, it is adequate.

However, that judgment only has validity if there is some reason to assume that the Three Blind Mice will somehow muddle through the EU sovereign debt crisis. And to be sure, events in the last six months suggested that the eurocrats have been so inept in dealing with their liquidity/insolvency problems that it seemed that they weren’t even capable of muddling through. The trip wire for me has been if they fail to adopt a reasonable endgame for Greece [which could include an orderly default]; my thinking being that if they can’t handle the problems of a dip sh** country like Greece, how in the world could they manage the default of a Spain or Italy?

Not that a solution for Greece has been found. But as I detailed in the Economics section above, for the first time, this week there was an ever so slight hint that some kind of plan could be formulating. France and Germany are going to bridge Greece for a couple of months ASSUMING its austerity measures continue to make progress. In addition, the ECB with the help of other central banks (read, the Fed) created a facility to assist liquidity strapped banks. These measures appear designed to hold the system together until the member countries individually approve an increase in the size of and the use of the EFSF (bail out) fund to bail out Greece. Implicit in this is that it (along with a controversial Eurobond) would also be used to improve bank asset quality and allow the banks to raise capital.

Let me repeat, a solution to Greece’s financial problems has not been found much less those of larger, not quite so insolvent countries. So I am certainly not getting jiggy with these latest steps. However, the odds that Europe will at least muddle through have gone up; so I am also not going to get more beared up in our investment strategy until the eurocrats prove themselves incapable of managing a reasonable outcome to Greece’s financial dilemma.

This week our Portfolios (1) Sold a portion of their foreign ETF’s and (2) Added to several individual stock positions.

           Bottom line:

(1)    our Portfolios will carry a higher cash balance than pre-financial crisis but it will be more a function of individual stock valuations and less on macro Market technical trends,

(2)    we continue to include gold and foreign ETF’s in our asset mix because we continue to believe that inflation is the major long term risk. An investment in gold is an inflation hedge and holdings in other countries provide a hedge against a weak dollar--although this is becoming problematic as investors flock to the dollar to avoid the EU solvency issue and exposure to better growth opportunities,

(3)    defense is still important.

                                                                             DJIA                    S&P

Current 2011 Year End Fair Value*               10760                  1330
Fair Value as of 9/30/11        10588                    1308
Close this week               11509                 1216

Over Valuation vs.9/30 Close
    5% overvalued                 11117                    1373
    10% overvalued               11646                      1438
    15% overvalued                               12176                     1504


Under Valuation vs. 9/30 Close
    5% undervalued                          10058                      1243
10%undervalued           9529                      1177
15%undervalued                               8999                        1112

* 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.

Another tiny step to a possible solution

Steve Cook — Fri, 16 Sep 2011 12:44:00 GMT

The Market

    Technical

    The Averages (DJIA 11433, S&P 1209) moved up again yesterday, remaining well within their respective intermediate term trading ranges (10725-12919, 1101-1372) and above the lower boundary of their short term up trends (11250, 1152).

    Volume fell; breadth continued to improve. While the VIX fell again, it still closed in the upper zone of its current trading range.

    GLD got whacked, again breaking the lower boundary of its short term up trend but closing right on a clearly defined initial support level. If this holds, our Portfolios will do nothing; if GLD breaks this level, they will likely lighten up.

    Bottom line: yesterday’s pin action was positive and our Portfolios will put some money to work. That said, it took the DJIA long enough to reconfirm the up trend that stocks are a little ahead of themselves, technically speaking. Therefore, our purchases will be relatively small.

    Fundamental

     Headlines

    Yesterday was a huge day for economic data: a hotter than anticipated CPI, lousy employment numbers, disappointing New York and Philadelphia Fed business indices accompanied by one positive stat--August industrial production which was stronger than expected.
    http://www.bespokeinvest.com/thinkbig/2011/9/15/ugly-economic-data.html

These figures had investors bummed out initially; but then as has been the case for the last week or so, news out of Europe took over the headlines. In this case, the ECB announced that with the help of other major central banks (read: the Fed) it would provide a (dollar funding) liquidity facility for the EU financial system (in other words, it provides dollars to meet dollar denominated funding agreements for banks that are having problems borrowing dollars). That eased investor concerns over the short term health of the major banks. To be clear, while it will assist banks meet dollar denominated liquidity requirements, it did nothing correct the longer term problem of their solvency.

Nevertheless, on a short term basis, liquidity is an easier problem to address than solvency. In this case, the ECB/Fed/global monetary authorities are basically saying that they are not going to allow the short term funding needs of the EU banks push them into bankruptcy/restructuring. At the very least this means that we have global leaders all sitting at the same table and acting in unison. At the most, this is another tiny step in the ‘wet dream’ scenario that I put forth in yesterday’s Morning Call: provide sufficient liquidity long enough (until late this fall) for the EU to enact measures (EFSF and a potential Eurobond) that when coupled with capital raises by the banks will allow an orderly solution (i.e. a managed bankruptcy/restructuring for the worse cases and the improvement in bank balance sheets for the less egregious profligates) to the solvency problem ASSUMING (1) the individual countries get their fiscal house in order and (2) all EU member countries can actually enact the proposed rescue plan (EFSF, Eurobond).

To be sure that is a tall order, may in fact never happen and the EU eventually runs off a cliff. But yesterday, it was a gleam in investors’ eyes and that helped push stock prices higher. Understand that I am not saying that this ‘happy’ scenario will occur; I am not even saying that there are at least even odds that it will occur. But the actions of the EU leadership over the last few days suggests that there is at least more than a zero probability that it will happen and that is better than a sharp stick in the eye.
http://www.zerohedge.com/news/walking-maginot-line

Bottom line (straight from yesterday’s Morning Call): ‘while the Greece relief rally continues, it would be irresponsibly naïve to assume that it won’t default on/restructure its debt or that as a result there won’t be some balance sheet destruction in the EU banking system. However, as I have repeatedly noted, I believe that much of this is in the price of stocks. What is not in the price of stocks is (1) that there may be a consensus slowly developing on how to deal with and reform the fiscally promiscuous elements in the EU and the financial fallout from said promiscuity, or (2) the inability of the Three Blind Mice to do anything but kick the can down the road until the EU runs off a cliff. The latter remains the biggest risk to our current forecast; the former, even if we are lucky enough for it to occur, will still present us with some scary headlines that will keep volatility high. So I remain cautious, but I believe that enough risk is in current prices that I am willing to commit funds to stocks that are in their Buy Value Ranges.

    The current strategy of a bottom fisher (medium):
    http://www.marketwatch.com/story/5-money-moves-one-bottom-fisher-is-making-now-2011-09-15

    For the bears amongst you (medium):
    http://www.nakedcapitalism.com/2011/09/bianco-on-earnings-volatility-and-recession.html

      Subscriber Alert

    I want to take advantage of the recent Market strength to reduce the size of several of our foreign ETF’s that (1) got whacked in the recent decline and (2) have not recovered presumably as a result of the rising dollar. If the EU crisis continues to drive investors into the US dollar as a safe haven, then ETF’s with exposure to EU economic malaise with likely remain under pressure. Therefore, at the Market open this morning, our Portfolios are reducing the Wisdom Tree Emerging Markets ETF (DEM) and the ishares EAFI Growth Index Fund (EFG) to one half positions.

    In addition, small additions will be made to the following holdings in the designated Portfolios.

    In the Dividend Growth Portfolio: Federated Investors (FII), Charles Schwab (SCHW), Nucor (NUE), Emerson Electric (EMR) and Paychex (PAYX).

    In the High Yield Portfolio: 3M (MMM), Federated Investors (FII), Mine Safety Appliances (MSA), Emerson Electric (EMR)

    In the Aggressive Growth Portfolio: Blackrock (BLK), Staples (SPLS), Reliance Steel (RS).

    Note: the net affect of these trades will actually raise our Portfolios’ cash position.

     Thoughts on Investing--from David Rosenberg

1. In order for an economic forecast to be relevant, it must be combined with a market call.

2. Never be a slave to the data – they are no substitute for astute observation of the big picture.

3. The consensus rarely gets it right and almost always errs on the side of optimism – except at the bottom.

4. Fall in love with your partner, not your forecast.

5. No two cycles are ever the same.

6. Never hide behind your model.

7. Always seek out corroborating evidence.

8. Have respect for what the markets are telling you.

9. Be constantly aware with your forecast horizon – many clients live in the short run.

10. Of all the market forecasters, Mr. Bond gets it right most often.

11. Highlight the risks to your forecasts.

12. Get the US consumer right and everything else will take care of itself.

13. Expansions are more fun than recessions
(straight from Bob Farrell’s quiver!).

Economics

   This Week’s Data

    The second quarter current account deficit came in at -$118 billion versus expectations of -$122 billion.
    http://mjperry.blogspot.com/2011/09/us-trade-with-rest-of-world-is-always.html

    August industrial production was up 0.2% versus estimates that they would be unchanged; capacity utilization was 77.4 in line with forecasts.
    http://scottgrannis.blogspot.com/2011/09/industrial-production-picks-up.html

    The September Philadelphia Fed general business conditions index was reported at -17.5 versus expectations of -15.0 and August’s reading of -30.7.
    http://advisorperspectives.com/dshort/updates/Philly-Fed-Business-Outlook.php

   Other

    A key metric for corporate profits, inflation and economic growth (short):
    http://advisorperspectives.com/dshort/updates/Profit-Margins-and-Inflation-Risk.php

Politics

Domestic

More poor investments (and accompanying shenanigans) from the White House (medium):
http://michellemalkin.com/2011/09/15/lightsquared-the-next-obama-pay-for-play-morass/

A history lesson from Thomas Sowell (medium):
http://townhall.com/columnists/thomassowell/2011/09/15/back_to_the_future_part_iii

There may be a light at the end of the tunnel, but it is a pen light

Steve Cook — Thu, 15 Sep 2011 12:56:00 GMT

The Market

    Technical

    The indices (DJIA 11246, DJIA 1188) had another good day, closing within their intermediate term trading ranges (10725-12919, 1101-1372). The S&P finished well above the lower boundary of its short term up trend (1151), while the DJIA closed right on the lower boundary of its short term up trend (11246). The latter solves a couple of problems, at least in the short term: (1) under our time and distance discipline, the DJIA’s recent break of its short term up trend is now negated and hence (2) the Averages are no longer out of sync.

That said, prices had been much higher in the early afternoon and were sinking fast into the close which, in turn, raises the possibility that if the Market had been open another 30 minutes, the DJIA would not have finished the day within its short term up trend. So for the sake of caution, I am waiting one more day before calling an ‘all clear’.

Volume was flat on the day; breadth continued to improve. The VIX fell but remains at an elevated level within its current trading range.

GLD slipped and again closed below the lower boundary of its short term up trend. That re-starts our time and distance discipline clock on a break of trend. Our Portfolios are taking no action on this position.

Bottom line: while the pin action was positive yesterday bringing the DJIA back in sync with the S&P and negating the damage of its recent break below the lower boundary of its short term up trend, the final hour of trading gives me pause. So I am waiting one more day before our Portfolios resume nibbling.

    Fundamental

    Lots of economic data released yesterday: weekly retail sales were disappointing though they still look good year over year; mortgage and purchase applications were quite strong, business inventories and sales were positive and August producer prices were not as ‘hot’ as expected. Solidly mixed numbers like this do provide some comfort that the economy is not rolling over.

    That said, all eyes remain focused Europe and there was lots going on. Initially, stocks sold off on a rumor that the Austrian parliament had voted down any participation by that country in a Greek bail out. Later, it was established that the vote had been to simple delay the vote. That took pressure off prices; then we got two developments that investors interpreted positively:

(1)    in an interview at an investment symposium, Geithner stated that there was not way that the EU debt crisis would devolve into another ‘Lehman Bros’.

    Here is the Geithner interview:
    http://video.cnbc.com/gallery/?video=3000045521

(2)    following a conference call, Merkel, Sarkozy and Papandreou announced that Greece remains an integral part of the EU and that Greece commits to implementing the necessary austerity measure to return to solvency. Implicit in this statement is that the EU would provide the necessary near term financing that Greece needs to remain liquid as it attempts to correct its solvency problems--the operative words, as emphasized, being ‘attempts to correct’.

That all sounds great but Greece is simply too far in debt to make full repayment of that debt economically or politically feasible. So don’t get too optimistic. It is still likely to go toes up; it just won’t happen for a while. But there may be the good news scenario. Indeed, it appears that the potential endgame has been scheduled for the late fall: following a vote [hopefully] of all the EU participants approving expansion of the European stability fund [EFSF] that will [perhaps along with what may be a newly created Eurobond instrument] possess TARP-like qualities allowing it to deal with the liquidity issues of Greece [and perhaps other associated PIIGS] and the likely losses in the sovereign debt on member bank balance sheets.

Without getting jiggy with it, this does have the potential to be the solution that fits the assumptions in our Model: Greece goes bankrupt but on a current budget account basis it is covering its expenses; its debts are ‘restructured’ but the sovereign debt losses get covered by an EU agency infusion of liquidity in to the banking system.

Right now, this is just the ‘wet dream’ scenario; but at least the eurocrats appear to have a plan. How likely is it? No clue; but if necessity is indeed the mother of invention, then it may have a chance.

    Bottom line: while the Greece relief rally continues, it would be irresponsibly naïve to assume that it won’t default on/restructure its debt or that as a result there won’t be some balance sheet destruction in the EU banking system. However, as I have repeatedly noted, I believe that much of this is in the price of stocks. What is not in the price of stocks is (1) that there may be a consensus slowly developing on how to deal with and reform the fiscally promiscuous elements in the EU and the financial fallout from said promiscuity, or (2) the inability of the Three Blind Mice to do anything but kick the can down the road until the EU runs off a cliff. The latter remains the biggest risk to our current forecast; the former, even if we are lucky enough for it to occur, will still present us with some scary headlines that will keep volatility high. So I remain cautious, but I believe that enough risk is in current prices that I am willing to commit funds to stocks that are in their Buy Value Ranges.

    The price of Chinese aid (medium):
    http://www.spiegel.de/international/world/0,1518,786287,00.html

    How shadow banking transactions fit into the high risk scenario (medium):
    http://www.zerohedge.com/news/shadow-banking-contagion-approaches-european-banks-sign-private-repo-agreements-us-counterparts


Economics

   This Week’s Data

    July business inventories rose 0.4% versus expectations of a 0.6% increase; more important, business sales were up 0.7%, pushing down the inventory to sales ratio.

    The August consumer price index was up 0.4% versus estimates of up 0.2%; core CPI was up 0.2% as anticipated.

    The New York Fed’s September manufacturing index came in at -8.8 versus forecasts of -3.0.

    Weekly jobless claims rose 14,000 versus expectations of a 4,000 decline.
    http://www.calculatedriskblog.com/2011/09/weekly-initial-unemployment-claims_15.html

   Other

    More analysis of yesterday’s August’s retail sales numbers (medium):
    http://www.capitalspectator.com/archives/2011/09/another_zero_fo.html#more

    An in depth look on why the US economy will grow at a below average secular rate for the foreseeable future (Medium):
    http://advisorperspectives.com/dshort/guest/Lance-Roberts-110914-Great-American-Lie.php

Politics

Domestic

An excellent four minute video featuring Paul Ryan discussing our current tax code:
http://www.powerlineblog.com/archives/2011/09/paul-ryan-on-pro-growth-tax-reform.php

A quiet day that won't last

Steve Cook — Wed, 14 Sep 2011 13:18:00 GMT

The Market

    Technical

    The Averages (DJIA 11105, 1172) experienced at relatively calm day, ending the day well within their respective intermediate term trading ranges (10725-12919, 1101-1372). While prices recovered, the DJIA could not regain the lower boundary of its short term up trend (11185). The S&P remains above its comparable level (1149). Net, net, the indices remain out of sync.

    Volume declined; breadth improved. The VIX fell but closed in the upper zone of its current trading range (not positive).

    Short interest is soaring (short):
    http://www.zerohedge.com/news/nyse-short-interest-soars-highest-july-2009-epic-squeeze-forming-bank-america-shares

    GLD recovered, closing right on the lower boundary of its short term up trend. That negates Monday’s penetration.

    Bottom line: while the DJIA rebounded yesterday, the increase was insufficient to regain the lower boundary of its short term up trend. Under our time and distance discipline, it has two more days before that trend is confirmed as broken. As long as it remains out of sync with the S&P, I am hesitant to commit cash.

    Fundamental

      Headlines

    The ho hum Market performance yesterday at least partially reflected the lack of news flow. In the US, a couple of secondary economic indicators were reported: weekly retail sales which were positive, import/export prices which were favorable and news out of a trucking industry conference (tonnage and pricing are up). In Europe, which has been the volatility trigger of late, there were some modestly positive mumblings out of Angela Merkel and the French banks. Clearly nothing wildly optimistic but good enough to move prices up.

    Bottom line: yesterday witnessed some investor relief that Greece didn’t go bankrupt nor did any of the major EU zone banks. It was welcome but it doesn’t mean that neither will happen. As you know, I believe that the financial demise of Greece and some impairment of the EU banking system are in the price of stocks. But we still have to live through both, at a minimum; and the risk to our Portfolios is that this situation will be worse than I expected. The point here is that the volatility that will be wrought by the occurrence of these events has not gone away even though a Market bottom may have been put in. So I remain cautious in putting cash to work especially with the indices out of sync.

    Can Europe sink the US? (medium):
    http://www.thedailybeast.com/articles/2011/09/12/europe-s-economic-crisis-can-default-in-greece-eurozone-sink-u-s.html

    Dutch finance minister says Greece is going down (medium):
    http://www.zerohedge.com/news/dutch-finance-ministry-says-greek-default-unavoidable-immediately-retracts

    A look at the possible endgame (medium):
    http://www.zerohedge.com/news/jefferies-describes-endgame-europe-finished

Economics

   This Week’s Data

    The International Council of Shopping Centers reported weekly sales of major retailers up 1.3% versus the prior week and up 3.3% versus the comparable period a year ago; Redbook Research reported month to date retail chain store sales up 0.2% versus the similar timeframe last month and up 4.5% on a year over year basis.

    August US import prices declined 0.4% while export prices rose 0.5%.

    Weekly mortgage applications rose 6.3% while purchase applications jumped 7.0%.
    http://www.calculatedriskblog.com/2011/09/mba-mortgage-purchase-application-index_14.html

    The August producer price index was unchanged in line with estimates; core PPI was up 0.1% versus forecasts of up 0.2%.

    August retail sales were unchanged versus expectations of an increase of 0.2%; ex autos sales were up 0.1% versus estimates of up 0.2%.

   Other

    A look at household income (medium):
    http://advisorperspectives.com/commentaries/dshort_91311.php

    A look a global industrial activity. It is not a pretty picture and in my mind raises the odds of a recession here (today’s must read(:
    http://www.investmentpostcards.com/2011/09/14/august-global-pmi-roundup-august-2011-weak-but-still-growing/?utm_source=feedburner&utm_medium=email&utm_campaign=Feed%3A+wordpress%2FVYxj+%28Investment+Postcards+from+Cape+Town%29