Thursday, September 20, 2018

The Morning Call--How low can they go?


The Morning Call

9/20/18

The Market
         
    Technical

The Averages (DJIA 26405, S&P 2907) advanced yesterday but at markedly different rates (Dow up .61%, S&P up .13%; plus the NASDAQ was down).  Still volume was up and breadth finally had a cleanly positive day.  So they remain strong technically; and my assumption is that they will challenge the upper boundaries of their long term uptrends (29807, 3065).

The VIX fell another 8%, catching up to the pin action in the indices.  In doing so, it is approaching the lower boundary of its short term trading range and reversing the recent trend in low volatility as stock prices rise. 

The long bond was down again on big volume, finishing below both moving averages and pretty much confirming Monday’s break of the long term uptrend.  While the lower boundary of its intermediate term trading range is only a couple of points away, given the length the pennant formation that was negated when TLT broke the lower boundary of its uptrend more downside should be expected.  To that end, the new lower boundary of its new long term trading range is 16+ points lower.  Finally, as I have noted repeatedly, I think this a significant event; not just from a technical standpoint, but the fundamental implications of noticeably higher interest rates on almost all asset classes.  It would also be the second sign (the dollar funding problem being the first) of the undoing of the mispricing and misallocation of assets.

The dollar was down fractionally, but still ended above the second very short term higher low.  So it continues to be technically strong.  Its pin action is not likely to change as long as dollar funding problems continue in the emerging markets.
                       
                        ***overnight, the dollar is falling


           GLD was up again (surprise, surprise), but is still the ugliest chart on the block---though it does seem to be trying to build a base.
               
          Bottom line: the indices remain technically strong. I continue to believe that they will challenge the upper boundaries of their long term uptrends. 

         The dollar will likely remain strong until the dollar funding problems are resolved. 

The pin action in TLT remains my main focus.  It appears to have broken a twenty year plus long term uptrend which, as I noted above, has potentially significant fundamental as well as technical implications---not all of which are positive.

Yesterday in the charts.
           
    Fundamental

       Headlines

            Yesterday’s economic stats were somewhat positive: weekly mortgage/purchase applications and the second quarter trade deficit were better than expected while August housing starts were up but building permits down.

            The morons in our ruling class held most of yesterday’s headlines.  I don’t have the words to express just how far I believe that our political process has descended into the toilet.  Ultimately, we will all be hurt whichever side of the political spectrum we are on.

            Putting the political process aside, there are two more easily quantifiable problems created by our ruling class---which I have harped on endlessly are:
           
(1)   putting our heads in the sand about the national debt is not a solution (medium):

(2)   central bankers have planted the seeds of the next financial crisis (medium):

            The Fed and the yield curve (medium):


                        Bottom line:  irrespective of whether the DOJ/FBI emails/memos are redacted, what our president’s d**k looks like or how deep in sewer our political class will go to advance their agenda, I believe that (1) fiscal policy is digging the country into such a deep debt hole and (2) the Fed has so crippled price discovery that sooner or later the securities’ markets will be penalized.

               ***overnight, Turkey’s new economic plan (medium):

                    ***China said that it is planning to cut the average tariff rates on many products             its major trading partners.

    News on Stocks in Our Portfolios
 
           
Economics

   This Week’s Data

      US

            Weekly jobless claims fell 3,000 versus expectations of a rise of 6,000.

            The September Philadelphia Fed manufacturing index came in at 22.9 versus estimates of 19.6.

     International

    Other
              
               Iranian oil sanctions appear to be working (medium):

               August architectural billings rebound (short):

              

What I am reading today

           

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Wednesday, September 19, 2018

The Morning Call--An olive branch?


The Morning Call

9/19/18

The Market
         
    Technical
                 
The Averages (DJIA 26246, S&P 2904) had a great day on slightly higher volume and mixed breadth (a bit unusual on a day of big price movement).  They remain strong technically; and my assumption is that they will challenge the upper boundaries of their long term uptrends (29807, 3065).

The VIX fell 6 ½ %.  I noted in yesterday’s Morning Call that the VIX spiked an unusual amount (13 ½ %) for a 100 point Dow down day.  Well, it declined only half as much (6 ½ %) yesterday in which the Dow was up 184 points.  I don’t want to make too much out of two days’ trading; but if it continues to be more volatile to the upside than the downside, it suggests a growing negative bias in the Market---which is supported by the weak breadth of late.

The long bond was hammered on big volume, finishing below its 200 DMA (now resistance), its 100 DMA (now resistance), and within a newly reset long term trading range (at least officially).  If there is any kind of additional follow through today, it seems that this time the break of its long term uptrend has happened (versus the six prior occasions this year).  That has implications for the dollar (if investors [think China] are selling bonds, they are also likely selling dollars; on the other hand, if higher Treasury yields attract foreign capital, that would be a plus), gold (higher interest rates are not good for gold), stocks (a rising bond yield tends to make stocks less attractive on a total return basis) and the economy (especially if the yield curve is flattening/inverting which it is).

            Bond yields are becoming increasing attractive viz a viz stock yields (medium):

The dollar was up, ending above the second very short term higher low.  So it continues to be technically strong.  Its pin action is not likely to change as long as dollar funding problems continue in the emerging markets.
                       

           GLD was up, but is still the ugliest chart on the block---though it does seem to be trying build a base.
               
          Bottom line: the indices remain technically strong. I continue to believe that they will challenge the upper boundaries of their long term uptrends. 

         The dollar will likely remain strong until the dollar funding problems are resolved. 

The pin action in TLT is my main focus.  Its price performance over the last week is pointing at the end of a twenty year plus bond bull market and that is going to force investors to re-gear their Market assumptions and valuation models.

            Tuesday in the charts.

    Fundamental

       Headlines

Yesterday’s economic data was mixed: month to date retail chain store sales grew slower than in the prior week while the September housing index came in line.

The focus of the headlines of the day returned to trade.  As China said it would, it immediately responded to Trump’s tariff hike on Chinese goods by raising tariffs on US goods.  But like the US, it reduced the initial tariff rate. 

If you believe the Donald, that ‘automatically’ triggers an additional $267 billion in tariffs on China.  So ostensively, the US/China trade war escalated. 

However, the Street was focused on the US and China scaling back their initial tariff rates.  The reasoning being that they are olive branches and a sign of de-escalation.  We will get a sense of that soon since US/Chinese talks are scheduled to resume this week.  That said, I remain convinced that the Chinese will do nothing ahead of the November elections (unless, of course, they offer some ostensively sweet deal [but decline to stop stealing our technology] to Trump that would help the GOP in November and he accepts).  The Chinese are great chess players; so I wouldn’t be getting jiggy just yet.

            Bottom line: as you know, I have been a believer in Trump’s trade strategy (though his style a bit boorish).  Long before Trump ever showed up on the scene, I have railed about the Chinese theft of US technology.  So I am not bothered by a rough, tumble and extended negotiating process.  I just think that it is going to take longer than what seems to be current consensus.

            That said, I also believe that (1) fiscal policy is digging the country into a debt hole and (2) the Fed has so crippled price discovery that a positive resolution in trade won’t be able to offset those factors.    

            The latest results from the BofA Fund Manager Survey (medium):

    News on Stocks in Our Portfolios
 
Microsoft (NASDAQ:MSFT) declares $0.46/share quarterly dividend, 9.5% increase from prior dividend of $0.42.

Economics

   This Week’s Data

      US

            Month to date retail chain store sales grew slower than in the prior week.

            The September housing market index was reported at 67, in line with projections.

            Weekly mortgage applications rose 1.6% while purchase applications were up 0.3%.

             August housing starts rose 9.2% versus expectations of up 6.0%; permits fell 5.6% versus estimates of a slight increase.

             The second quarter trade deficit was $101.5 billion versus forecasts of $104.0 billion.

     International

            The Bank of Japan met and left rates as well as its bond buying program unchanged.

            The August Japanese trade deficit was twice that of the July number.

            August UK retail prices rose 3.5% versus consensus of 3.2%.

    Other

            Fed likely to raise rates next week (medium):

                Nine facts about inflation (short):

What I am reading today

            Three surprising social security benefits (short):

                The tale of Jesus’s wife (long and very interesting):
           
How to do apolitical analysis (medium):
           
North Korea promises to dismantle key missile facilities (medium):


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Tuesday, September 18, 2018

The Morning Call---Trump ups the ante, Markets snooze


The Morning Call

9/18/18

The Market
         
    Technical

The Averages (DJIA 26062, S&P 2888) retreated yesterday on flat volume and mixed breadth.  However, they remain strong technically; and my assumption is that they will challenge the upper boundaries of their long term uptrends (29807, 3065).

The VIX spiked 13 ½ %---a lot more than normally expected on a day in which the Dow is down 100 points.  In doing so, it ended back above its 100 DMA (now resistance; if it remains there through the close on Wednesday, it will revert to support) but remained below its 200 DMA (now resistance). This see sawing around the middle of its short term trading range as stock prices are rising is making it less valuable as a directional indicator. 

The long bond was unchanged, finishing below its 200 DMA (now resistance), its 100 DMA (now resistance), and the lower boundary of its long term uptrend for a fifth day, resetting to trading range (at least officially).  As I noted several times last week, TLT has already challenged, some successfully, this boundary a number of times over the last twelve months and subsequently regained the lower boundary of its long term uptrend.  Given this poor recent record of marking the break of the TLT long term uptrend, my reset of trend call is a weak one.  I am waiting for a longer follow through than normal before concluding that TLT’s long term uptrend is over.

The dollar fell, but remained above the second very short term higher.  So it continues to be technically strong and.  Its pin action is not likely to change as long as dollar funding problems continue in the emerging markets.
                       

           GLD was up, but is still the ugliest chart on the block.
               
          Bottom line: the indices remain technically strong. I continue to believe that they will challenge the upper boundaries of their long term uptrends. 

The dollar will likely remain strong until the dollar funding problems are resolved. 

The pin action in TLT is my main focus.  Even though I am being cautious in calling a break in its long term uptrend, it is still a break.  And if it is indeed marking the end of the huge bull market (declining interest rates) in bonds, there are significant implications in all the other Markets. 

            Yesterday in the charts.

    Fundamental

       Headlines

We started the week with a poor datapoint: the NY Fed’s September manufacturing index came in well below estimates.

Investors remain focused on the emerging markets dollar funding problem---here is a good discussion of it happened: (medium):
      
            As had been anticipated, Trump upped the ante in the trade dispute with China.  Last night, he imposed tariffs on $200 billion of imported Chinese goods.  Of note (1) the tariffs start at 10% but will rise to 25% in January 2019 if no progress is made.  From a macroeconomic point of view that would add only single digit tens of a percent to CPI.  So this is not a punishing move for the US consumer, (2) about $180 million in imports were actually removed from the original list, (3) Trump threatened to add another $267 billion in tariffs if China retaliates and (4) the Chinese immediate response was fairly calm.

            Part of the problem is the Chinese refusal to negotiate; most likely their motive is to wait to see the mid-term election results---which could determine how strong a hand Trump has to play (an expression of disapproval from the electorate could not only result in a change of control in the house but weaken his moral authority).  So the ‘trade war’ with China likely isn’t going anywhere until after November 7th.

Here is Goldman’s take (medium):

           Bottom line: we keep getting reminded that the economy is not as strong as Market narrative portrays---that will eventually show up is disappointing earnings.   We keep getting reminded that the Fed’s unwinding of QE is causing problems for weak credit borrowers as they struggle to service loans that they shouldn’t have taken out in the first place---that eventually will show up strained bank balance sheets/liquidity and slowing US overseas sales.  We keep getting reminded that the trade issues are not going away anytime soon---that eventually will show up in slower economic growth if not resolved.  None of these circumstances need be ruinous to the economy.  But eventually they will likely alert investors that they are paying too much for future earnings. 

           I believe the risk/reward tradeoff in equity prices weighs heavily on risk.  Accordingly, I want to own some cash when equities mean revert.

            A recovery based debt funding isn’t a recovery at all (medium):

            Stock valuation hinges on interest rates and inflation (medium):

            Today’s look back at the financial crisis (medium):

            The latest from David Stockman (medium):

    News on Stocks in Our Portfolios
 
Mastercard (NYSE:MA) declares $0.25/share quarterly dividend, in line with previous.
           
Oracle (NYSE:ORCL): Q1 Non-GAAP EPS of $0.71 beats by $0.02.
Revenue of $9.19B (+1.0% Y/Y) misses by $120M.

Oracle (NYSE:ORCL) declares $0.19/share quarterly dividend, in line with previous.
General Mills (NYSE:GIS): Q1 Non-GAAP EPS of $0.71 beats by $0.07; GAAP EPS of $0.65.
Revenue of $4.09B (+8.5% Y/Y) misses by $30M.


Economics

   This Week’s Data

      US

     International

    Other

            The latest on student loans (medium):

            The latest look at the big four economic indicators (medium):
           
Hotel occupancy rates are declining (short):

What I am reading today

            Beware of those selling private equity funds (medium):

            Waffle House and risk management (medium):

            Quote of the day (short):

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Monday, September 17, 2018

Monday Morning Chartology


The Morning Call

9/17/18

The Market
         
    Technical

              Nothing in the S&P’s chart even hints that it won’t challenge the upper boundary of its long term uptrend.
                                


              The long bond had a bad week and is now on the cusp of breaking a long term uptrend that is twenty plus years old.  Under my time and distance discipline, that challenge becomes successful today if TLT can’t regain the lower boundary of that long term uptrend.  That said, as you can see, it has unsuccessfully challenged this boundary six times this year alone---though, to be sure, several of those challenges lasted longer than normal.  This is by far the most important chart to watch at the moment because of the economic and Market implications of a break of that uptrend which would presage a move towards much higher in rates.



             The dollar also had a rough week but managed to bounce on Friday on big volume, making a second higher low.  Viz a viz its moving averages and its short term uptrend, it remains strong technically.  As you know, I believe that it will continue to do so as long as dollar funding problems persist.



             This would be laughable if it weren’t so sad.  Clearly, gold investors believe interest rates are going higher.



            The VIX traded back below its 100 and 200 DMA’s last week and appears headed for another challenge of the lower boundary of its short term trading range.  It is supporting a move higher in equities.



    Fundamental

       Headlines

            It keeps getting worse in Turkey (medium):

    News on Stocks in Our Portfolios
 
           

Economics

   This Week’s Data

      US

            The September NY Fed manufacturing index was reported at 19 versus expectations of 23.

     International

    Other

What I am reading today

           

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Saturday, September 15, 2018

The Closing Bell


The Closing Bell

9/15/18


Statistical Summary

   Current Economic Forecast
                       
2018 estimates (revised)

Real Growth in Gross Domestic Product                          1.5-2.5%
                        Inflation                                                                          +1.5-2%
                        Corporate Profits                                                                10-15%

   Current Market Forecast
           
            Dow Jones Industrial Average

                                    Current Trend (revised):  
                                    Short Term Trading Range                      21691-26646
Intermediate Term Uptrend                     13628-29833
Long Term Uptrend                                  6410-29847
                                               
2018     Year End Fair Value                                   13800-14000

            Standard & Poor’s 500

                                    Current Trend (revised):
                                    Short Term Uptrend                                     2636-3407
                                    Intermediate Term Uptrend                         1308-3122                                                          Long Term Uptrend                                     905-3065
                                                           
2018 Year End Fair Value                                       1700-1720         


Percentage Cash in Our Portfolios

Dividend Growth Portfolio                          59%
            High Yield Portfolio                                     55%
            Aggressive Growth Portfolio                        55%

Economics/Politics
           
The Trump economy is providing a slight upward bias to equity valuations.   The data flow this week was mixed: above estimates: weekly purchase applications, weekly jobless claims, September preliminary consumer confidence, the August small business confidence index; below estimates: weekly mortgage applications, month to date retail chain store sales, July wholesale inventories/sales, July business inventories/sales, August budget deficit; in line with estimates: August/revised July retail sales, August industrial production, August PPI and CPI, August import/export prices.

Primary indicator were also mixed: August/revised July retail sales (0), August industrial production (0) and August PPI/CPI (0).  So I rate this week a neutral.   Score: in the last 153 weeks, fifty-one were positive, seventy-one negative and thirty-one mixed.

            Two comments:

(1)   I rated the August PPI/CPI and import/export price reports neutral because they are a double edged sword.  On the one hand, lower prices are great for us paeans, but they are also a sign of a weak economy. The $64,000 question is, what does the Fed do with this information?

(2)   given the strength on the second quarter GDP [and revisions], I am increasing my forecast for real GDP growth in 2018 from 1.5%-2.5% to 2%-3%.  But that is simply the recognition of a one-time pop in the economy brought on by the tax cuts.  It in no way alters my outlook for the long term secular growth rate of the economy.
          
The numbers from overseas this week were mixed, continuing the trend of mixed to negative stats.  That means our own economy is losing that as a tailwind.

Our (new and improved) forecast:

A pick up in the long term secular economic growth rate based on less government regulation. There is the potential that Trump’s trade negotiations could also lead to an improvement in our long term secular growth rate,  The agreement with Mexico is clearly a step in that direction.  Further, the Canadians made noises this week suggesting our trade issues with them could be resolved.  However, that still leaves the EU, China and now Japan.  So a lot is left to be done before raising my assumption of the US long term secular  growth rate.

Moreover, the tax cut and spending bills, as they are now constituted, are negative for long term growth (you know my thesis: at the current high level of national debt, the cost of servicing the debt more than offsets any stimulative benefit); and we got news this week that the deficit is growing faster than anticipated.

On a cyclical basis, while the second quarter numbers were definitely better than the first, there is insufficient evidence at this moment to indicate a strong follow through.  So my current assumption remains intact---an economy struggling to grow.  
                       

       The negatives:

(1)   a vulnerable global banking system.  

‘The overseas dollar funding problems [the necessity to buy dollars to service/refinance current dollar denominated debt] continue to grow as more countries are having problems.  This issue impacts the banks because they own a major portion of the debt that is being serviced/refinanced.  If that debt goes into default, then the banks’ balance sheets/capital account takes a direct hit and that would in turn [a] impede lending and [b] weaken their solvency, making their own debt more difficult to service/refinance. 

The global economy has had crises brought on by dollar funding problems twice in the last thirty years.  The results were not pretty.  To date, we are not in as extreme a circumstance; but we are clearly moving in that direction.’

(2)   fiscal/regulatory policy. 

Trade talks initially took a turn for the better this week with [a] Canadians seemingly willing to compromise on dairy imports and [b] the Chinese initiating a charm offense and the US responding in kind.  Then on Friday, Trump spoiled the party, instructing aides to proceed with the $200 billion in tariffs against China.

While clearly a disappointment, I reiterate my thesis that resolving the outstanding issues with Canada, the EU and China will be a plus for the long term secular economic growth rate of the US.

On a more discouraging note, the CBO forecasted that the US budget deficit would hit $1 trillion in this fiscal year which was then pretty much confirmed when the Treasury reported a huge jump in August budget deficit .  My bottom line here hasn’t changed: a rising budget deficit/national debt are deterrents to economic growth.  The risk being that the positive accomplishments by Trump [deregulation, potentially fairer trade] will be offset by the country’s inability to service its debt and grow at the same time.
              
(3)   the potential negative impact of central bank money printing:  The key point here is that [a] the Fed has inflated bank reserves far beyond any comparable level in history and [b] while this hasn’t been an economic problem to date, {i} it still has to withdraw all those reserves from the system without creating any disruptions---a task that I regularly point out it has proven inept at in the past and {ii} it has created or is creating asset bubbles in the stock market as well as in the auto, student and mortgage loan markets.  

The misallocation of assets problem continues to reveal itself in the emerging market dollar funding problem.  These difficulties will likely spread as the Fed continues to unwind QE [which its representatives insist it will and which the narrative in this week’s latest Beige Book supports] and the federal government continues to run ever higher deficits [which it is doing].

This week, it clearly manifested itself in Turkish central bank’s move to raise interest rates by over 600 basis points [dramatically higher rates hopefully encourages inflows to the Turkish lira which in turn provides the funds to service the country’s dollar denominated debt].  While that may solve its dollar funding problem, it clearly won’t be a stimulus to the economy [higher borrowing rates].  Less dramatic but still notable, the Russian central bank also increased rates to stem the depreciation of its currency and the rise of inflation.

Don’t cry for me, Argentina.

In other central bank news, both the Bank of England and the ECB met and both left rates unchanged.  In the ECB’s case, its accompanying narrative reiterated its intent of leaving rates unchanged through mid-2019 but will continue to unwind its QE by lessening bond purchases through the end of the year and suspending them thereafter. No mention was made of when sales might begin.  Nevertheless, given the size of the ECB bond buying program, the cessation of liquidity injections is a big step toward ending QE.

As you know, my thesis is that ending QE will have little impact on the US economy but cause pain for the Markets whenever and however it unwinds.    

The hubris of the Fed (medium):

(4)   geopolitical risks:  not much news this week, though North Korea, Iran/Middle East, Brexit, Italy and Russia hang in the background as potential sources of economic/military disruptions.

(5)   economic difficulties around the globe.  Another week of mixed results:

[a] July EU industrial production declined more than expected,

[b] the August Chinese trade surplus with the US hit a record high; both August PPI and CPI came in above estimates, retail sales were ahead of forecasts, industrial production was in line and fixed asset investment was a disappointment,

[c] Q2 Japanese GDP growth was the strongest in three years.

            Bottom line:  on a secular basis, the US long term economic growth rate could improve based on decreasing regulation.  In addition, if Trump is successful in revising the post WWII political/trade regime, it would almost certainly be an additional plus for the US long term secular economic growth rate.  ‘If’ remains the operative word though clearly the US/Mexico agreement is a positive step.

At the same time, these long term positives are being offset by a totally irresponsible fiscal policy.  The original tax cut, increased deficit spending, a potentially big infrastructure bill and funding the bureaucracy of a new arm of military (space force) will push the deficit/debt higher, negatively impacting economic growth and inflation, in my opinion.  Until evidence proves otherwise, my thesis remains that cost of servicing the current level of the national debt and budget deficit is simply too high to allow any meaningful pick up in long term secular economic growth.

Cyclically, growth in the second quarter sped up, helped along by the tax cuts.  At the moment, the Market seems to be expecting that acceleration to persist.  I take issue with that assumption, based not only on the falloff in global activity but also the lack of consistency in our own data and the never ending expansion of debt.

The Market-Disciplined Investing
         
  Technical

The Averages (DJIA 26154, S&P 2904) ended basically flat after a roller coaster day.  Volume fell; breadth was mixed.  They remain strong technically; and my assumption is that they will challenge the upper boundaries of their long term uptrends (29807, 3065).

The VIX was down again, ending below its 200 DMA (now resistance) and its 100 DMA (now resistance).  It now appears poised to challenge the lower boundary of its short term trading range (which it has already done three times this year).  That generally supports higher equity prices. 

The long bond declined, finishing below its 200 DMA (now resistance), its 100 DMA (now resistance), and the lower boundary of its long term uptrend for a fourth day (if it remains there through the close next Monday, it will reset to a trading range).  Clearly, TLT is at a potentially critical level.  All I can do is wait for follow through.  That said, it has challenged this boundary six times in the last year, so I will wait for a longer follow through than normal before concluding that TLT’s long term uptrend is over.

The dollar was up on good volume, remaining technically strong and making a second very short term higher low.  Its pin action is not likely to change as long as dollar funding problems continue in the emerging markets.

           GLD was down (pitifully), making it the ugliest chart on the block.
               
          Bottom line: the indices remain technically strong. I continue to believe that they will challenge the upper boundaries of their long term uptrends. 

The dollar will likely remain strong until the dollar funding problems are resolved. 

The pin action in TLT is my main focus because if the long term uptrend breaks, pointing to much higher rates, that will have implications in all the other Markets. 

                Friday in the charts.

Fundamental-A Dividend Growth Investment Strategy

The DJIA and the S&P are well above ‘Fair Value’ (as calculated by our Valuation Model).  However, ‘Fair Value’ is being positively impacted based on a new set of regulatory policies which should lead to improvement in the historically low long term secular growth rate of the economy.  A further increase could come if Trump’s drive for fairer trade is successful.  On the other hand, a soaring national debt and budget deficit are negatives to long term growth and, hence, ‘Fair Value’.

At the moment, the important factors bearing on corporate profitability and equity valuations are:

(1)   the extent to which the economy is growing.  Clearly, the second quarter GDP number was a sign of improved growth.  However, that is a single stat and in no way implies a trend.  Indeed, most Street estimates for third quarter GDP growth are lower than that of Q2.  Unless the tax cuts alter investing and consumption behavior on a more permanent basis, Q2 growth will likely prove to be an outlier.  Furthermore, the effect that those tax cuts are, at least presently, having on the deficit/debt {see above} are just as meaningful, in my opinion, as any growth implications, to wit, the servicing of that debt will constrain growth.

My conclusion remains that while the economy is growing, it simply isn’t growing as rapidly as many think.  On the other hand, as you know, I have never thought that the economy was going into a recession.  And while there clearly is some probability of a meaningful pick up in the long term secular growth rate of the economy [deregulation, trade], I am not going to change a forecast, beyond what I have already done, based on the dataflow to date or the promise of some grand reorientation of trade.

Also, lest we forget, the growth rate in rest of the global economy is starting to slow and will not be helped by the decelerating effects of the dollar funding problems in the emerging market.  That can’t be good for our own prospects.  It is certainly possible, even probable, that the US can continue to growth if the rest of the world slows.  But it is not likely that its growth rate will accelerate.  

My thesis remains that the financing burden now posed by the massive [and growing] US deficit and debt has and will continue to constrain economic as well as profitability growth.

In short, the economy is not a negative but it not a positive at current valuation levels.

(2)   the success of current trade negotiations.  If Trump is able to create a fairer political/trade regime, it would almost certainly be a plus for secular earnings growth.  Clearly, the US/Mexico agreement is a step in that direction.  In addition, this week, Canada made some positive sounds with regard to resolving its trade issues with the US; but as of this moment, there has been no new developments. 

As I noted above, China and the US were making nicey nice over the air waves early this week; then Trump dropped a turd in the punchbowl, issuing instruction to proceed with the imposition of $200 billion in tariffs on Chinese goods.  This, of course, is just a repeat of what happened two weeks ago, when everyone got all atwitter over potential talks that promptly fell flat.  In spite of all this, I, perhaps foolishly, remain hopeful that the Donald’s current negotiating strategy will pay off; however, the risks and rewards associated with failure and success are very high.  Either outcome would almost surely have an impact on corporate earnings and, probably, on stock prices,

(3)   the rate at which the global central banks unwind QE.  At present, it is happening.  Given the recent comments from various Fed members, it seems likely to continue at least in the US.  As I noted above, the ECB is on track to cease bond purchases by the end of this year.  While not removing excess liquidity in the global money supply, it will not be contributing to it.  And that is a start. In the meanwhile, the central banks of several emerging markets have been forced to raise interest rates as the dollar funding problem persists.   I remain convinced that [a] QE has done and will continue to do harm to the global economy in terms of the mispricing and misallocation of assets, [b] sooner or later that mispricing/misallocation will be reversed---and the dollar funding problem is the first material sign that it is happening and [c] given the fact that the Markets were the prime beneficiaries of QE, they will be the ones that take the pain of its demise. 

(4)   finally, valuations themselves are at record highs based on the current generally accepted economic/corporate profit scenario which includes an acceleration of economic growth [which I consider wishful thinking].  Even if I am wrong, there is no room in those valuations for an adverse development which we will inevitably get.

Bottom line: a new regulatory regime plus an improvement in our trade policies should have a positive impact on secular growth and, hence, equity valuations.  On the other hand, I believe that fiscal policy will have an opposite effect on economic growth.  Making matters worse, monetary policy, sooner or later, will have to correct the mispricing and misallocation of assets---and that will be a negative for the Market.

Our Valuation Model assumptions may be changing depending on the aforementioned economic tradeoffs impacting our Economic Model.  However, even if tax reform proves to be a positive, the math in our Valuation Model still shows that equities are way overpriced.  That math is simple: the P/E now being paid for the historical long term secular growth rate of earnings is far above the norm.

                As a long term investor, with equity valuations at historical highs, I would want to own some cash in my Portfolio; and if I didn’t have any, I would use any price strength to sell a portion of my winners and all of my losers.

                As a reminder, my Portfolio’s cash position didn’t reach its current level as a result of the Valuation Models estimate of Fair Value for the Averages.  Rather I apply it to each stock in my Portfolio and when a stock reaches its Sell Half Range (overvalued), I reduce the size of that holding.  That forces me to recognize a portion of the profit of a successful investment and, just as important, build a reserve to buy stocks cheaply when the inevitable decline occurs.

DJIA             S&P

Current 2018 Year End Fair Value*              13860             1711
Fair Value as of 9/30/18                                  13764            1698
Close this week                                               26154            2904

* 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. 

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 50 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 Investing  for Survival, Steve hopes that his experience can help other investors build their wealth while avoiding tough lessons that he learned the hard way.