The Closing Bell
7/22/17
Statistical
Summary
Current Economic Forecast
2016 actual
Real
Growth in Gross Domestic Product 1.6%
Inflation
(revised) 1.6%
Corporate Profits (revised) 4.2%
2017 estimates
(revised)
Real
Growth in Gross Domestic Product -1.25-+0.5%
Inflation +.0.5-1.5%
Corporate
Profits -15-0%
Current Market Forecast
Dow
Jones Industrial Average
Current
Trend (revised):
Short
Term Uptrend 20479-22990
Intermediate Term Uptrend 18467-25716
Long Term Uptrend 5751-24198
2016 Year End Fair Value 12600-12800
2017 Year End Fair Value
13100-13300
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Uptrend 2392-2694
Intermediate
Term Uptrend 2167-2961
Long Term Uptrend 905-2763
2016 Year End Fair Value
1560-1580
2017
Year End Fair Value 1620-1640
Percentage
Cash in Our Portfolios
Dividend Growth
Portfolio 59%
High
Yield Portfolio 55%
Aggressive
Growth Portfolio 55%
Economics/Politics
The Trump
economy is providing an upward bias to equity valuations. By
volume, the data flow this week slightly weighed to the negative: above
estimates: weekly mortgage and purchase applications, June housing starts and
building permits, weekly jobless claims and June leading economic indicators;
below estimates: the July housing index, month to date retail chain store
sales, the July NY and Philly Fed manufacturing indices, June import/export
prices; in line with estimates: none.
However, the
primary indicators were positive: June housing starts (+) and June leading
economic indicators (+). I score this
week a plus: in the last 93 weeks, twenty-nine were positive, fifty-one
negative and thirteen neutral.
Overseas, the
numbers were also upbeat with a second week of encouraging data from
China. It is too soon to get jiggy over
this; and we have to keep in mind that these guys lie a lot. That said, if this trend towards an improving
economy continues, I will have to remove China from the global ‘muddle through’
scenario, which would in turn spell the demise of that part of our forecast.
With respect to fiscal policy reform the news
was mixed. The senate failed in its
attempt at healthcare reform though both senate majority leader McConnell and
Trump are pressing for a solution (-). McConnell
has proposed an outright repeal of Obamacare (with a two year delay to provide
time for ‘replace’ legislation). The
initial senate response was not good; plus the CBO scored an outright ‘replace’
bill very negatively.
In addition, the
house presented its FY2018 budget proposal (but only a portion of the necessary
legislation) which was long on hopeful rhetoric and short on math (0). The CBO will be a better arbiter of that than
I.
The US released
its blueprint for the renegotiation of NAFTA.
It also began and ended trade talks with China with disappointing
results. But Trump continues to press
forward with reform in those areas that he controls.
Finally, the Fed
(thankfully) was mute this week; but the ECB and BOJ both had meetings and both
remained firm in their QEInfinity policies.
Bottom line: this
week’s US economic stats were constructive.
But clearly one week does not a trend make. That said, if the Chinese economy joins the
EU in renewed growth that should have a positive impact on the US. Still, it is way too soon to be contemplating
any change in our forecast. Longer term, I remain confident in my recent
upgrading our long term secular growth rate assumption by 25 to 50 basis points
based on Trump’s deregulation efforts as well as his more reasoned approach to
trade. However, any further increase in
that long term secular economic growth rate assumption stemming from enactment of
the Trump/GOP fiscal policy is still on hold as they struggle to get anything
done.
Our (new and
improved) forecast:
A positive pick
up in the long term secular economic growth rate based on less government
regulation. This increase in growth
could be further augmented by pro-growth fiscal policies including repeal of
Obamacare, tax reform and infrastructure spending; though the odds of that are
uncertain.
Short term, the economy has seemingly lost its
post-election Trump momentum meaning that our former recession/stagnation
forecast is back as the current expansion seems to be dying of old age.
It is important
to note that this forecast is made with a good deal less confidence than normal;
so it carries the caveat that it will almost surely be revised.
The
negatives:
(1)
a vulnerable global banking system. Nothing this week.
(2)
fiscal/regulatory policy. This week:
[a] Trump
can’t shake off the Russian connection/Comey firing problems. This week it got worse as the special
prosecutor has expanded his investigation to include Trump’s business
dealings. As I noted previously,…while it is not at all clear how much
substance there is to the multiple accusations, in the best case where all are
innocent, the opposition is still going to hang on to the prospect of delaying
the Trump/GOP fiscal agenda like a dog to a soup bone. In politics, one never knows what the next
turn will bring; but at the moment its advantage dems which means lower odds of
success of the Trump/GOP effort to alter the inefficient economic model this
country has been operated on for the past sixteen years,
[b] as you know, the senate version of the healthcare
bill had to be withdrawn for lack of support.
Clearly this is a setback for the rationalization of our costly,
inefficient healthcare system. Later, McConnell said that he would introduce a
straight ‘repeal’ of Obamacare {with a two year delay to allow for the
‘replace’ element} which was met with more opposition. There is a question as to whether all those
senators that voted seven times to ‘repeal and replace’ during Obama’s reign
will vote against it this time {which is clearly McConnell’s point}. Not helping matters the CBO scored a straight
‘repeal’ vote a disaster.
In addition, Trump is trying to do his part by
conferencing with the entire senate GOP.
Though I will say that he if wanted ‘repeal and replace’ as much as he
said that he did, he could have been doing a lot more, a lot sooner.
I still have hope that the DC sausage factory will
generate something workable and more effective than what we have now. But clearly there is little to be optimistic
about on this issue at this point.
[c] in the wake of the CBO scoring Trump’s FY2018 budget {estimated
revenue increases---too optimistic; the cost reductions, OK}, the house
released its own version of a FY2018 budget.
Or more properly said, its partially documented version. Speaker Ryan insists that there is more
consensus within the GOP house about taxing and spending than on healthcare. I would like to believe that. But I think patience is in order.
[d] in those cases where Trump is free to act,
progress continues:
{i} trade agreements with NAFTA and China continue,
with the latter being a bit more contentious,
{ii} deregulation efforts are generating successful results
(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.
This week,
center stage was held by the meetings of the Bank of Japan and the ECB; and
they both took a page from the Fed’s playbook---keep them guessing. In the case of the former, a BOJ official
prior to its gathering suggested that the bank would abandon its 2% inflation
objective; but at the meeting, the BOJ simply moved out the timing of achieving
that goal and reiterated its devotion to QEInfinity
As for the ECB,
it too ran an official out to make dovish comments following an earlier hawkish
narrative, then at the meeting made both hawkish and dovish statements, leaving
policy unchanged.
If you think
our political class is making a mess of things, the central bankers make them
look like pikers---and they don’t have to worry about political
compromise. They remind me of my
daughter when she was a teenager. My wife
and I used to laugh saying that every day when she woke up, she would sit on
the bed and ask herself ‘what can I do to f**k up my life today?’ and then she
would go out and do it. The only
difference is, the bankers are f**king the entire economic system [i.e. price
discovery] up.
(4) geopolitical
risks: the bad news is the hot spots in North Korea and the Middle East remain;
the good news is that both were relatively quiet this week. Nothing
may come of any of these problems; but they all pose a risk which we must
remain aware of.
(5)
economic difficulties around the globe. The stats continued upbeat out of Europe this
week. Plus Chinese numbers improved for
a second week in a row.
[a] UK CPI and retail sales were above expectations,
[b] Chinese second quarter GDP, retail sales and
factory output were better than anticipated,
[c] the June Japanese trade balance was disappointing.
Oil remains a
factor in global economic health and its price continued its roller coaster
ride. The main factors playing on price being
inventories, rig counts and the inability of OPEC to make production cuts
stick---this week, Ecuador said that it would not abide by the agreement. The point here is that since energy is a
major component of production, its price usually has a significant impact on
economic growth; and lower prices have proven not to be an ‘unmitigated
positive’.
In sum, our
outlook remains that the European economy is out of the woods. China seems to be improving. If that trend continues [and there is no
indication of data fudging], I will likely remove it from our global ‘muddle
through’ scenario; indeed, it will necessitate the elimination of this factor
as a negative.
Bottom
line: our near term forecast is that the
US economy is stagnating despite this week’s better numbers, an improved
regulatory outlook and a now growing EU economy. The latter two should have a
positive impact on US growth though there is no evidence of it to date. However,
if Trump/GOP were to pull off a (near) revenue neutral healthcare reform, tax
reform and infrastructure spending on a reasonably timely basis, I would
suspect that sentiment driven increases in business and consumer spending would
return; and more importantly, our long term secular economic growth rate assumption
would almost certainly rise.
Unfortunately its fate is uncertain given the antics of our political
class.
For the long
term, the Donald’s drive for deregulation and improved bureaucratic efficiency
is a decided plus. As you know, I inched
up my estimate of the long term secular growth rate of the economy because of
it. In addition, a more reasoned
approach to trade and foreign charity should support that revision.
The
Market-Disciplined Investing
Technical
The indices
(DJIA 21580, S&P 2472) were actually mixed this week with the Dow down and
the S&P up. It is a little
surprising that the DJIA would stall in a week of good economic news and dovish
comments out of both the BOJ and ECB. Volume
was low (Friday’s spike was related to option expiration) and breadth dismal. But the upward momentum as defined by their
100 and 200 day moving averages and uptrends across all timeframes remains intact. At the moment, technically speaking, I see little
except for the VIX, to inhibit the Averages’ challenge of the upper boundaries
of their long term uptrends---now circa 24198/2763.
The VIX (9.3) declined
another 2 %, finishing in downtrends across all timeframes. It is not surprising that it is at all-time
lows at a time when stocks are at all-time highs. But it does say something about all the
dreamweavers who believe that stocks are fairly valued and have plenty of room
to run on the upside.
The long
Treasury had a solid up week, ending above its 100 and 200 day moving averages
and the lower boundary of its very short term uptrend.
The dollar got cracked
again, ending in a very short term downtrend, below its 100 and 200 day moving
averages and a short hair away from the lower boundary of its short term
trading range. It has now surpassed GLD
as the most discouraging chart that I watch.
Speaking of
which, GLD moved up strongly, closing above its 100 day moving average. If it remains there through the close on
Tuesday, it will revert to support.
Bottom line: stocks
continue their move higher, though I was a bit surprised by their lack of
positive reaction to the dovish comments from both the BOJ and ECB. It may be that investors know that the
economy is weak and the Fed will likely back off of any tightening moves. The TLT, UUP and GLD certainly support that
point of view as TLT and GLD lifted smartly and UUP is getting monkey hammered.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (21580)
finished this week about 66.1% above Fair Value (12990) while the S&P (2472)
closed 54.0% overvalued (1605). ‘Fair
Value’ will likely be changing based on a new set of regulatory policies which has
led to improvement in the historically low long term secular growth rate of the
economy (though its extent could change as the affects become more obvious); but
it still reflects the elements of a botched Fed transition from easy to tight
money and a ‘muddle through’ scenario in Japan and China.
The US economic stats
continue to point to a weak economy---this week’s data notwithstanding. If I am correct about the economy slowing, short
term that means Street forecasts will begin declining. The question is when; and more important from
a Market standpoint, given investor proclivity for interpreting bad news as
good news, whether they will even care.
I can’t answer that latter issue except to say that someday, bad news
will be bad news; and mean reversion will likely occur.
There was a lot
going on related to fiscal policy this week.
The events surrounding healthcare reform were disappointing; though
Trump/GOP continue trying. Speaker Ryan
says a tax reform measure is coming and there is much more agreement among the republicans
on this issue than on healthcare. Thank
God for small favors; but I am in the ‘wait and see’ camp. My concern, as you know, is that any
resulting legislation will not be (near) revenue neutral in which case it only exacerbate
the economic growth problems stemming from too large a deficit and too much
debt.
Unfortunately, a portion of the Trump/GOP
inability to get things done are a result of their own unforced errors (1) the
Donald’s insistence in wallowing in the mud with his opponents and making it
worse by his factually challenged tweets, (2) the inability to escape the
Russian tar baby because of the apparent absence of political savvy, and (3)
the GOP congress’ lack of preparation for assuming the reins of power. They had eight years to construct a viable
alternative to Obamacare and tax reform; and yet here they are arguing over
issues that should have been resolved long ago.
My point with
regard to fiscal policy is that any progress towards healthcare reform, tax reform
and infrastructure spending would be positive for the Market in its impact on businesses
and consumers as well as their and investor sentiment. On the other hand, my enthusiasm for a
significant improvement in the long term economic and profit growth is well
contained. And if little occurs, that should
probably result in the eventual lowering of Market expectations for growth as
well as the discount factor that it places on that growth.
Finally, the
central banks continue to confuse, obfuscate and pursue a policy that has
destroyed price discovery---and it is being done not to have some potential
positive effect on the economy, but to avoid a Market hissy fit. Not something that I believe is in the best
long term interests of the economy or the Markets. As
you know, I have long time believed that the loss of faith in or the dismantling
of QE will result in correcting the mispricing and misallocation of assets; and
that most assuredly will not be a plus for equity prices.
Net, net, my
biggest concern for the Market is the unwinding of the gross mispricing and
misallocation of assets caused by the Fed’s (and the rest of the world’s central
banks) wildly unsuccessful, experimental QE policy. While
I am encouraged about the changes already made in regulatory policy, a more
rational approach to trade and our global commitments, fiscal policy remains a
mess. Whatever happens, stocks are at or
near historical extremes in valuation, even if the full Trump agenda is enacted;
and there is no reason to assume that mean reversion no longer occurs.
Bottom line: the
assumptions on long term secular growth in our Economic Model are beginning to
improve as we learn about the new regulatory policies and their magnitude. Plus, there is a tiny ray of hope that fiscal
policy could make progress though its timing and magnitude are unknown. I continue to believe that end results will be
less than the current Street narrative suggests---which means Street models will
ultimately will have to lower their consensus of the Fair Value for equities.
Our Valuation
Model assumptions are also changing as I raise our long term secular growth
rate estimate. This will, in turn, lift
the potential ‘E’ component of Valuations; but there is a decent probability
that short term this could be at least partially offset by the reversal of
seven years of asset mispricing and misallocation. In any case, even with the improvement in our
growth assumption, the math in our Valuation Model still shows that equities
are way overpriced.
As a long term investor, with
equity valuations at historical highs, I would want to own cash in my Portfolio
and would use the current price strength to sell a portion of your winners and
all of your losers.
DJIA S&P
Current 2017 Year End Fair Value*
13200 1630
Fair Value as of 7/31/17 12990
1605
Close this week 21580 2472
Over Valuation vs. 7/31
55%overvalued 20069 2480
60%overvalued 20716 2560
65%overvalued 21364
2640
70%overvalued 22011 2720
* 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 47 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.
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