The Closing Bell
9/9/17
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 21013-23492
Intermediate Term Uptrend 18825-26156
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 (?) 2457-2742
Intermediate
Term Uptrend 2240-3014
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. The
data flow this week was sparse and ended mixed: above estimates: weekly mortgage and purchase applications,
month to date retail chain store sales, the July trade deficit, July consumer
credit, revised second quarter productivity and unit labor costs; below
estimates: weekly jobless claims, July factory orders, the August Markit
services PMI, the August ISM services index, July wholesale inventories/sales; in
line with estimates: none
The primary
indicators were also mixed: revised second quarter productivity and unit labor
costs (+) and July factory orders (-). So the call is neutral. Score: in the last 100 weeks, twenty-nine
were positive, fifty-four negative and seventeen neutral.
That said, I don’t
think a lot of weight should be given to this week’s data, just because there
was so little of it. So I leave open the
question as to whether the recent string of neutral ratings was just a brief
respite in the midst of slowing economy or the economy has ceased weakening.
Overseas, the data
was mixed.
Three other notable
items on the economic front:
(1)
the potential impact of Hurricane Irma on
Florida. This would be the second
catastrophic natural disaster in the last month. Estimates from Harvey are now in $150 billion
plus range and Irma will likely be as bad if not worse. And then there is Jose. To reiterate a point, this is not an economic
plus no matter what the chattering class alleges [sort of like lower oil prices
were an unmitigated positive].
(2) Trump
made a deal with the dems raising the debt ceiling, provide for Harvey funding
and delaying a further vote for three months.
That clears the legislative slate for work on tax reform. That could be good or bad news depending on
what the GOP does [more below],
(3) Fed
vice chair Fischer resigned which short term is a negative for those hoping for
a return to monetary normality. Trump
announced Gary Cohn won’t be the next Fed chairman. That means little for monetary policy but a
lot for Cohn [more below].
I have to
mention that Trump went another entire week without insulting or threatening
anyone or making some lame, factually challenged statement. He is on a roll; let’s hope he keeps it
up.
Bottom line: this
week’s US economic stats were neutral, confirming the pattern for the last two
years---the economy struggling to keep its head above water. The question is, has it stopped sinking? At some point, I would think that the
improving European economy would have some positive influence on our own; but
for the moment, that is not happening.
Longer term, I
remain confident in my upgrading our long term secular growth rate assumption by
25 to 50 basis points based on Trump’s deregulation efforts. 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 the Washington morality play unfolds.
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 is struggling and will likely continue to do so; though the improving
global economy may at some point have an impact.
The hurdle debt
poses to long term economic growth (medium):
The
negatives:
(1)
a vulnerable global banking system. Nothing this week.
(2)
fiscal/regulatory policy.
Trump went another week without making himself the
issue. More important, he got the entire
political class’s attention by cutting a deal with the dems on the debt ceiling
and Harvey funding.
I discussed this in Thursday’s Morning Call; so I
won’t be repetitive except to provide my conclusion: he has altered the DC
operating model, putting the GOP congress in position of either coming up with
a tax reform package that can pass or risk Trump making yet another compromise
with the dems. We won’t know if that is
good news [the GOP fashions a near revenue neutral tax reform] or bad news [if
the bill raises the deficit/debt significantly] until we see the final
product.
But just
to reiterate my bottom line on this issue: [a] if the fiscal agenda doesn’t get
enacted, it is not bad news. The result
would be continued gridlock and historically, that has been good news. However, it would mean that the potential
economic benefits from tax reform and infrastructure spending would not occur
and [b] even if tax reform and infrastructure spending do happen but further
increase the deficit spending and the federal debt, that would be a negative,
in my opinion.
(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.
There were a
number of notable events this week regarding monetary policy, though I also
covered them in this week’s Morning Calls; so again, just my conclusions:
[a] the latest
Beige Book said nothing different about policy,
[b] Harvey and
Irma will likely give the Fed cover to do nothing the rest of the year,
[b] the
departure of Stanley Fischer is likely mildly dovish short term for monetary
policy,
[c] Cohn
getting ruled out as the future Fed chair is a nothing burger. There are several candidates for that
position that are more versed in monetary policy and equally if not more
hawkish. However, Cohn could pout, pick
up his marbles and go home---which could be a negative for tax reform,
[d] Draghi/ECB left rates and the bond buying
program unchanged. In other words, EU QEInfinity for as far as the eye
can see.
My thesis here
remains unchanged: any tightening in monetary policy will have little impact on
the economy but will likely wreak havoc on the securities’ markets. But the visibility of any tightening is limited.
On the other
hand, credit spreads are compressing:
The plunging
dollar suggests that the Fed has overstayed QE.
And the
political makeup of the Fed is about to change.
(4) geopolitical
risks: North Korea remained a hotspot as
the regime detonated an underground nuclear device, keeping the rest of the
world at Def con two. Plus there is a
strong probability of another missile launch today in honor of the founding of
the regime. So far, Trump has avoided further inflammatory statements and
appears to be attempting to allow diplomacy to work.
To be sure, this
story isn’t over and there remains a decent probability of an unpleasant
outcome. But for the moment, the US is
acting the part of the adult in the room.
Still there
remains plenty of hotspots that could explode any minute: Syria, the Qatar
sanctions, US/Russian confrontation, the US sanctions on Chinese and Russian
individuals/companies, Trump’s aggressive language on Iran and Venezuela.
I am not trying
to fear monger war; but I do think that Trump’s aggressive attitude toward
foreign opposition is overdone and increases the risk of a costly misstep. Hopefully, this week’s performance marks a
change in his presentation.
(5)
economic difficulties around the globe. This week:
[a] August EU services
PMI was above expectations; August German factory orders and industrial output were
below estimates,
[b] August
Chinese Caixin services PMI was better than anticipated; however, its August
trade surplus declined.
Our
outlook remains that the European economy is out of the woods. In addition, the Chinese economy seems to be
improving; though it is too soon to change our forecast.
Bottom
line: our near term forecast is that the
US economy is stagnate though there is a possibility that the improved
regulatory outlook and a now growing EU economy may halt any worsening. Further, 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.
For better or
worse, with the debt ceiling deal, the Donald has likely altered the political
dynamics in Washington. I have no idea
if this is good news or bad news with regard to the federal deficit and
debt. But I continue to believe that the
single biggest factor that could impact a change in the future long
term US secular economic growth rate is the success or failure of the Trump/GOP
fiscal program.
To be sure,
Trump’s drive for deregulation and improved bureaucratic efficiency is and will
remain a decided plus. As you know, I
inched up my estimate of the long term secular growth rate of the economy
because of it. But I believe that the
order of magnitude of its effect is less than the enactment of healthcare, tax
reform and infrastructure spending would be.
The
Market-Disciplined Investing
Technical
The indices
(DJIA 21797, S&P 2461) turned in another mixed day---Dow up and the S&P
down. Volume decline; breadth improved
slightly. Both remain above their 100
and 200 day moving averages and are in uptrends across all time frames (the
S&P just barely above the lower boundary of its short term uptrend). But both are still below the resistance
offered by their former all-time highs.
A break of either their short term uptrends or the August resistance
levels would likely add some octane to the follow through directional move.
The VIX (12.1)
rose 5% leaving it below the upper boundary of its short term downtrend, back
above its 100 day moving average (it reverted to resistance on Friday, then
traded back above it Tuesday, then below on Thursday, than back above on
Friday; so this MA is acting more like a magnet than resistance or support),
above its 200 day moving average and the lower boundary of a developing very
short term uptrend. The question as to whether or not the VIX has bottomed
clearly remains open.
The long
Treasury fell slightly, but still finished above its 100 and 200 day moving
averages (both support), the lower boundaries of its short term trading range
and its long term uptrend and remained above the resistance level marked by its
August high.
The dollar
continued its downward plunge, closing in short term and very short term
downtrends, below its 100 and 200 day moving averages and in a series of six
lower highs.
GLD slipped fractionally, but ended above the
lower boundaries of its short term and very short term uptrends and above its
100 and 200 day moving averages (both support).
Bottom line:
long term, the indices remain strong viz a viz their moving averages and
uptrends across all timeframes. Short
term, they have moved sideways since early August. That is not necessarily bad; after all,
stocks can’t go up every day. Still, I
am watching the indices’ August highs as resistance and the lower boundaries of
their short term uptrends as support. A
break in either one would provide directional information.
The unambiguous
performances of TLT, GLD and UUP continue to point at a weakening economy.
I remain
uncomfortable with the overall technical picture.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (21797)
finished this week about 66.7% above Fair Value (13074) while the S&P (2461)
closed 52.3% overvalued (1615). ‘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 effects 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 reflect sluggish to little growth. However, Street economic growth expectations
are higher than my own---in my opinion, based on an overly positive reading of
the numbers plus the hope of fiscal policy reform. To be sure, the odds of some action on fiscal
policy got a boost this week when Trump cut a deal with the dems on the debt
ceiling and Harvey funding because (1) it cleared the legislative deck of most
major issues save tax reform and (2) it tightened GOP sphincters over the need
for compromise. That, however, doesn’t
mean that the economic outlook will necessarily improve. Certainly, revenue neutral tax reform would
be a plus. But nothing could happen (not
bad, just not good). Or congress could pass
a tax/infrastructure bill that explodes the federal debt/deficit even higher---and
that would be economically detrimental, in my opinion.
In any case, I
believe that Street estimates for economic and corporate profit growth are too
optimistic based on the improving economy, easy Fed, fiscal reform
narrative. And when it wakes up from this
fairy tale that could in turn lead to declining growth expectations as well as
valuations. 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.
That said,
fiscal policy is a distant second where it comes to Market impact. The 800 pound gorilla for equity valuations
is central bank monetary policy.
Unfortunately, this crowd continues 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.
Witness this week’s lack of commitment to normalizing monetary policy from the
ECB in face of an improving EU economy.
As you know, for
a long time, I have believed that the loss of faith in or the dismantling of QE
will result in correcting the mispricing and misallocation of assets. The question has always what was going to
prompt that loss of faith or dismantling.
To date, my assumption had been that sooner or later the central banks
would take action of their own accord.
Now, it may be that the Markets force the issue in the form of a flattening
yield curve and a declining dollar. That
is not a prediction. It is an
observation that if those trends continue, the odds of forcing the Fed’s hand
goes up.
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. Stock
prices have ballooned and are now at or near historical extremes in valuation; 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 further increase that growth assumption though its timing and
magnitude are unknown. I continue to
believe that the end results will be less than the current Street narrative
suggests---which means Street models will ultimately will have to lower their consensus
of 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 9/30/17 13074
1615
Close this week 21797
2461
Over Valuation vs. 9/30
55%overvalued 20264 2503
60%overvalued 20918 2584
65%overvalued 21572 2664
70%overvalued 22258 2745
* 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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