The Closing Bell
11/11/17
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 21745-24401
Intermediate Term Uptrend 19230-26561
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 2540-2815
Intermediate
Term Uptrend 2295-3069
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 a higher upward bias to equity valuations. The
data flow this week was extremely sparse: above estimates: weekly mortgage
applications, September wholesale inventories/sales; below estimates: month to
date retail chain store sales, weekly jobless claims, November consumer
sentiment; in line with estimates: weekly mortgage applications.
There were no
primary indicators. The only call is
neutral: Score: in the last 109 weeks, thirty-three were positive, fifty-six
negative and nineteen neutral.
To be clear, I don’t
think this impacts either my long term call of sluggish growth/stagnation or
the hope that the recent improvement in the economic numbers could be signaling
an improvement in the cyclical growth.
Overseas, there
was also an absence of data; so no changes there in our forecast: the EU
continuing to show solid growth, China not so much.
The only other
newsworthy items were: (1) the GOP’s continued bumbling of their tax plan and
(2) a shakeup in Saudi Arabia, the meaning of which I have no idea. More below.
Our (new and
improved) forecast:
A questionable (though
increasingly less so) pick up in the long term secular economic growth rate
based on less government regulation.
This hoped for increase in growth could be further augmented by pro-growth
fiscal policies including repeal of Obamacare and enactment of tax reform and
infrastructure spending---‘could’ being the operative word. Unfortunately, any expected increase in the
secular rate of economic growth would likely be rendered moot if tax reform
(assuming its passes) increases the national debt and the deficit.
In addition, the
cyclical growth may be turning up though I am not sure whether it is a function
of organic or a pickup in international growth. I may raise our 2018 growth
forecast as a result.
The
negatives:
(1)
a vulnerable global banking system. While none of this news made into the main
stream media, it may be far more important than tax reform or a Saudi coup. The linked articles provide evidence that the
banking system is again pushing the envelope on risk in order to enhance
profitability. We know how that
ends. To be clear, I am not suggesting
that the financial systems current transgressions are as egregious as in
2007/2009 and I recognize that the US banking system has a much improved
balance sheet. However, that doesn’t
mean trauma can’t be felt in foreign banking systems that will have an impact
on our own.
More on the internal EU banking imbalances (medium):
Also, Deutschebank ramps up its leveraged loan business
(medium):
As other entities pursue even riskier strategies (medium):
(2)
fiscal/regulatory policy.
The
house and senate presented their versions of tax reform. Their provisions are close enough together
that some kind of bill seems likely. And
that should have the GOP feeling giddy about delivering on its campaign promise
and investors feeling all warm and fuzzy because nirvana is here. Cue the raspberry.
Yes, the
GOP is moving forward with tax reform but it is sorely lacking in its current
form. It is not simpler, fairer and won’t
create growth [in my opinion]. I have
hammered too long on these points so I am not going to beat a dead horse. But the bottom line is that the value of the
current tax reform is not economic; rather it is political, i.e. it might help
republicans in the 2018 elections but at least its absence won’t hurt. Maybe.
David
Stockman on the tax reform (medium):
Lance
Roberts on tax reform (medium):
You know
my bottom line, too much debt stymies economic growth even if it partly comes
from a tax cut.
(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.
Little news
this week on monetary affairs, excepting the IMF encouraging the Japanese to
continue their massive bond buying program. Why I don’t know. The Japanese
version of QE is the most obscene example of central bank liquidity
injections. So far its economic impact
has been marginal; though like everywhere else, it has had a profound effect on
asset pricing and allocation. So why recommend
more?
Draghi’s trap
(medium and a must read):
You know my
bottom line: when QE starts to unwind, so does the mispricing and misallocation
of assets. That thesis is about to be
tested.
(4) geopolitical
risks: international events did gain
some headlines this week. Some of it was
related to the Donald’s Asia trip. Everybody
held hands and sang kumbaya; but I am not sure much substantive occurred.
The other item
was the shakeup in the Saudi government.
I covered this all week long; so I am not going to rehash the
circumstances. My only observation is
that history says trying to usurp the entrenched royalty of a nation can be a
dangerous undertaking and bad for one’s health. To be sure, I could care less what happens
to any of those clowns; but internal Saudi strife could have repercussions in oil
supply/demand and the regional geopolitical stability.
The latest (medium):
(5)
economic difficulties around the globe. This week was also short on overseas
data. The only meaningful stats were the
October Chinese trade numbers which were in line and September UK industrial
output which was better than estimates while construction spending was worse.
Venezuela defaults (medium):
So like the US:
little data, means little analysis. There
is no interpretation here and no impact on my general conclusion that Europe
remains strong and the rest of the world continues to ‘muddle through’
Bottom
line: given the dearth of
activity/numbers, nothing has changed: our near term forecast is that the US
economy growth rate should be improving as a result of a better regulatory
outlook, though until very recently the signs of that pick up have been
lacking. That could be changing
augmented by a now growing EU economy.
More data is need to make that call, but I am hopeful. Unfortunately, the economy remains saddled
with (1) too much debt that will not be assuaged by the recently announced tax
bill, in its current form and (2) a Fed that has long since missed the deadline
for normalizing monetary policy---a condition that will likely only be
perpetuated by the newly nominated Fed chair.
The
Market-Disciplined Investing
Technical
The indices
(DJIA 23422, S&P 2582) drifted lower on Friday (a hitch in the relentless
drive higher? probably not.). Volume rose;
breadth weakened. Both remain above
their 100 and 200 day moving averages and are in uptrends across all time
frames.
The VIX (11.3) soared
another 7 ½ % (it was up 20%+ on Thursday and Friday; two days in which the
indices were down fractionally)---finishing below the upper boundary of its
short term downtrend, but above its 100 day moving average (now resistance; if
it remains there through the close on Tuesday, it will revert to support), above
its 200 day moving average (now resistance; if it remains there through the
close on Wednesday, it will revert to support) and above the lower boundary of
its long term trading range. Suddenly,
it has gone from threatening a direction change to the downside to one to the
upside. I am not sure what this means; it
may be just noise. Follow through will
tell the tale. In any case, there is probably
some tightened sphincters in the short volatility crowd---which if you have
been reading my links is very, very short.
The July low (8.8) remains the bottom.
The long
Treasury plunged 1 ½ % on big volume, voiding a newly developing very short
term uptrend and ending back below its 100 day moving average (now support; if
it remains there through the close on Tuesday, it will revert to
resistance). But it held its 200 day
moving averages (now support) and above the lower boundaries of its short term
trading range and long term uptrend. Again this may be just noise; or a move this
big on high volume could indicate something is going on the bond pits. Follow through.
The dollar declined
fractionally, ending below its 200 day moving average (now resistance), below the
upper boundary of its short term downtrend, but above its 100 day moving
average (now support) and continues to develop a very short term uptrend. (Still caught in the narrowing gap between
the upper boundary of its short term downtrend and the lower boundary of its
very short term uptrend).
GLD fell, closing
back below its 100 day moving average (its third violation of this MA this week),
but above its 200 day moving average (support) and the lower boundary of a
short term uptrend.
Bottom line: long term, the indices remain
strong viz a viz their moving averages and uptrends across all timeframes.
Short term, they are above the resistance level marked by their August highs,
meaning that there is no resistance between current price levels and the upper
boundaries of the Averages long term uptrends. The technical assumption has to
be that stocks are going higher.
Trading in UUP,
GLD and TLT were again out of sync with themselves, the VIX and stocks, and
seem to be pointing at a change in trends---but in different directions. I am watching for follow through in the TLT
and VIX on Monday to see if Friday was a one off or a sign of change.
I remain
uncomfortable with the overall technical picture.
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’ could be rising based
on a new set of regulatory policies which would lead to improvement in the
historically low long term secular growth rate of the economy (depending on the
validity of Reinhart/Rogoff; also note an improvement in the cyclical growth
rate resulting from better growth overseas doesn’t affect the secular growth as
calculated in our Model); 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 economic stats
both here and abroad were few and were of little informative value. So nothing to alter my outlook on the economy
or equity valuations---which is that the economy stumbles along but could be
improving and that condition is more than adequately reflected in stock prices.
The GOP made
progress on its tax reform. However, while
I believe that if passed, it will score political points with the electorate
and price points with investors, I also believe that it will do little to
promote secular economic growth. As a
result, if stocks fly on tax cuts, they will discount even more future growth
that is either not there or so far in the future as to not be really relevant
to today’s valuations.
In short, even
if passage is achieved, I believe that Street estimates for economic and
corporate profit growth based on the improving economy, fiscal reform narrative
are too optimistic. And when it wakes up
from this fairy tale that could, in turn, lead to declining valuations.
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 based on the thesis that (1) QE did little to
help the economy but led to extreme distortions in asset pricing and allocation
and (2) hence, its unwinding will do little to hurt the economy but much to
equities as the severe perversion of security valuations is undone. That thesis is about to get tested, albeit at
an agonizingly slow pace, as the Fed and other central banks inch their way
toward monetary normalization.
Bottom line: the
assumptions on long term secular growth in our Economic Model may be beginning
to improve as we learn about the new regulatory policies and their
magnitude. Plus, there is a ray of hope (though
fading) that fiscal policy could further increase that growth assumption though
its timing and magnitude are unknown. On
the other hand, if it raises the deficit/debt, I believe that it would negate any
potential positive. In any case, I continue to believe that the current Street
narrative is overly optimistic---which means Street models will ultimately will
have to lower their consensus of Fair Value for equities.
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.
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.
The latest from Doug Kass
(medium and a must read):
DJIA S&P
Current 2017 Year End Fair Value*
13200 1630
Fair Value as of 11/30/17 13158 1625
Close this week 23422
2582
Over Valuation vs. 11/30
55%overvalued 20394 2518
60%overvalued 21052 2600
65%overvalued 21710
2681
70%overvalued 22368 2762
* 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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