Thursday, January 18, 2018

The Morning Call---And now, back to the melt up

The Morning Call

1/17/18

The Market
         
    Technical

If first you don’t succeed, try again.  The indices (DJIA 26115, S&P 2802) did and with great success.  They were up huge, with the Dow closing above the upper boundary of its short term uptrend.  And they did it on big volume and strong breadth.

            New equity buyers are helping to lift prices (medium):

The only source of cognitive dissonance was the VIX, which didn’t soar but was still up.  It again closed above the upper boundary of its short term downtrend; if it does so today, the short term trend will re-set to a trading range.  It continues to almost entirely divorce itself from any (inverse) correlation with stocks.  I think that means one of two things and perhaps both: (1) somebody in stock land is doing serious hedging [of their equity positions] and (2) volatility will likely be much higher going forward than it was in 2017.

  In any case, long term, the Averages remain robust 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 their long term uptrends. The technical assumption has to be that stocks are going higher. 

The long Treasury again slipped fractionally.  While it remains below the upper boundary of a very short term downtrend, it closed below its 100 day moving average.  Nonetheless, it remains in a directional no man’s land, closing above its 200 day moving average and the lower boundaries of its short term trading range and its long term uptrend. 

The impact of the Apple announcement (short):

The other indicators that I follow pointed to higher interest rates/stronger economy---GLD down, the dollar up.  This is the first sign that their investors could be considering that scenario; so again, follow through.

Bottom line: one down day, then the ‘buy the dip’ mentality once again kicked in.  That has been the dominant trading strategy for the last year and a half; and it remains operative.  The current weight of technical evidence is that stocks appear likely to go higher.  But the further the current ‘melt up’ goes, the more tenuous that assumption becomes.   I remain uncomfortable with the overall technical picture.
           
    Fundamental

       Headlines

            The very strong December industrial production number is clearly a positive sign for the economy, supporting our improved growth forecast and going a long way to offset last week’s disappointing dataflow. 

            Another upbeat headline was Apple’s announcement that it would bring back its huge horde of overseas cash and that it would increase its capital spending and hiring.   That fed right into the already positive narrative on the impact of the tax bill---much of it the result of actions by other major US companies, increasing pay and employment.  To be honest, it certainly appears that at least the initial actions of the business community are far more promising than I had expected.  And that is all to the good. 

I don’t want to get too far out over my skis, so I am not going to alter my forecast with only three weeks of experience following the tax bill.  But if this trend continues then the economy is likely to be stronger than my forecast indicates.  What we need now is additional confirmation of a broader participation in corporate America’s plans for increasing cap spending and improving wages before making that change.  But, as I said, it has only been three weeks since the tax bill passed; so it seems reasonable to assume that more of the same would be forthcoming.  If so, then my 2018 economic growth projection will rise.

As a result, two issues would present themselves.  Number one, will this apparent change in corporate behavior lead to an improvement in the long term secular growth rate of the economy?  Certainly when combined with loosening in the regulatory environment, it almost assuredly would.   One the other hand, a more restrictive trade policy, as is being threatened by the Donald, would limit any increase in the secular growth rate.  In addition, the current level of debt service (which I harp on continuously) will restrict the amount of resources that can be used for growth.  And that will only get worse if interest rates rise.  As a result, the magnitude of increase in the secular growth would still be in question.

Number two is Fed policy---it is hammer time.  The corner that it has painted itself into would get a lot smaller and offer the age old dilemma that every other Fed has faced when it waited too long to normalize monetary policy---choose the limp wristed wimp alternative and watch inflation accelerate or choose the big boy alternative, doing what it should have done years ago, and hit the brakes just at the point that economic growth is starting meaningfully increase.  Either way, the economy will not be served well.

                        Again, this is all speculation on my part.  And since I am not getting paid to make public forecasts, I won’t.  At least not yet.  But it certainly seems like change is in the air; and that my forecast six months from now will not be the same as the present.


            Also worth mentioning is that the Friday deadline for a budget deal approaches; and it appears increasingly likely that the outcome will be a continuing resolution with a new deadline in February.  While that may be an initial positive in that it avoids a government shutdown, it just prolongs the agony.  Furthermore, it is not like there is a good versus bad alternative.  We either get a shutdown or we get another budget with yet a higher deficit.  The best result would be to do nothing forever; but we couldn’t get that lucky.

Bottom line:  I am surprised by the recent positive steps taken by corporate America in response to the tax cut.  I would like more information before raising my economic forecast; but if the first three weeks of experience is an indication of things to come, I will.

The immediate issue is the impact an increase in economic growth will have on our Valuation Model.  Without running the numbers, that answer appears obvious. It will and to the positive.  However, as I have noted a number of times, I have already run ‘what if’ simulations assuming higher economic growth.  The net result is that even in a ‘best case’ scenario, equities would just be less overvalued.  Hence, I think it wise to own some cash for your own protection.  As you know, I am 50% invested and sleeping well.

Economics

   This Week’s Data

     US

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

            December industrial production surged ahead by 0.9% versus estimates of up 0.4%; capacity utilization was 77.9 versus forecasts of 77.3.

            The January housing market index came in a 72 versus projections of 73.

                        The Fed released its most recent Beige Book survey, the bottom line being that the economy continues to grow and the labor market is tightening.  Not exactly front page news; but it does portray an economy that is NOT in need of QE.

                        December housing starts fell 8.2% versus consensus of down 1.3%; building permits were in line.

            Weekly jobless claims fell 41,000 versus an anticipated decline of 11,000.

            The January Philadelphia Fed manufacturing index came in at 22.2 versus expectations of 25.0

     International

            December Chinese GDP was reported +6.8% versus expectations of +6.7%, industrial production +6.2% versus 6.1%, retail sales +9.4% versus 10.2% and fixed asset investment +7.2% versus 7.1%.

   Other

            A trade war with China would backfire (medium):

            Another optimistic take on the tax bill (medium):

                Update on big four economic indicators (medium):

What I am reading today

            The randomness on investment performance (medium):

            What if diversity isn’t America’s strength (medium):

            Pentagon confirms existence of a Russian underwater nuclear torpedo (medium):

            Another example of how the US is wasting treasure in the Middle East (medium):

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