The Closing Bell
5/12/18
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 13178-29383
Long Term Uptrend 6410-29847
2018 Year End Fair Value
13800-14000
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Uptrend 2504-3275
Intermediate
Term Uptrend 1271-3086
Long Term Uptrend 905-2963
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: month to date retail chain
store sales, weekly jobless claims, April CPI, April import/export prices;
below estimates: weekly mortgage and purchase applications, the preliminary May
consumer sentiment reading, March consumer credit growth; in line with
estimates: April PPI, ex food and energy, March wholesale inventories/sales.
No
primary indicators were released this week.
So I am rating the week a neutral. Score: in the last 135 weeks,
forty-five were positive, sixty-three negative and twenty-seven neutral.
As I noted on
Friday, I do believe that those inflation numbers have significance. Certainly for the consumer. But they also could give the Fed a bit more
wiggle room when it comes to tightening monetary policy. At this point there are two questions:
(1)
is inflation low because the economy is not as strong
as many believe or because of some longer term secular reason? The answer, in my opinion, is both. The economy is not growing as fast many
believe; and it is doing so because of a misguided fiscal policy that has
loaded so much debt on the economy that servicing it absorbs almost all of the
net increase in productivity,
(2)
will, in fact,
the Fed slowdown the unwind of QE or [a] is it more intent on shrinking its
balance sheet in anticipation of the next recession and/or [b] will the current
flattening of the yield curve plus the move up in longer term rates even give
it that option? My answer is one that
you know---in its history, the Fed has botched every [I mean every] transition
from easy to tight money, it is already doing it this time as well.
Overseas,
Chinese inflation numbers were good but the stats out of the EU remain
negative. As you know, I have removed
‘global synchronized growth’ as a positive factor supporting our US economic
forecast.
Most of the
political news was of the international variety: Trump getting the US out of
the Iran nuclear deal, the US/North Korean summit moving forward. Unfortunately, also in the mix is the bubbling
pot of Trump/Mueller/Stormy Daniels/Russia love stew. I have no idea where this whole thing ends up;
but at this moment, it is becoming an increasing distraction from the business
of the state. Mostly, that is a good
thing. The more time our ruling class
indulges in self-flagellation, the less time it has to screw with you and
me. My concern is that this ends in
another impeachment circus which historically has never been good for the
Markets.
Our (new and
improved) forecast:
A pick up in the
long term secular economic growth rate based on less government
regulation. As a result, I raised that
growth forecast. There is the potential that Trump’s trade negotiations could
also lead to an improvement in our long term secular growth rate---though that
has yet to be determined. On the other
hand, 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 could potentially offset any positives from deregulation and trade.
On a cyclical
basis, the economy appears to have lost any steam it might have had, after having
achieved one of the longest growth cycles in history. In the short term that will overwhelm any
benefit to the long term secular growth rate.
The negatives:
(1)
a vulnerable global banking system.
(2)
fiscal/regulatory policy.
It was a
quiet week for real news, though developments are occurring. Trade negotiations continue between the US
and its NAFTA partners. It appears that
much effort is being expended by all parties to reach an agreement. I count that as a hopeful positive.
Trade
negotiations also continue between the US and China. While the narrative, in this case, hasn’t
sounded as upbeat as with NAFTA, I suspect that the China has a heavy hand in
the potential US/North Korea détente. If
the Donald succeeds in obtaining a meaningful agreement with Un, it wouldn’t
surprise me to see substantial progress in the US/China talks.
On the
domestic front, the Donald announced a plan for reducing drug costs. As you probably know, healthcare is a big
chunk of the economy and it is one of the primary sources of inflation [i.e.
rising health costs]. So if this
initiative bears fruit, it will be yet another plus for the economy. That said, it is far too soon to make any
predictions about its ultimate impact on the economy; but the potential is
there.
Congressional leaders are also promising to rescind some
spending measures---this after foisting a trillion dollar budget deficit on American
electorate just months ago. Economically
speaking, given the current size of those rescissions, this is an act of tilting
at windmills. Though I am sure it will
make for great soundbites in the upcoming elections.
Finally,
there is the possible disruptive effect of the aforementioned ruling class soap
opera that has managed to grow into this malignant, amorphous tar baby that
includes such wildly diverse components as Russian collusion and sex with porn
stars.
The good
news is that it gives the late night hosts plenty of material and keeps our reigning
elite’s collective eye on something other than perpetrating mischief on the
electorate.
The bad
news is……..oh gee, what was that?
Ah…….another potential impeachment process? But wait, isn’t that also good economic news---again
allowing us plebeians to dodge more harmful fiscal tomfoolery. Unfortunately, it could be bad news for the
Markets.
So a
pretty upbeat week. The problem remains
too much national debt and too large a budget deficit.
The math
of the debt bomb (medium and a must read):
(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 central
bank news this week came from overseas: the Bank of England met and left rates
and its QE policy unchanged. However,
unlike its counterpart across the Channel, it admitted that economic growth
sucked. So don’t expect any monetary
tightening from the Brits. But then, who cares?
Given the lack of success of QE to date, I can’t imagine how continuing
the process will be of any economic benefit.
That said, the
Fed has already started to unwind US QE, putting our monetary policy at odds
with the most other central banks. I am
not sure how that conflict in monetary policies works itself out in the global
asset markets, particularly with respect to the timing of the reversal of the mispricing
and misallocation of assets; but I believe that ultimately it will impact
Markets negatively.
(4) geopolitical
risks: the good news is that North Korea
seems to be willing to give up its bellicose ways---‘seems’ being the operative
word. Remember, these guys have jerked
us off before. The bad news is that
tensions in the Middle East have escalated with Trump opting the US out of the
Iranian nuclear deal. I don’t see this
as an existential threat to the US; but it doesn’t take much imagination to see
a conflict that could push oil prices much higher.
(5)
economic difficulties around the globe. The international data this week was mixed
with most of the bad news still emanating from Europe.
[a] March German industrial orders fell more than
anticipated but industrial production was above consensus; April UK retail
sales were disappointing, May EU investor confidence slipped,
[b] April
Chinese CPI and PPI came in lower than expected.
Bottom
line: the US long term secular economic growth
rate could improve based on increasing deregulation. In addition, if the success of the trade
negotiations with South Korea can be repeated with NAFTA and China, which
appears increasingly likely, then a fairer trading regime would almost
certainly be an additional plus for the US long term secular economic growth
rate. ‘If’ remains the operative word;
plus we need to see the shape of any new agreement before changing our forecast.
At the same time,
those long term positives are being offset by a totally irresponsible fiscal
policy. The original tax cut, a second proposed
new improved tax cut, increased deficit spending and a potentially big
infrastructure bill will negatively impact economic growth and inflation, in my
opinion. The current level of the national debt and budget deficit are simply
too high to allow the additional economic growth; and the current spending rescission
proposal is too small to have any effect.
I believe that a bigger deficit/debt=slower growth and a higher deficit
spending=inflation, even if they are the result of a tax cut and/or
infrastructure spending. Hence, this is
a negative for the long term secular growth rate of the economy.
It is important
to note that the negative impact that a rapidly growing national debt and budget
deficit have on economic growth is not just long term in nature. There is also a short term effect on Fed
policy (via the increase in interest rates) which has its own problem
extricating itself from its irresponsible venture into QE.
As a result, the
central bank is in a no win situation: [a] if I am wrong about the economy and
it accelerates and the Fed does
nothing, it risks inflation, [b] in fact even if economic doesn’t pick
up, with LIBOR and long term US rates continuing to rise and the yield curve
flattening, the Fed may not even have the option of doing nothing, [c] in
either event, if it moves forward with the unwind of QE, it will begin the unwinding
of the mispricing and misallocation of global assets.
The
Market-Disciplined Investing
Technical
The Averages
(DJIA 24831, S&P 2737) had another good day on Friday. Breadth continued to
improve but volume was down, again (not a good sign). The S&P ended above its 100 day moving
average for a second day (now resistance; if it closes above that level on
Monday, it will revert to support); the Dow finished right on its 100 day
moving average. Both remained above
their 200 day moving averages. The DJIA
closed in a short term trading range but in intermediate and long term
uptrends. The S&P is in uptrends
across all timeframes.
At the moment,
it seems likely that both of the indices will move above their 100 day moving
averages. If so, the short term
technical outlook will be positive with an objective of their former all-time
highs. Longer term, the assumption is that equity
prices will continue to rise.
The VIX was down, ending
below its 100 day moving average as well as its 200 day moving average for the third
day (now support; but if it remains there through the close on Monday, it will
revert to resistance). It also finished
below the lower boundary of its short term trading range for the second day; if
it remains there through the close on Monday, it will reset to a
downtrend. Clearly, the VIX is trading
in line with a surging Market.
The long
Treasury was up, continuing its bounce off the lower boundary of its long term
uptrend. However, it is right on a
minor resistance level. Assuming it
successfully challenges that level, TLT is still facing serious overhead
resistance from its 100 and 200 day moving averages and the upper boundary of a
short term downtrend.
The dollar
declined fractionally, but remained close to the upper boundary of its newly
reset intermediate term trading range and above its 100 and 200 day moving
averages (now support).
GLD was off
slightly, but still finished above its 200 day moving average (now support) and
in a newly reset short term trading range.
In addition, it is approaching its 100 day moving average (now
resistance).
Bottom line: once
the Averages clear their 100 day moving averages, the next visible resistance
level is their former all-time highs. I
see no reason why those levels won’t be tested.
The other
indicators that I follow aren’t breaking resistance (support) levels. TLT backed off the lower boundary of its long
term uptrend, the dollar felled back from the upper boundary of its
intermediate term trading range. That
continues to point to a narrative that includes an improving economy but with
little inflationary pressure.
Goldilocks.
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 positively
impacted 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. 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’.
Moreover, on a
short term basis, the continuous undershooting of economic growth markers
suggests that any benefit from enhanced corporate spending stemming from the
tax bill was short lived. Plus neither a
second round of tax cuts nor additional infrastructure spending, in my opinion,
will improve the outlook for economic growth, given the current stratospheric
level of debt. On the other hand, the current pathetic attempt to rescind some
spending measures is almost meaningless in the economic scheme of things though
clearly it will make for great headlines as the elections approach. As a
result, I believe that current consensus economic growth expectations are too
optimistic as well as any stock valuation based on that inaccuracy.
Meanwhile, my
operating scenario is that the positive impact of deregulation and a potential
improvement from better trade deals could very well be offset by the likelihood
of subdued growth and higher inflation resulting from an irresponsible fiscal policy
(expanding the national debt and the budget deficit to the point at which the
cost of servicing the debt/deficit negates any benefit from tax cuts or
infrastructure spending). I needn’t be
repetitive here; but:
(1) the budget deficit and national debt are
already too high to render either deficit spending or tax cuts an effective
growth stimulant. Making them bigger
will only make things worse. I believe that Street estimates for economic and
profit growth will prove too optimistic and valuations will have to adjust when
that reality becomes manifest, and
(2)
even worse for the Market is the need for the Fed to
normalize monetary policy, ending QE. Indeed, as I noted above, if long rates
continue to rise it may be forced to do irrespective of its own economic
forecast. Since QE led to the gross
mispricing and misallocation of assets, the process of unwinding it, in my
opinion, would not be good for the Markets because they are the only thing that
benefitted from QE.
Bottom line: a
new regulatory regime plus an improvement in our trade policies should have a
positive impact on secular growth. 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 5/31/18 13536
1669
Close this week 24831
2737
* 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
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 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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