The Closing Bell
8/11/18
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 13488-29683
Long Term Uptrend 6410-29847
2018 Year End Fair Value
13800-14000
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Uptrend 2597-3368
Intermediate
Term Uptrend 1298-3112 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: June month to date retail chain
store sales, weekly jobless claims, July PPI; below estimates: weekly mortgage/purchase
applications, consumer credit, June wholesale inventories/sales; in line with
estimates: July CPI.
No primary
indicators. So I rate this week a neutral.
Score: in the last 148 weeks, fifty were positive, sixty-nine negative and
twenty-nine neutral. In short, nothing
here to give a reason for a change in our outlook.
I still want to
comment on a couple of numbers:
(1)
the June wholesale/sales figure was hardly a sign of an
accelerating economy,
(2)
since the Fed is zeroed in on inflation, the CPI/PPI
bear mention. On the one hand, the month
over month PPI suggests a stable economy and, hence, might provide an excuse
for the Fed to pursue a ‘go slow’ approach to tightening. However, the year over year stats for both
indices registered a more rapid advance of inflation. Indeed, the CPI was at the high end of the
Fed’s acceptable range. That will likely
keep it on its current path of unwinding QE and could even hasten the return to
normality. If so, the point where the
unwind of QE starts to cause Market pain draws closer [at least in my opinion].
The numbers from
overseas this week were again disappointing.
So the overall trend continues to suggest that the ‘synchronized global
expansion’ theme is over; and that means our own economy loses that as a
tailwind.
Our (new and
improved) forecast:
A pick up in the
long term secular economic growth rate based on less government regulation. There
is the potential that Trump’s trade negotiations could also lead to an
improvement in our long term secular growth rate. Unfortunately, the reverse would also be
true. In addition, 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, while the second quarter numbers were definitely better than the first,
there is insufficient evidence at this moment to indicate a strong follow
through. So my current assumption
remains intact---an economy struggling to grow.
The
negatives:
(1)
a vulnerable global banking system.
On Friday, I noted
that the Turkey had joined the crowd that are having currency [dollar funding]
problems. The importance of this is that
much of Turkey’s debts are dollar denominated and owed to banks in other
countries. If Turkey’s lira is plunging
in value versus the dollar, that means that servicing that dollar denominated
debt is getting very expensive---the risk being, that it becomes prohibitively
so.
One man’s
thoughts (medium):
Sheila Bair on the US banking system (medium and a must
read):
(2)
fiscal/regulatory policy.
This
week, trade stayed in the news but not in the three inch headline sense. US and China swapped threats to raise tariffs
on August 23---something we basically already knew.
As you
know, I believe that [a] the Donald is right in attempting to reset the post
WWII political/trading regime, but that said [b] the outcome of current negotiations are an important variable in our
long term secular economic growth rate forecast.
At the
moment, the only thing that has changed is the increase in tariffs, which is
definitely not good for the global economy.
The hope, of course, is that his strategy will produce a fairer deal for
the US. However, right now all there is,
is hope. We need to see concrete results
before getting jiggy about the potential growth benefits of a fairer trade
system.
The other item was the Pence announcement of a proposal for
a ‘space force’. I covered this in
Friday’s Morning Call, so I won’t be repetitive except to say that it will only
contribute a huge existing problem to which Trump has contributed: too much
national debt and too large a budget deficit which will usurp investment
dollars that would otherwise be used for increased productivity.
The rising interest payments on US
government debt (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.
Another must
read from Jeffery Snider (medium):
All quiet on
the central bank front.
In my opinion,
ending QE will cause little economic impact but major pain for the Markets whenever
and however it unwinds.
(4) geopolitical
risks: since political risk is so
tightly enmeshed with the trade negotiations, it seems impossible to separate
the two [i.e. North Korea with China, immigration with Mexico and NATO funding
with the EU]. About the only thing I can
say is that the risks are higher than before Trump started down his current
path.
In addition,
the saber rattling between the US and Iran is escalating---the most immediate
economic threat being a sizable reduction in oil supplies to the world.
(5)
economic difficulties around the globe. Another week of sub-par results:
[a] June German factory orders fell dramatically,
industrial production was down more than anticipated and its trade balance
declined,
[b] the July Chinese exports and imports were both
above forecasts as were July PPI and CPI.
[c] June
Japanese machine orders fell 8.8% versus projections of -1.0%; but second
quarter GDP was better than expectations.
Bottom
line: on a secular basis, the US long
term economic growth rate could improve based on decreasing regulation. In addition, if Trump is successful in
revising the post WWII political/trade regime, it would almost certainly be an
additional plus for the US long term secular economic growth rate. ‘If’ remains the operative word.
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, a potentially
big infrastructure bill and funding the bureaucracy of a new arm of military will
negatively impact economic growth and inflation, in my opinion. Until evidence proves otherwise, my thesis
remains that the current level of the national debt and budget deficit are
simply too high to allow any meaningful pick up in long term secular economic
growth.
Cyclically,
growth in the second quarter sped up, helped along by the tax cuts. At the moment, the Market seems to be
expecting that acceleration to persist.
I take issue with that assumption, based not only on the falloff in
global activity but also the lack of consistency in our own data and the never
ending expansion of debt.
The
Market-Disciplined Investing
Technical
The Averages
(DJIA 25313, S&P 2833) had a rough day on increased volume and
deteriorating breadth. However, they
remain strong technically. Plus Friday’s
pin action was a gap down; and, historically, gaps get closed (i.e. the price
trades up to close the gap between the high for the day with the low of the
prior day). On the other hand, if the
Averages continue to decline, the Dow’s 100 DMA will likely fall below its 200
DMA---and that is not a positive signal.
In addition, the VIX bounced dramatically back above the lower boundary of
its short term trading range---suggesting that any advance in stock prices may
be labored.
TLT’s battle
with its long term uptrend’s lower boundary got interrupted on Friday by the mounting
Turkish currency crisis (and its potential impact on the EU banking
system). Suddenly, it spiked as a result
of its role as a safety trade which superseded any debate over US economic
strength and Fed policy. Looking ahead,
the question is, is the Turkish crisis a short term problem (and the Market’s
focus will return to the earlier dispute over the long term direction of
interest rates) or is it a sign of more dollar funding problems for the global
banking system (in which case it will remain a safety trade)? Stay tuned.
The dollar spiked also reflecting
its function as a safety trade. GLD couldn’t
manage an uptick even on a big risk off day.
Bottom
line: on Friday, every index was impacted by the situation in Turkey; and
until, as and if that gets cleared up, their pin action may likely be more a
function of international events versus anything going on in this country. That said, it is way too soon to be drawing
any long term conclusions.
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’ is being positively
impacted based on a new set of regulatory policies which should 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’.
At the moment,
the important factors bearing on corporate profitability and equity valuations
are:
(1)
the extent to which the economy is growing. There was not enough in the numbers this week
to provide much evidence of growth or not.
My conclusion remains that the economy simply
isn’t growing as rapidly as many think; and to the extent that second quarter
growth was an improvement over the first, there is certainly no evidence of
sustainability.
On the
other hand, I have never thought that the economy was going into a recession. And while there clearly is some probability
of a meaningful pick up in the long term secular growth rate of the economy
[deregulation, trade], I am not going to change a forecast based on the dataflow
to date or the promise of some grand reorientation of trade.
Also,
lest we forget, the economic growth rate in rest of the global is starting to
slow; and that can’t be good for our own prospects. It is certainly possible, even probable, that
the US can continue to growth in this environment. But it is not likely that its growth rate is accelerating.
My
thesis remains that the financing burden now posed by the massive [and growing]
US deficit and debt has and will continue to constrain economic as well as
profitability growth.
In
short, the economy is not a negative but it not a positive at current valuation
levels.
(2)
the success of current trade negotiations. If Trump is able to create a fairer political/trade
regime, it would almost certainly be a plus for secular earnings growth. However, with vacations and some regional
elections, there was not really any news on this front---though the US and
China did both reiterate prior threats of increased tariffs I remain hopeful that the Donald’s current
negotiating strategy will pay off; however, the risks and rewards associated
with failure and success are very high.
Either outcome would almost surely have an impact on corporate earnings
and, probably, on stock prices,
(3)
the rate at which the global central banks unwind
QE. Very quiet this week. However, the global economy is still facing a
confusing and somewhat contradictory array of central bank monetary policy
moves. I have little confidence is
projecting a path for global QE in that environment; but I remain convinced
that [a] it has done and will continue to do harm to the global economy in
terms of the mispricing and misallocation of assets, [b] sooner or later that
mispricing will be reversed and [c] given the fact that the Markets were the
prime beneficiaries of QE, they will be the ones that take the pain of its
demise.
(4)
finally, valuations themselves are at record highs
based on the current economic/corporate profit scenario which includes an
acceleration of economic growth [which I consider wishful thinking]. Even if I am wrong, there is no room in those
valuations for an adverse development which we will inevitably get.
Bottom line: a
new regulatory regime plus an improvement in our trade policies should have a
positive impact on secular growth and, hence, equity valuations. 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 8/31/18 13733
1694
Close this week 25313
2833
* 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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