The Closing Bell
9/15/18
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 13628-29833
Long Term Uptrend 6410-29847
2018 Year End Fair Value
13800-14000
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Uptrend 2636-3407
Intermediate
Term Uptrend 1308-3122 Long Term Uptrend 905-3065
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: weekly purchase applications,
weekly jobless claims, September preliminary consumer confidence, the August
small business confidence index; below estimates: weekly mortgage applications,
month to date retail chain store sales, July wholesale inventories/sales, July
business inventories/sales, August budget deficit; in line with estimates: August/revised
July retail sales, August industrial production, August PPI and CPI, August
import/export prices.
Primary
indicator were also mixed: August/revised July retail sales (0), August
industrial production (0) and August PPI/CPI (0). So I rate this week a neutral. Score: in the last 153 weeks, fifty-one were
positive, seventy-one negative and thirty-one mixed.
Two comments:
(1)
I rated the August PPI/CPI and import/export price reports
neutral because they are a double edged sword.
On the one hand, lower prices are great for us paeans, but they are also
a sign of a weak economy. The $64,000 question is, what does the Fed do with
this information?
(2)
given the strength on the second quarter GDP [and
revisions], I am increasing my forecast for real GDP growth in 2018 from 1.5%-2.5%
to 2%-3%. But that is simply the
recognition of a one-time pop in the economy brought on by the tax cuts. It in no way alters my outlook for the long
term secular growth rate of the economy.
The numbers from
overseas this week were mixed, continuing the trend of mixed to negative stats. That means our own economy is losing 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, The agreement with Mexico is clearly a step
in that direction. Further, the
Canadians made noises this week suggesting our trade issues with them could be
resolved. However, that still leaves the
EU, China and now Japan. So a lot is
left to be done before raising my assumption of the US long term secular growth rate.
Moreover, 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 we
got news this week that the deficit is growing faster than anticipated.
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.
‘The overseas dollar funding problems [the
necessity to buy dollars to service/refinance current dollar denominated debt] continue
to grow as more countries are having problems.
This issue impacts the banks because they own a major portion of the
debt that is being serviced/refinanced.
If that debt goes into default, then the banks’ balance sheets/capital
account takes a direct hit and that would in turn [a] impede lending and [b]
weaken their solvency, making their own debt more difficult to
service/refinance.
The global economy has had crises brought on
by dollar funding problems twice in the last thirty years. The results were not pretty. To date, we are not in as extreme a
circumstance; but we are clearly moving in that direction.’
(2)
fiscal/regulatory policy.
Trade
talks initially took a turn for the better this week with [a] Canadians seemingly
willing to compromise on dairy imports and [b] the Chinese initiating a charm
offense and the US responding in kind. Then
on Friday, Trump spoiled the party, instructing aides to proceed with the $200
billion in tariffs against China.
While
clearly a disappointment, I reiterate my thesis that resolving the outstanding
issues with Canada, the EU and China will be a plus for the long term secular
economic growth rate of the US.
On a
more discouraging note, the CBO forecasted that the US budget deficit would hit
$1 trillion in this fiscal year which was then pretty much confirmed when the
Treasury reported a huge jump in August budget deficit . My bottom line here hasn’t changed: a rising
budget deficit/national debt are deterrents to economic growth. The risk being that the positive
accomplishments by Trump [deregulation, potentially fairer trade] will be
offset by the country’s inability to service its debt and grow at the same
time.
(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
misallocation of assets problem continues to reveal itself in the emerging
market dollar funding problem. These
difficulties will likely spread as the Fed continues to unwind QE [which its
representatives insist it will and which the narrative in this week’s latest
Beige Book supports] and the federal government continues to run ever higher
deficits [which it is doing].
This week, it clearly
manifested itself in Turkish central bank’s move to raise interest rates by
over 600 basis points [dramatically higher rates hopefully encourages inflows
to the Turkish lira which in turn provides the funds to service the country’s
dollar denominated debt]. While that may
solve its dollar funding problem, it clearly won’t be a stimulus to the economy
[higher borrowing rates]. Less dramatic
but still notable, the Russian central bank also increased rates to stem the
depreciation of its currency and the rise of inflation.
Don’t cry for
me, Argentina.
In other
central bank news, both the Bank of England and the ECB met and both left rates
unchanged. In the ECB’s case, its accompanying
narrative reiterated its intent of leaving rates unchanged through mid-2019 but
will continue to unwind its QE by lessening bond purchases through the end of
the year and suspending them thereafter. No mention was made of when sales
might begin. Nevertheless, given the
size of the ECB bond buying program, the cessation of liquidity injections is a
big step toward ending QE.
As you know, my
thesis is that ending QE will have little impact on the US economy but cause
pain for the Markets whenever and however it unwinds.
The hubris of
the Fed (medium):
(4) geopolitical
risks: not much news this week, though
North Korea, Iran/Middle East, Brexit, Italy and Russia hang in the background
as potential sources of economic/military disruptions.
(5)
economic difficulties around the globe. Another week of mixed results:
[a] July EU industrial production declined more than
expected,
[b] the August Chinese trade surplus with the US hit a
record high; both August PPI and CPI came in above estimates, retail sales were
ahead of forecasts, industrial production was in line and fixed asset
investment was a disappointment,
[c] Q2 Japanese GDP growth was the strongest in three
years.
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 though
clearly the US/Mexico agreement is a positive step.
At the same
time, these long term positives are being offset by a totally irresponsible
fiscal policy. The original tax cut, increased
deficit spending, a potentially big infrastructure bill and funding the
bureaucracy of a new arm of military (space force) will push the deficit/debt
higher, negatively impacting economic growth and inflation, in my opinion. Until evidence proves otherwise, my thesis
remains that cost of servicing the current level of the national debt and
budget deficit is 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 26154, S&P 2904) ended basically flat after a roller coaster
day. Volume fell; breadth was
mixed. They remain strong technically;
and my assumption is that they will challenge the upper boundaries of their
long term uptrends (29807, 3065).
The VIX was down
again, ending below its 200 DMA (now resistance) and its 100 DMA (now
resistance). It now appears poised to
challenge the lower boundary of its short term trading range (which it has
already done three times this year).
That generally supports higher equity prices.
The long bond declined,
finishing below its 200 DMA (now resistance), its 100 DMA (now resistance), and
the lower boundary of its long term uptrend for a fourth day (if it remains
there through the close next Monday, it will reset to a trading range). Clearly, TLT is at a potentially critical
level. All I can do is wait for follow
through. That said, it has challenged
this boundary six times in the last year, so I will wait for a longer follow
through than normal before concluding that TLT’s long term uptrend is over.
The dollar was up
on good volume, remaining technically strong and making a second very short
term higher low. Its pin action is not
likely to change as long as dollar funding problems continue in the emerging
markets.
GLD was down (pitifully),
making it the ugliest chart on the block.
Bottom line: the indices
remain technically strong. I continue to believe that they will challenge the
upper boundaries of their long term uptrends.
The dollar will
likely remain strong until the dollar funding problems are resolved.
The pin action
in TLT is my main focus because if the long term uptrend breaks, pointing to
much higher rates, that will have implications in all the other Markets.
Friday
in the charts.
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. Clearly, the second quarter GDP number was a
sign of improved growth. However, that
is a single stat and in no way implies a trend.
Indeed, most Street estimates for third quarter GDP growth are lower
than that of Q2. Unless the tax cuts alter
investing and consumption behavior on a more permanent basis, Q2 growth will
likely prove to be an outlier.
Furthermore, the effect that those tax cuts are, at least presently,
having on the deficit/debt {see above} are just as meaningful, in my opinion, as
any growth implications, to wit, the servicing of that debt will constrain growth.
My
conclusion remains that while the economy is growing, it simply isn’t growing
as rapidly as many think. On the other
hand, as you know, 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, beyond
what I have already done, based on the dataflow to date or the promise of some
grand reorientation of trade.
Also,
lest we forget, the growth rate in rest of the global economy is starting to
slow and will not be helped by the decelerating effects of the dollar funding
problems in the emerging market. That
can’t be good for our own prospects. It
is certainly possible, even probable, that the US can continue to growth if the
rest of the world slows. But it is not
likely that its growth rate will accelerate.
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. Clearly, the US/Mexico agreement is a step in
that direction. In addition, this week,
Canada made some positive sounds with regard to resolving its trade issues with
the US; but as of this moment, there has been no new developments.
As I
noted above, China and the US were making nicey nice over the air waves early
this week; then Trump dropped a turd in the punchbowl, issuing instruction to
proceed with the imposition of $200 billion in tariffs on Chinese goods. This, of course, is just a repeat of what
happened two weeks ago, when everyone got all atwitter over potential talks
that promptly fell flat. In spite of all
this, I, perhaps foolishly, 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. At present, it is happening. Given the recent comments from various Fed
members, it seems likely to continue at least in the US. As I noted above, the ECB is on track to
cease bond purchases by the end of this year.
While not removing excess liquidity in the global money supply, it will
not be contributing to it. And that is a
start. In the meanwhile, the central banks of several emerging markets have
been forced to raise interest rates as the dollar funding problem
persists. I remain convinced that [a] QE 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/misallocation will
be reversed---and the dollar funding problem is the first material sign that it
is happening 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 generally accepted 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 9/30/18 13764
1698
Close this week 26154
2904
* 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 Investing for Survival, Steve hopes that his experience can help other investors build
their wealth while avoiding tough lessons that he learned the hard way.
No comments:
Post a Comment