The Closing Bell
12/1/18
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 13824-30031
Long Term Uptrend
6410-29847
2018 Year End Fair Value
13800-14000
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Trading Range 2705-3476
Intermediate
Term Uptrend 1318-3133 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 a neutral for equity valuations. The
data flow this week was quite negative: above estimates: weekly mortgage and
purchase applications, October personal income and spending, month to date
retail chain store sales, the November Chicago PMI; below estimates: October
new home sales, October pending home sales, weekly jobless claims, November
consumer confidence, the November Dallas and Richmond Fed manufacturing indices,
second estimate of Q3 corporate profits, the October trade deficit; in line
with estimates: the September Case Shiller home price index, the
October/revised September Chicago Fed national activity index, second estimate
of Q3 GDP.
However, the primary
indicators slightly positive: October personal income (+), October personal
spending (+), Q3 GDP (0) and October new home sales (-). I am giving this week a neutral rating. Score: in the last 164 weeks, fifty-three
were positive, seventy-three negative and thirty-eight neutral.
The data from
overseas was not that great. Plus, the
ongoing turmoil over Brexit, the Chinese/US trade relations and Italy’s budget
dispute with the EU potentially detract from global economic growth and, hence,
US growth.
My forecast:
A number of
Trump policy changes should have a positive impact on what is now a below
average long term secular economic growth rate.
These include less government regulation with possible minor help from
the recent agreements with Mexico/Canada/South Korea. There is the potential
that (1) Trump’s trade negotiations with Japan, the EU and China and (2)
possible spending cuts could also lead to a further improvement in our long
term secular growth rate.
However, the
explosion in deficit spending, especially at a time when the government should
be running a surplus, is a secular negative.
My thesis on this issue is that at the current high level of national
debt, the cost of servicing the debt more than offsets (1) any stimulative
benefit of tax cuts and (2) the secular positives of less government regulation
and fairer trade [at least on the agreements that have been renegotiated].
On a cyclical
basis, while the second quarter numbers were definitely better than the first,
third quarter stats showed slower growth and current expectations for the
fourth quarter are even lower. Perhaps
more concerning is the forward sales/earnings guidance from leaders in major
sectors of the economy suggesting a further slowdown in growth that is more
pronounced than current consensus.
So my current
assumption remains intact---an economy growing slowly though the risk of
recession may be mitigated somewhat by a less hawkish Fed.
The
negatives:
(1)
a vulnerable global banking [financial] system.
I re-introduced
this subject a couple of weeks ago, altering it slightly to incorporate the
entire financial system, specifically the shadow banking system [nonbank loans
from hedge funds, finance companies, etc.].
The reason being [a] the tremendous growth in this segment of the
financial market [b] the weak credit standards currently demanded by the
lending institutions, i.e. a lot of nonrecourse and covenant lite loans, and
[c] the use of derivatives by the lenders to hedge their bets. Recall that this was one of the main problems
in the 2008/2009 crisis. I am not
suggesting that conditions can deteriorate as significantly as they did back
then. But they don’t have to in order to
result in liquidity/solvency problems.
Troubles in the Chinese financial system.
Goldman joins Wells Fargo and Deutsche Bank as
examples of how the financial system is not fixed (must read):
Speaking of Deutsche Bank.
(2)
fiscal/regulatory policy.
Trade remains the
most immediate issue; in particular, the negotiations between Trump and Xi this
weekend. You know my thesis on this
matter: the US has allowed China to get away with egregious policies [theft of
intellectual property] so that it could move into the twentieth century. Those policies were [a] the right thing to do
and [b] very successful. But the more
that they succeeded, the more disadvantageous the US economic position
became. So now the US is faced with
enduring some short term pain to correct these inequities or take the long term
pain of being China’s patsy. My vote is
the former, but, as I noted, I don’t think that it can’t be achieved without negative
consequences.
Another issue
is the funding of the border wall. While
fiscal gridlock appears to the favored scenario for the next two years, funding
for the wall will be a problem in this lame duck session. Trump wants it; the dems don’t. With a partial government funding deadline
rapidly approaching [12/7], the Donald is threatening to shut down the
government if the dems don’t relent. We’ll
see; historically, that is not a winning strategy. We have that to look forward to next week.
Two minor notes:
[a[ the US, Canada and Mexico signed the NAFTA 2.0 agreement, though congress
still has to ratify it and [b] the house suspended the vote on a new tax bill.
My bottom line: once the national debt reaches a certain
size in relation to GDP [and the US has already attained that dubious honor]
the cost of servicing that debt offsets any benefits to growth that might come
from tax cuts/infrastructure spending.
(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 asset bubbles in the stock market as well as
in the auto, student and mortgage loan markets.
The major central
bank/monetary policy headline this week was a speech by Powell [Wednesday] in
which he seemed to completely reversed his prior hawkish position on QT. This
more dovish stance on policy was supported by the narrative in the minutes of
the last FOMC meeting released on Thursday. I say ‘seemed’ because while he
implied fewer rate hikes were forthcoming, he left the matter of the unwind of
the Fed’s balance in question. I covered
this in Thursday’s Morning Call; but to summarize my conclusion:
[a] slowing the increase in interest rates may help the economy a bit;
but I was never really worried about it in the first place. To be sure, that may act as a decelerant to any
slowdown in economic growth; but I don’t think it critical to my forecast for the
economy, short or long term,
[b] what is important, in my opinion, is the unwind of the Fed’s balance
sheet, i.e. the removal of the QE excess liquidity and the reversal of the mispricing
and misallocation of assets {price/risk discovery}. At the moment, we don’t know what policy will
be on this issue. But if it continues my
bottom line remains the same: the unwinding of QE will have little effect on
the US economy but will reverse the gross mispricing and misallocation of
assets.
A trade war is
not a reason to ease money:
The corporate
debt party is getting out of hand.
(4) geopolitical
risks:
Brexit, the
EU/Italy standoff; and now Russia and Ukraine are threatening each other. They all could be much to do about nothing;
or any one could cause serious negative financial consequences. I have no clue
on any potential outcome; but they can’t be ignored.
(5)
economic difficulties around the globe. The stats this week were negative.
[a] October EU
unemployment was higher than expected; October German retail sales were lower;
and the November EU economic confidence was above estimates,
[b] November Chinese
composite, manufacturing and nonmanufacturing PMI’s were all below forecasts,
[c] October Japanese
retail sales and November industrial production were well above expectations
while November CPI was well below.
Bottom
line: on a secular basis, the US economy
is growing at an historically below average secular rate although I assume decreased
regulation, the likely successful completion of the NAFTA 2.0 agreement and
Trump’s spending cuts (assuming implementation) will improve that rate somewhat.
However,
these potential long term positives are being offset by a totally irresponsible
fiscal policy. To be sure, the Trump
mandated spending cuts would be a great start to correcting this problem. Further, political gridlock could shut down
any new tax cut/spending increase measures.
For that, we should all be thankful.
But until evidence proves otherwise, my thesis is 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 derived from
deregulation or the current somewhat improved trade regime.
Cyclically,
growth in the second quarter sped up, helped along by the tax cuts. Plus (1) removing the uncertainty of no NAFTA
treaty should help return economic conditions within the three countries to what
they were before and (2) a slowdown in the rise of short term interest rates
will likely improve economic sentiment.
On the other hand, trade fears [China] and a weakening global economy
point to slower growth if not outright recession. As I noted above, that is not my forecast at
the moment.
The Market-Disciplined
Investing
Technical
The Averages
(DJIA 25538, S&P 2760) had another good day and are starting to work
through some of the technical damage to their charts: (1) the Dow traded above
its 200 DMA for the third day [now resistance, if it remains there through the close
Monday, it revert to support, (2) the S&P traded above the upper boundary
of the developing very short term downtrend [if it closes there on Monday, the
trend will be voided]. Two other factors
that should have a positive impact on the pin action: (1) we are in a historically strong seasonal
period for stock prices and (2) both indices have made a higher low off the
late October low.
That said, the
S&P remains below its 200 DMA (just barely). As you know, I think that this most important
current resistance level for both indices.
The VIX was down
3%. Its chart remains positive (bad for
stocks): above both MA’s and within a short term uptrend. It is amazing to me
that the VIX held up so well in a week in which the Dow was up 1300
points.
The long bond rose
3/8 %. While it continues to build a
base very short term, it still finished below both moving averages and in a
short term downtrend; meaning that until some of these resistance levels are
successfully challenged, the assumption is that bond prices are going lower.
The dollar was up
3/8%, finishing in very short term and short term uptrends as well as above
both MA’s. In short, the chart remains
technically strong. I continue to
believe that UUP will move higher as long as the dollar funding problem
persists.
GLD traded down
but remained above its 100 DMA and continues to build a base. Its chart is
getting less negative.
Bottom line: investors remain jiggy, I
assume over the prospects of a more dovish Fed and a China/Xi trade deal. As you know (1) I have reservations about the
Fed’s move being that positive and (2) I have no idea how to be optimistic
about anything coming out of the China trade talks other than smoke and
bulls**t. I take some solace that investors
in the VIX, the dollar, bonds and gold seem to agree with me. But as I noted yesterday, I am clearly
subject to being wrong on both counts.
If I am wrong, then prices are going higher.
Latest on margin debt.
Fundamental-A Dividend Growth
Investment Strategy
The DJIA and the
S&P are well above ‘Fair Value’ (as calculated by our Valuation Model), the
improved regulatory environment and the potential pluses from trade and
spending cuts notwithstanding. At the
moment, the important factors bearing on Fair Value (corporate profitability
and the rate at which it is discounted) are:
(1)
the extent to which the economy is growing. Economic activity in the third quarter slowed
and everyone pretty much agrees that it will do so again in the fourth quarter. This is all borne out in the dataflow.
Also,
lest we forget, the growth rate in rest of the global economy has slowed and appears
to be slowing even further as fears of a prolonged US/China trade war impact
corporate investment/spending plans. That can’t be good for our own prospects. It is certainly possible, even probable, that
the US can continue to grow as the rest of the world slows. But the rate of growth will likely be
declining nonetheless.
My
thesis is that, a trade war aside, the financing burden now posed by the
massive [and growing] US deficit and debt is offsetting the positive effects of
deregulation and fairer trade and will continue to constrain economic as well
as profitability growth.
In
short, the economy is not a negative [yet] but it is 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 surely be a plus for secular earnings growth. And while the US/Mexico/Canada and South Korean
agreements help short term cyclical growth in that they remove uncertainty, there
is general agreement [except within the Administration] that these revised
treaties largely reshuffled the deck chairs and will barely move the needle on
the secular growth rate of the economy.
A
potential deal with China would be a huge plus if its theft of US intellectual
property can be stopped; but any agreement that mimics the aforementioned NAFTA
2.0 agreement is not a template for success on that point.
(3)
the rate at which the global central banks unwind
QE. The Fed appears to be pulling back
from its move to hike the Fed Funds rate.
However, that is less important to QT than the run off of its balance
sheet---and, at the moment, we don’t know what is happening on that issue. In
addition, the ECB appears on schedule to halt its bond purchase program.
On the
other hand, the BOJ remains entrenched in its version of QE and the Chinese are
using every policy tool available, including monetary easing, to stem the
negative effects of the trade dispute with the US. I have no clue how this dance of conflicting
monetary policy will play.
As you
know, I applaud the end of QE because of its destructive impact on corporate
and individuals’ investment decision making, i.e. price discovery and the mispricing and
misallocation of assets. But it will
have negative consequences for [a] credit borrowers---we are starting to see in
the dollar funding problems in foreign economies and [b] financial markets, in
general, as price discovery returns.
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 [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 remain at record highs [at least as
calculated by my Valuation Model] based on the current generally accepted economic/corporate
profit scenario.
Whether
or not I am right about overall valuation levels, investors seem to be balking
at raising valuations any further. That doesn’t mean that a crash is imminent
but it does suggest that, at a minimum, further upward progress may be limited.
Bottom line: a
new regulatory regime plus an improvement in our trade policies along with
proposed spending cuts should have a positive impact on secular growth and,
hence, equity valuations. On the other
hand, I believe that overall fiscal policy (growing deficits/debt) will have an
opposite effect. 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.
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 12/31/18 13860
1711
Close this week 25538
2760
* 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.
No comments:
Post a Comment