The Closing Bell
12/22/18
I am taking off for the holidays.
Back 1/2/19. If I take any
actions in this period, I will send out a Subscriber Alert.
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%
2019
Real
Growth in Gross Domestic Product 1.5-2.5%
Inflation +1.5-2.5%
Corporate
Profits 5-6%
Current Market Forecast
Dow
Jones Industrial Average
Current Trend (revised):
Short
Term Trading Range 21691-26646
Intermediate Term Uptrend 13952-30159
Long Term Uptrend
6585-29947
2018 Year End Fair Value
13800-14000
2019 Year End Fair Value
14500-14700
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Trading Range 2536-2942
Intermediate Term Uptrend 1323-3138 Long Term Uptrend 905-3065
2018
Year End Fair Value 1700-1720
2019
Year End Fair Value 1790-1810
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 slightly negative: above estimates: November housing
starts, November existing home sales, month to date retail chain store sales, weekly
jobless claims, December consumer sentiment, November personal spending, final Q3
corporate profits; below estimates: weekly mortgage and purchase applications,
the December housing index, November personal income, November durable goods
orders, December NY, Kansas City and Philly Fed manufacturing indices, the
revised October/November leading economic indicators, final Q3 GDP ; in line
with estimates: the Q3 trade deficit.
However, the primary
indicators were mixed: November housing starts (+), November existing home
sales (+), November personal spending (+), Q3 corporate profits (+), November
personal income (-), November durable goods orders (-), October/November
leading economic indicators (-), final Q3 GDP (-). I am giving this week a neutral rating. Score: in the last 167 weeks, fifty-four were
positive, seventy-four negative and thirty-nine neutral.
The data from
overseas was a bit thin but still not good.
Not helping is the ongoing turmoil over Brexit, the civil unrest in
France/Macron’s response and the Chinese/US trade relations.
My forecast:
Less government
regulation, Trump mandated spending cuts and possible help from a fairer trade
regime are pluses for the long-term US secular economic 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, the economic growth rate is slowing as the effects of the tax cut wear
off, the global economy decelerates and the unwind of the Fed’s balance sheet
limits credit expansion.
The
negatives:
(1)
a vulnerable global banking [financial] system.
Credit rating downgrades in the corporate sector are
rising.
Plus, a freeze
up in the CLO and leveraged loan markets.
(2)
fiscal/regulatory policy.
Trade remains the
most important near-term issue. Developments
this week included [a] in a speech, Xi said that China would not be bullied {yawn},
[b] Mnuchin made more of the ‘we are making great progress’ comments {ZZZZZ},
[c] the US indicted two Chinese hackers and [d] perhaps most important, some of
our allies are apparently willing to stand by the US in its fight against
Chinese unfair trade practices. If the Chinese see that most of their major
trading partners are willing to follow the US lead in imposing sanctions, this
could be the factor that brings them to heel.
Now, if those trading partners will act.
The other issue
is the government shutdown over funding of the border. To be clear, it is not a total shutdown
because much of the agency funding has already been done in other bills. So,
its economic impact will not be as significant as it would be if the entire
government were closed. In addition, not
much gets done in DC this time of year anyway.
So, the most immediate affect will be psychological; and the Market will
be where it is mostly felt. In short, I don’t consider this a big deal, economically
speaking; but it could be for the Market.
I will spare you my usual rant about the weakening effects
of an outsized federal debt/deficit on the economy.
(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 big news of
the week was the Fed raising the Fed Funds rate and continuing to unwind its
balance sheet. You know my bottom line
on this issue: as long as the Fed continues a QT policy, liquidity shrinks
creating credit funding problems and putting downward pressure on asset
prices. However, I don’t expect it to
have a major impact on the economy.
Trump now considering
firing Powell---which will only make matters worse.
Meanwhile both
the Bank of England and Bank of Japan left rates unchanged and the Chinese
announced plans for more fiscal and monetary stimulus.
I have no idea what
the ultimate net economic impact of conflicting monetary policies will have on
global liquidity; though to date, US policy seems to be overwhelming the rest.
(4) geopolitical
risks:
The EU/Italians
seemed to have worked a solution to Italy’s budget issue. That takes one potential negative off the table.
Still Brexit is causing heartburn in the
UK. There were no headlines this week in
the Russia/Ukraine dust up, but I don’t think that is going away. 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.
Update on Brexit.
US withdrawal
from Syria and Afghanistan will almost surely have some effects on Middle East
politics and the fight against terror. As
you know, I think that we should wall the whole region off and let them keep
killing each other until no one’s left or they figure out that is not a good
strategy. Getting our own troops out may
be the next best thing: it will save the lives and money: [a] if the US had all
the money that it has spent in the Middle East for meager if any long-term benefit,
how much better offer would our fiscal situation be and how many young men
would still be alive? [b] why are we
involved in an internecine Arab food fight?
We don’t need their oil. What
else do they have to offer us or the rest of the world?
Dates?
The ‘supposed’ inside story about the withdrawal
decision.
(5)
economic difficulties around the globe. The stats this week were very negligible but negative:
[a] the October EU trade surplus was below estimates; November
UK retail sales were above consensus; December German business sentiment was
slightly below forecast,
[b] the November Japanese trade deficit was much
larger than anticipated.
Bottom
line: on a secular basis, the US economy
is growing at an historically below average 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. The long term positive potential from an
altered Chinese industrial policy would have a meaningful effect on the US long
term secular growth rate.
However,
these possible long term positives are being offset by a totally irresponsible
fiscal policy. 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 even with improvement from deregulation
or the current trade regime (a caveat being if China does change its industrial
policy).
Cyclically, the
US economy to once again slowing. (1) Removing
the uncertainty of no NAFTA treaty should help return economic conditions within
the three countries to what they were before, (2) increase in Chinese purchases
of soybeans and oil and the lower tariffs on autos and (3) a slowdown in the
rise of short-term interest rates will help keep the slowdown under control. On the other hand, a weakening global economy
points to slower growth. As a result of
these factors, my guess is that my initial US 2019 economic growth rate
assumption will likely change as their impact becomes more apparent.
The Market-Disciplined
Investing
Technical
The Averages
(DJIA 22445, S&P 2416) again started off the day on their front foot then
faded through the day and closed down significantly. They both finished below
both moving averages and are now in a pronounced very short-term
downtrend. The Dow finished below its
February low, while the S&P ended below the lower boundary of its short-term
trading range (also its February low) for a third day, resetting to a downtrend.
Volume was up;
breadth was terrible again and is getting even more extremely oversold.
The VIX was up 6%,
ending above both moving averages and in a short-term uptrend. Its chart remains strong which is bad on
stocks.
The long bond
was down two cents, but still closed above its 100 DMA (now support), above its
200 DMA (now support) and in a short-term trading range. It appears that the rise in long term interest
rates (decline in bond prices) is over.
And.
The dollar was up
½ %, ending below the lower boundary of its very short term up trend (just
barely) for a second day, voiding that trend.
It still finished above both MA’s and in a short-term uptrend. So, the
chart continues to be technically strong.
GLD was down ½ %
on big volume, closing above its 100 DMA but right on its 200 DMA, negating Thursday’s
move above it (now resistance).
Bottom line: the Averages continued their
plunge with the S&P resetting its short-term trend to down. To state the obvious, that is not good news. Further, there is no sign of any slowing in
downward momentum. That said, the
indices are becoming ever more oversold.
So, rally seems inevitable.
Longer term, the
next major support level for the S&P is ~1800, coincidentally roughly the
same level as my Model’s 2019 Year End Fair Value. Also remember that the lower boundary of the S&P’s
intermediate term uptrend is ~1300; so, there is plenty more downside before
real technical damage is incurred.
The
long bond is in trading ranges across all timeframes, suggesting the end of the
2016-2018 rise in rates.
The
dollar recovered Thursday’s loss, but not enough begin rebuilding a very short-term
uptrend. Still its chart remains strong
and will likely continue to do so as long as there are increasing dollar funding
(liquidity) problems.
Friday
in the charts.
Fundamental-A Dividend Growth
Investment Strategy
The DJIA and the
S&P are still 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. US economic activity is slowing; and the rest
of the globe is slowing even faster than I expected.
It is
certainly possible, even probable, that the US can continue to grow as the rest
of the world slows. But declining global
growth will still act as a drag on any improvement.
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. Having whiffed on NAFTA 2.0, the prospect of a
meaningful change in the trade regime with China seems questionable, but if it
happens, would be a big plus to the US long term secular economic growth
rate.
As I
noted above, China’s move to buy more soybeans and oil along with lowering auto
tariffs will help over the very near term.
Longer term, if our allies stand with us against China’s unfair trade
practices AND it has the desired effect, that would be a huge plus. I think it reasonable to be hopeful but nothing
more.
(3)
the rate at which the global central banks unwind
QE. The Fed has reduced the rate at which
it will hike the Fed Funds rate.
However, that is less important to QT than the run off of its balance
sheet---and, at the moment, it appears that it will continue unabated. In
addition, this week Draghi said that the ECB is 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.
However,
I remain convinced that [a] QE has done and will continue to do harm 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)
the recent sell off has begun to rationalize valuations
in some Market sectors, offering some buying opportunities. But large segments remain overvalued, though investors
are clearly beginning to balk in general. If there is follow through, then
investors that have built cash positions for the last three years will be rewarded.
I hear
lots of woe over the recent decline; and the S&P resetting its short-term
trend to down won’t help. But I repeat
my comment above: the S&P can trade down to its next support level (~1800) which
is also my Model’s 2019 Year End Fair Value and not even break the lower boundary
of its intermediate term uptrend (~1300).
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 is getting more reasonable.
The indices and some sectors of the Market remain overpriced. However, other sectors have been beaten like
a rented mule. As you know, I am
focusing on that set of companies as potential buy candidates. Quality companies whose stocks are down 50%
or more should be bought.
That said, I believe
that there is more pain to come; so, my purchases, for the moment, will be small. Still this situation is what I designed my
Valuation for---to buy low after having sold high.
The
latest from Doug Kass.
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 24100
2599
* 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.
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