The Closing Bell
12/17/16
We leave for our daughter’s home on Monday and will be there through
Christmas; then we go to the beach for New Year’s. We don’t get back until 1/3. As always, I will have my computer with me
and will be in touch if necessary. Hope
all have a Happy Holiday.
Statistical
Summary
Current Economic Forecast
2016 estimates
Real
Growth in Gross Domestic Product -1.25-+0.5%
Inflation
(revised) 0.5-1.5%
Corporate
Profits (revised) -15-0%
2017 estimates
Real
Growth in Gross Domestic Product +1.0-2.5%
Inflation +1.0-2.0%
Corporate
Profits +5-10%
Current Market Forecast
Dow
Jones Industrial Average
Current Trend (revised):
Short
Term Uptrend 18224-21274
Intermediate Term Uptrend 11627-24477
Long Term Uptrend 5720-20271
2016 Year End Fair Value
12600-12800
2017 Year End Fair Value
13100-13300
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Uptrend 2127-2471
Intermediate
Term Uptrend 2006-2608
Long Term Uptrend 881-2419
2016 Year End Fair Value
1560-1580
2017
Year End Fair Value 1620-1640
Percentage
Cash in Our Portfolios
Dividend Growth
Portfolio 55%
High
Yield Portfolio 54%
Aggressive
Growth Portfolio 55%
Economics/Politics
The Trump
economy will likely provide am upward bias to equity valuations. Overall
this week’s data was positive: above
estimates: the December housing market index, month to date retail chain store
sales, November small business optimism index, the December Philly Fed business
outlook survey, the December NY Fed manufacturing survey, the December Markit
flash manufacturing index, October business inventories and sales, third
quarter trade deficit; below estimates: November housing starts and building
permits, weekly mortgage and purchase applications, November retail sales, November
industrial production, the November budget deficit, November PPI; in line with
estimates: weekly jobless claims, November import/export prices, November CPI.
However the
primary indicators were all negative: November retail sales (-), November
industrial production (-) and November housing starts and building permits (-). If these indicators had been mixed or if
there had only been one poor number, I would have scored this a positive week;
but that is not what happened. This week
was negative. The score is now: in the
last 63 weeks, twenty-one were positive, thirty-eight negative and four
neutral.
Is
there more slack in the economy than is generally perceived? (medium):
Overseas, the
data was positive but other factors continue to exert a negative influence over
my outlook: the problems with bailing out Monte Paschi, the British parliament’s
vote to proceed with the Brexit, Greece’s bailout difficulties and China’s
ongoing battle to keep the yuan from declining and the potential for increased
global economic turmoil due to a change in US trade policy. So our global ‘muddle through’ forecast
remains intact.
Other factors
figuring into the global outlook:
(1) data
this week suggest that OPEC members are already cheating before the ink on the
production cut agreement is dry on the page.
Clearly that only supports my thought that the production cut agreement
won’t have a lasting positive impact on oil prices,
(2) the
Bank of Japan joined the ECB in talking out of both side of its mouth, hinting
early in the week that a tightening in monetary policy was coming, then jacking
up its bond buying program later in the week.
On the other hand, the Fed turned a bit more hawkish than many had
expected. If this divergence in central
bank monetary policies continues, it likely means a continuing rise in the dollar
which will not be helpful to our trade balance or earnings of corporations with
a large international exposure,
(3) on
a related item, the Donald’s trade policy.
All we have so far is words. But
if he does what he says that he is going to do, it could have a negative impact
on global trade which already has a problem in the form of a soaring dollar and
a depreciating yuan. Speaking of which, the yuan took another shellacking
this week and the drawdown of China’s currency reserves continues.
In summary, this
week’s US economic stats were negative, though I think that the data flow has
less relevance at the moment than it will be when it starts to reflect the
likely coming changes in fiscal/regulatory policies---but we may not know that
for a year. Nevertheless, if the current
Market euphoria in any way anticipates a rise in consumer and business
sentiment (spending/investment), then we could see the numbers start to improve
as early as next month.
That said, the
recent trend back to negative numbers is a little concerning in the sense that
the economy may be weaker (than it seemed to be trending two weeks ago) going
into what I anticipate as a more positive fiscal/regulatory environment. Meaning that it might take more aggressive action
to overcome a weakening economy than a slowly improving one. For the moment, I am sticking with my revised
tentative short term forecast but will wait until we see any concrete changes
in the Trump/GOP fiscal agenda before altering the long term secular economic
growth rate in our Models.
Our (new and
improved) forecast:
‘a possible pick up in the long term secular
economic growth rate based on lower taxes, less government regulation and an
increase in capital investment resulting from a more confident business
community. However, there are still a
number of potential negative unknowns including a more restrictive trade
policy, a possible dramatic increase in the federal budget deficit, a Fed with
a proven record of failure and even whether or not the aforementioned tax and
regulatory reforms can be enacted.
It is important to note that this change in
our forecast is all ‘on the come’ and hence made with a good deal less
confidence than normal. Nonetheless, I
have made an initial attempt to quantify this amended outlook with the caveat
that it will almost surely be revised.’
Bottom line: after
a trend towards more upbeat the stats, the data turned negative a couple of
weeks ago, raising (once again) the question of whether the more positive
respite was just that or the sign of a real improvement in economic activity. I don’t have the answer to that; but whatever
it is, we should soon start to see any impact that an upturn in sentiment might
have---assuming that there is one. So by
the time we get the February economic data we should know how the economy if
behaving, ex a new fiscal/regulatory agenda.
But at that point we should have some feel as to the shape of the new policies
and how rapidly they will take effect.
In the meantime, Market euphoria notwithstanding, we are stuck in a
period in which the economic uncertainties are higher than usual.
To be clear,
that shouldn’t be interpreted as a negative necessarily. The economy could, indeed, be turning and
sentiment could by itself stimulate business investment and consumer spending. All I am saying is that, at the moment, it is
not clear to me how the economy is trending and no one knows the impact a
pickup in sentiment will have.
The problems of
an irresponsible monetary policy and global economic weakness remain.
The
negatives:
(1)
a vulnerable global banking system. This week:
[a] the ECB
rejected a request from Monte Paschi for more time to arrange private
financing; however, the Italian treasury said that it would help with the
recap. The problem, as I noted last
week, is that how that is done; because many of the obvious alternatives
violate EU rules. In addition, Italy’s
largest bank said in would lay off 14,000 workers and raise E13 billion in new capital. And last but not least, Moody’s cut its
outlook for Italian banks to negative,
[b]
Wells Fargo failed a key financial test for the second time,
[c] the Eurozone
financial minsters refused to approve the third Greek bailout payment.
[d] importantly, this week the Fed issued new capital
requirements for the large US banks which will further improve their solvency
and liquidity.
The point here is that while the US banks, the
aforementioned Wells Fargo news notwithstanding, have and will continue to
improve their balance sheets, the global banking system in overleveraged and
chocked full of nonperforming loans.
(2) fiscal/regulatory
policy. I continue to be hopeful that
this potential negative goes away, given the Donald’s campaign promises. And indeed, looking at his cabinet nominees,
policy seems to be headed in the direction of lower taxes and less
regulations.
However, this
week, Mitch McConnell indicated that any measure that would increase the budget
deficit was a non-starter. It is likely that
this is just an initial negotiating position.
But it still indicates that any tax cut or increased spending
legislation may not speed its way through congress. In addition, those aforementioned cabinet
nominees are facing opposition, which may require Trump to spend political
capital to get them approved [i.e. I will vote for him Mr. President, but I need
or I can’t go along with……….you fill in the blank].
The government’s
interest rate payments is one of the big things McConnell is worried about
(medium):
There is also
the issue of trade policy which could potentially lead to disruptions and
higher prices. For the moment, all we
have is rhetoric; but it could prove to be troublesome.
(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.
As you know,
this week the Fed raised the Fed Funds rate by a quarter of point---which, in
my opinion, falls under the category of ‘a day late and a dollar short’. In addition, the narrative in the press
release as well as Yellen’s post meeting news conference were a bit more
hawkish [three instead of two rate hikes in 2017] than had been expected. The $64,000 question, is this really the
start of the tightening process?
Remember last December, the Fed said that there would be four rate hikes
in 2016; and look how that turned out.
And speaking of
wusses, early this week, the Bank of Japan made noises that suggested a coming
tightening in monetary policy. That was
followed by an increase in its bond buying program. Sort of a repeat of last week’s ECB head fake
on its ‘tapering’ initiative.
The point here
is that global central banks’ monetary policy is starting to diverge---which
will initially be a problem for the US [i.e. its impact on trade and corporate
profits]. But sooner or later it becomes a problem for everybody if foreign
investors flock to dollar strength [forcing their countries’ central banks to
tighten monetary policy in order to keep their currency stable and prevent the
outflow of reserves].
That said, I could
be getting ahead of myself in that this Fed has been, is and forever will be more
dovish than its rhetoric. So this latest
move may just be a flash in the pan.
(4) geopolitical
risks: The Syrian conflict seems to be winding down [the US again losing] and
being replaced by [a] the US/China sparring match, [b] the brouhaha over
whether Russia interfered in the US elections and [c] the Donald’s selection
for Secretary of State. As I said last
week, I feel less comfortable about the geopolitical risks now than before
Trump’s actions of the last two weeks.
Re: the
US/China sparring match (medium):
(5)
economic difficulties in Europe and around the globe. This week:
[a] the December EU flash manufacturing PMI was
stronger than anticipated while the services PMI was weaker; November UK
inflation was higher than forecast; November UK employment fell,
[b] November Chinese
retail sales and industrial output were above expectations while fixed asset
investment was in line; although a Chinese official said that the reported data
contained a lot of fake numbers,
[c] November
Japanese business sentiment rose for the first time in 18 months.
Other
factors bearing on that state of the global economy include:
[a] the
potential difficulties with rescuing Italy’s third largest bank and the
consequences of whatever occurs,
[b] OK, I
was wrong on the likelihood of success of the OPEC production cuts; however,
the hard part {following the agreement} lies ahead. Making matters a bit tougher, China announced
that it was ramping up oil production by the most in three years. Plus there are already signs of cheating
{Iraq},
And the
US rig count is surging (short):
[c] the
EU finance ministers refused to approve the next portion of the Greek bailout,
[d]
China continues to have difficulties stabilizing the yuan. This week it continued to fall. Plus, the government couldn’t attract enough
investors to its latest treasury auction to complete it---meaning investors are
shy of the yuan, suggesting further declines.
That is not helpful to all its trading competitors.
This
week’s data was upbeat, keeping the streak of mixed or upbeat readings intact. This has gone on long enough to suggest that
the global economy may be stabilizing---not improving, just not
deteriorating. But to be sure, that in
itself is an improvement. However, when
coupled with the potential economic/financial problems in Italy, Greece, China
and the UK, I am not persuaded to change my ‘muddle through’ scenario; though
to be fair, six weeks ago I was afraid that I was going to have to revise it to
a more negative outlook.
Bottom
line: the US economic stats were slightly
disappointing this week, while the global economic numbers were somewhat better. That said, both the US and global economies
may be about to change, perhaps dramatically---which would make the current
dataflow less relevant. If the stars
align, the US will be getting an injection of fiscal stimulus in 2017, which
offers promise of not only better data but a normalization of Fed monetary
policy. Not just that, there has been a huge increase in sentiment as a result
of the foregoing which itself could propel a pickup in economic activity. On the other hand, global trade may become an
issue as the dollar rises, the yuan weakens and the Donald gets tough with our
trading partners.
A
counterproductive central bank monetary policy is the biggest economic risk to
our forecast; although, it is still unclear how much fiscal stimulus will be
forthcoming.
This week’s
data:
(1)
housing: the December housing market index was upbeat;
November housing starts and building permits were very disappointing; weekly
mortgage and purchase applications fell,
(2)
consumer: November retail sales were weak relative to
projections; month to date retail chain store sales grew more than in the prior
week; weekly jobless claims fell slightly more than estimates,
(3)
industry: November industrial production was well below
expectations; November small business optimism was stronger than expected; the
December Philadelphia business outlook survey was ahead of forecast as were the
December NY Fed manufacturing survey and the December Markit flash manufacturing
index; October business inventories fell but largely due to an increase in
sales,
(4)
macroeconomic: the November budget deficit was
considerably higher than anticipated; third quarter trade deficit was less than
projections; November import prices fell less than consensus while export
prices were down more; both the November headline and ex food and energy PPI’s
were up more than estimates, while CPI was in line.
The
Market-Disciplined Investing
Technical
Yesterday, the
indices (DJIA 19843, S&P 2258) inched lower; but on a quad witching and
pension rebalancing day, this move was meaningless, indicative of nothing. Volume was enormous, but again that was partly
a function of option expirations.
Breadth weakened slightly. The
VIX (12.2) fell 4 ½ %, closing below its 200 day moving average (now
resistance), below its 100 day moving average (now resistance) and within a
short term downtrend. The lower boundaries
of its intermediate term trading range (10.3) and long term trading range (9.8)
are close by---both of which were set back in 2006.
The Dow ended
[a] above on its 100 day moving average, now support, [b] above its 200 day
moving average, now support, [c] in a short term uptrend {18224-20274}, [c] in
an intermediate term uptrend {11627-24477} and [d] in a long term uptrend {5720-20271}.
The S&P
finished [a] above its 100 day moving average, now support, [b] above its 200
day moving average, now support, [c] within a short term uptrend {2127-2471},
[d] in an intermediate uptrend {2006-2608} and [e] in a long term uptrend {881-2419}.
The long
Treasury (117.1) fell fractionally, ending below its 100 day moving average
(now resistance), below its 200 day moving average (now resistance), below a
key Fibonacci level and in a very short term downtrend. In addition, it closed right on the lower boundary
of its short term trading range (for a second time), clearly a set up for
another challenge.
GLD (108) recovered
somewhat, finishing below its 100 day moving average (now resistance), below
its 200 day moving average (now resistance), below the lower boundary of its short
term downtrend and below a key Fibonacci level.
There is not much stopping it from going to the lower boundary of its
intermediate term trading range (100.0).
The dollar slipped,
but closed above the upper boundary of its short term trading range (for the
fourth time) and for the third day. I am
going to follow my own rule and reset the short term trend to up but with the
caveat that given the back and forth of recent weeks, this isn’t as solid a reset
as normal. On the other hand, lending
some strength to this call is that UUP also ended above the upper boundary of
its intermediate term trading range of the second day; if it remains there
through the close next Tuesday, it will reset to an uptrend.
Bottom line: throw
Friday’s pin action in the trash can---it was largely a function of option
expirations and pension rebalancing.
That leaves us with a Market that is on a sizz propelled by investor
assumptions that everything will come up roses and that staged one of the
weakest consolidations from an extreme overbought condition that I have seen. So my assumption remains that the Averages
will surmount the 20000/2300 levels near term and could challenge of the upper
boundaries of their long term uptrends.
UUP is
challenging two major trading ranges. If
those are broken to the upside, there should be a strong follow though---that
is not good for our trade balance or corporate earnings of US
internationals. The TLT is making its
second stab at going lower (higher rates).
If that is successful, then it adds upward pressure on the dollar,
contributes another negative to corporate earnings and cash flow and creates
some cognitive dissonance to many Street valuation models. If a higher dollar and higher interest rates
occur, it will likely only make life more miserable for the gold bulls.
And:
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (19843)
finished this week about 56.2% above Fair Value (12700) while the S&P (2258)
closed 43.8% overvalued (1570). ‘Fair
Value’ will likely be changing based on a new set of fiscal/regulatory policies
which will lead to an as yet undetermined improvement in the historically low
long term secular growth rate of the economy but it still reflects the elements
of a botched Fed transition from easy to tight money and a ‘muddle through’
scenario in Europe, Japan and China.
This week’s US economic
data was negative while the global stats upbeat. But they are both secondary considerations as
we try to figure out what a Trump presidency/GOP sweep means for the economy,
trade and the Markets.
Unfortunately,
the Market euphoria notwithstanding, we really have no better idea about what
is coming than we ever did. We know, of
course, what the Donald/GOP promised in the campaign; most of which is a plus
for the economy. But since the election,
Trump has gotten involved with the operations of both Carrier and Boeing, suggesting
that deregulation may not be as encompassing as many assumed. His, as yet to be revealed, fiscal policy
(cut taxes, increase spending) is getting push back from senate leader
McConnell. And problems with Trump’s more aggressive stated trade policy are likely
to be exacerbated by a rising dollar and falling yuan. The point here is not to
criticize his actions/statements but to point out that they don’t reflect some
of his campaign rhetoric and, therefore, rather than there being more certainty
with respect to the policies of a Trump administration, there is less.
In addition, the
Fed’s recently stated new more hawkish stance on monetary policy could create
problems. On the economic side, higher
interest rates have a lifting effect on the dollar, which in turn (1) makes any
attempts by Trump revise trade agreements all the more difficult, (2) penalizes
corporate profits [higher interest costs] and (3) hurts the foreign profits
reported by our large international companies.
The latter two make stocks less attractive on a valuation basis. Indeed, I linked to several articles this
week that suggested the interest rates were about to start having an impact.
The Market could
apparently care less about this at the moment and is ignoring the potential for
Market moving surprises in the near future. While I doubt that this willful disregard will
last, there is still the problem of quantifying the uncertainty surrounding
these elements of change---which is clearly a determinant of Fair Value. To be sure many of these shifts in policy
will have a positive impact. However, I
am less sure about what deregulation means as well as the outcome of altered
trade relations and a big increase in deficit spending. In addition, there are the problems of the
effects of rising interest rates and an appreciating dollar on the economy and
corporate profits. So while I wait for
clarity in order to attempt to quantify these changes, I have to settle for a qualitative
statement that I believe that the net effect will be positive.
‘That said, aside from the aforementioned
uncertain economic effects, valuation continues to be a major problem because:
(1)
at this
point, the Market is seemingly only
focused on the positive results,
(2)
while I think it reasonable to assume that the
rate of corporate profit growth could pick up, that is not a forgone conclusion
because earnings expansion will likely be hampered by the negative elements,
among which are rising interest rates, rising labor costs, adverse currency
translation costs, rising trade barriers and a slowdown in corporate buybacks,
(3)
the P/E at
which those earnings are valued will be adversely impacted by higher interest
rates,
(4)
the current
assumptions in our Valuation Model are for a better secular economic and
corporate profit growth rate than has actually occurred. So any pickup in the
‘E’ of P/E is at least partially reflected already in our Year End Fair Values,
(5)
finally, the
Market’s problem right now is the absence of real price discovery, i.e. asset
mispricing and misallocation, brought on by a totally irresponsible monetary
policy. One of the major things a stronger fiscal policy will do is allow the
Fed to normalize monetary policy, i.e. raise rates and sell the trillions of
dollars of bonds on its balance sheet. In other words, start unwinding asset
mispricing and misallocation.’
Net, net, my
biggest concern for the Market is the unwinding of the gross mispricing and
misallocation of assets caused by the Fed’s (and the rest of the world’s
central banks) wildly unsuccessful, experimental QE policy, aggravated by a
rising dollar and rising interest rates.
In addition, while I am positive about the potential changes coming in
fiscal/regulatory policy, I caution investors not to get too jiggy with any accompanying
acceleration in economic growth and corporate profitability until we have a
better idea of what, when and how new policies will be implemented.
Bottom line: the
assumptions in our Economic Model are likely changing. They may very well improve as we learn about
the new fiscal policies and their magnitude.
However, unless they lead to explosive growth, then Street models will
undoubtedly remain well ahead of our own which means that ultimately they will have
to take their consensus Fair Value down for equities.
Our Valuation
Model will also change if I raise our long term secular growth rate
assumption. This would, in turn, lift
the ‘E’ component of Valuations; but there is an equally good probability that
this could be offset by a lower discount factor brought on by higher interest
rates/inflation and/or the reversal of seven years of asset mispricing and
misallocation.
As a long term investor, I
would use the current price strength to sell a portion of your winners and all
of your losers. If I were a trader, I would
consider buying a Market ETF (VIG, VYM), using a very tight stop.
DJIA S&P
Current 2016 Year End Fair Value*
12700 1570
Fair Value as of 12/31/16 12700
1570
Close this week 19843 2258
Over Valuation vs. 12/31 Close
5% overvalued 13335 1648
10%
overvalued 13970 1727
15%
overvalued 14604 1805
20%
overvalued 15240 1884
25%
overvalued 15875 1962
30%
overvalued 16510 2041
35%
overvalued 17145 2119
40%
overvalued 17780 2198
45%
overvalued 18415 2276
50%
overvalued 19050 2355
55%overvalued 19685 2433
60%overvalued 20320 2512
Under Valuation vs. 12/31 Close
5%
undervalued 12065
1491
10%undervalued 11430 1413
15%undervalued 10795 1334
* 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.
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 47 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 74hard way.
