The Closing Bell
7/23/16
Statistical
Summary
Current Economic Forecast
2015
estimates
Real
Growth in Gross Domestic Product (revised)
-1.0-+2.0%
Inflation
(revised) 1.0-2.0%
Corporate
Profits (revised) -7-+5%
2016 estimates
Real
Growth in Gross Domestic Product -1.25-+0.5%
Inflation
(revised) 0.5-1.5%
Corporate
Profits (revised) -15-0%
Current Market Forecast
Dow
Jones Industrial Average
Current Trend (revised):
Short
Term Uptrend 17334-19084
Intermediate Term Uptrend 11243-23973
Long Term Uptrend 5541-19413
2015 Year End Fair Value
12200-12400
2016 Year End Fair Value
12600-12800
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Uptrend 2025-2264
Intermediate
Term Uptrend 1903-2505
Long Term Uptrend 862-2246
2015 Year End Fair Value
1515-1535
2016
Year End Fair Value 1560-1580
Percentage
Cash in Our Portfolios
Dividend Growth
Portfolio 53%
High
Yield Portfolio 54%
Aggressive
Growth Portfolio 53%
Economics/Politics
The
economy provides no upward bias to equity valuations, though that could be
changing. The dataflow this week was mixed: above estimates: June housing starts, June
existing home sales, weekly jobless claims, the Chicago national activity index
and the July flash manufacturing PMI; below estimates: the July housing index,
weekly mortgage and purchase applications, month to date retail chain store
sales, the Philly Fed index; in line with estimates: June leading economic indicators.
However, the
primary indicators were weighed to the positive side: June housing starts (+),
June existing home sales (+) and June leading economic indicators (0). That clearly puts the week in the plus again,
extending the streak of upbeat weeks to four in a row. So the economy is, at the least, taking a
pause in the midst of cyclical weakness and, at the most, beginning to stabilize
after a tough ten months. I remain as
yet unsure primarily because the pattern of the economic indicators over the
past couple of years has been a lousy first quarter, a bounce back in the
second quarter and then a return to mixed to negative numbers for the rest of
the year.
The growth
pattern of the US economy (medium and today’s absolute must read):
I am not
altering our recession forecast but the red light for change is flashing. The
score is now: in the last 44 weeks, thirteen have been positive to upbeat,
twenty nine negative and two neutral.
On the other
hand, the numbers from abroad continued to be negative as China suspends reporting
on several important economic indicators (that can’t be good news). In addition, the consequences from the Brexit
and the developing problems in the Italian, German and Greek banking systems
remain in question.
In the last two
weeks, the Fed has been out in force beating the ‘no rate hike’ drums,
suggesting to me that an increase is off the table at least until after the
election. It is somewhat ironic that
this latest campaign to quell fears of tighter money comes in the midst of a
marked improvement the economic data as well as a Market moonshot---which, as
we all know, is the true object of their ‘data dependency’.
In addition, the
ECB left rates unchanged, which is to say, quite low. However, the Bank of Japan poo pooed the idea
of ‘helicopter’ money. I don’t know if
this means that the Bernank was unsuccessful in pushing the idea onto the
Japanese or if these guys are just lying to prevent the algos from front
running the policy. We will likely know
soon enough.
In summary, this
week’s stats from the US were positive, keeping alive the prospect that our
recession forecast may be wrong. On the
other hand, the international data continues to disappoint; and we haven’t even
seen the potential fallout from Brexit and/or the mounting EU banking
difficulties. For the moment, I am not
altering our outlook though the red warning light is flashing.
Our forecast:
a recession or a zero economic growth rate, caused
by too much government spending, too much government debt to service, too much
government regulation, a financial system with conflicting profit incentives
and a business community hesitant to hire and invest because the aforementioned,
the weakening in the global economic outlook, along with the historic inability
of the Fed to properly time the reversal of a vastly over expansive monetary
policy.
The
negatives:
(1)
a vulnerable global banking system. Deutschebank and the Italian banking system
continue on red alert. The latter was
not helped this week by an EU high court ruling that its current bailout plan
was illegal.
Either one of the
above could stimulate a Lehman Brothers type crisis in their respective countries
and increase the likelihood that the contagion could spread throughout
Europe.
(2) fiscal/regulatory
policy. None and there won’t be until
next year. That said, in his acceptance
speech, The Donald not only promised a lot of stuff that costs money but also
to lower taxes. Same old, same old.
(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 I noted
above, the Fed is doing what it does best---standing around looking like a deer
in the headlights.
As for other
central banks, the ECB left rates unchanged [surprise, surprise] and the BOJ
said that there was no need for ‘helicopter’ money.
Why helicopter money
won’t work (medium):
You know my
bottom line: QE [except QE1] and negative interest rates have done nothing to
improve any economy, anywhere, anytime; so their absence will do little
harm. What they have done is lead to asset
mispricing and misallocation. Sooner or later, the price will be paid for that.
The longer it takes and the greater the magnitude of QE, the more the pain.
Comments from a
former BIS chief economist (medium):
(4) geopolitical
risks: Brexit vote proved a nonevent, the Middle East quagmire is, at the
moment, just white noise while terrorism has gained center stage. Of course, the latter can go on forever with
little impact on the US or global economy.
Their risk is largely psychological and they to only have economic or
Market influence if they add fuel to a larger negative narrative---like the vanishing
anchovies off the Peruvian coast back in the mid-70’s inflation crisis. And as we all know, at the moment, there is
no negative narrative anywhere is sight---at least that anyone is paying
attention to.
That said,
lurking in the weeds is the potential banking crises developing in Germany and
Italy. Of course, the willingness of the
central banks to continue paper over bank insolvencies is without limit and the
willingness of the Markets to ignore the obvious has been story line for the
last eighteen months. So this too may
only matter in the context of the aforementioned as yet unappreciated larger
negative narrative.
A sanguine look
at the Italian banking problem and its potential solution (medium):
(5)
economic difficulties in Europe and around the globe. The international economic stats this week
were mixed to negative.
[a] the June UK inflation rate rose, unemployment fell
to an eleven year low, retail sales declined and its flash composite PMI was a
disaster; German and EU economic sentiment declined; the EU flash composite PMI
fell but less than anticipated,
[b] China suspended the reporting of two key economic
indicators {any thoughts on why?}
[c] the July
Japanese manufacturing PMI rose slightly but remained in negative territory.
Add the mounting banking problems in Europe and little
support for the US economy can be expected from abroad.
Bottom line: the US economy remains weak though there is a
growing chance that it could be stabilizing.
However, there is little aid from the global economy; and the potential
consequences of the Brexit and the mounting EU banking crisis could make things
worse. Meanwhile, our Fed remains
confused, inconsistent and seemingly oblivious to data. Central bank credibility is a growing issue;
though to date, investors don’t seem to care.
A deteriorating
global economy and a counterproductive central bank monetary policy are the biggest
economic risks to our forecast.
This week’s
data:
(1)
housing: the July housing index was below estimates; June
housing starts were quite strong and existing home sales were above
expectations; weekly mortgage and purchase applications were down,
(2)
consumer: month to date retail chain store sales were weaker
than the prior week; weekly jobless claims fell versus forecasts of a rise,
(3)
industry: the July Philadelphia Fed manufacturing index
was disappointing while the June Chicago NAI and the July flash manufacturing
PMI were better than consensus,
(4)
macroeconomic: the June leading economic indicators
were up and in line.
The Market-Disciplined Investing
Technical
The indices
(DJIA 18570, S&P 2175) maintained their relentless advance on strong
breadth and benign volatility (VIX)---indeed, after trying to rebound from
resetting to a downtrend, it (12) fell again on Friday and is not the far from
the lower boundary of its intermediate term trading range (10.3).
The Dow closed
[a] above rising 100 day moving average, now support, [b] above its 200 day
moving average, now support, [c] within a short term uptrend {17334-19084}, [c]
in an intermediate term uptrend {11243-23973} and [d] in a long term uptrend {5541-19431}.
The S&P
finished [a] above its rising 100 day moving average, now support, [b] above
its 200 day moving average, now support, [c] within a short term uptrend {2027-2266},
[d] in an intermediate uptrend {1903-2505} and [e] in a long term uptrend {862-2246}.
The long
Treasury was up on Friday. It seems to
have stabilized after a couple of tough weeks and continues to trade above its
100 day moving average and well within very short term, short term,
intermediate term and long term uptrends.
GLD was down on
Friday, but remained above its 100 day moving average and within very short
term, short term and intermediate term uptrends.
Finally, on
Friday, the dollar closed above the upper boundary of its short term downtrend. If this trend gets broken and opens up the possibility
of further advances of the dollar, it will not bode well for revenue and profit
growth on the large US multinationals.
Bottom
line: the bulls control the field. Both Averages are in solid uptrends across
all timeframes; and so far, consolidations have been very tame. On top of that
the VIX seems headed for new lows. I
believe that a challenge of the indices’ upper boundaries of their long term
uptrends is highly likely; but I question its success.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (18570)
finished this week about 48.0% above Fair Value (12543) while the S&P (2175)
closed 40.3% overvalued (1550). Incorporated
in that ‘Fair Value’ judgment is some sort of half assed attempt at getting fiscal
policy under control, a botched Fed transition from easy to tight money, a
historically low long term secular growth rate of the economy and a ‘muddle
through’ scenario in Europe, Japan and China.
This week’s US economic
numbers were again positive. Now we have
a trend---at least a very short one. But
that is not quite enough to prompt a change in forecast. If you didn’t read the above post (The growth
pattern of the US economy), please do.
The author expresses much more eloquently than I my hesitancy in
altering our outlook. Of course,
investors have no such timidity. They
may be right; but I am going to opt for getting more information. That said, as I have repeatedly said, the
health of the Market right now is less dependent on the health of the economy
and more on continuing central bank ease.
Overseas---still
no improvement. The effects of Brexit
are clearly visible in the latest UK numbers; whether that spreads to the rest
of the EU remains to be seen. Of course, the EU has its own set of problems
(banking system) to deal with. In Asia,
Japan remains in recession. Plus we have
no idea what is happening in China because things have deteriorated enough that
lying about the numbers no longer suffices.
This week the government simply refused to report the data. In short, if the US economy has started to gain
strength, it is doing it on its own.
What concerns me
is that, (1) most Street forecasts for the moment are more optimistic regarding
the economy and corporate earnings [down 4% in the second quarter at the latest
count] than our own but (2) even if all those forecasts prove correct, our
Valuation Model clearly indicates that stocks are overvalued on even the
positive economic scenario and (3) that raises questions of what happens to
valuations when reality sets in.
On the other
hand, the Fed continues to press forward to even greater heights on asset
mispricing and misallocation. Despite
the recent improvement in the dataflow, virtually the entire membership of the
FOMC have in the last two weeks voiced the ‘no rate hike’ mantra. I can understand that the QE narrative would remain
unchanged at the same time the dataflow turns upbeat because that whole data
dependency spiel was just a lot smoke.
What I don’t understand is the seeming unwillingness to consider
tightening when the Market is at all-time highs---which, after all, has been
the true determinant of Fed policy lo these many years. My only explanation is that these guys/gal are
so paralyzed by fear of QE unraveling, they are frozen into inaction.
As you know, I
believe that sooner or later, the price will be paid for flagrant mispricing
and misallocation of assets.
Net, net, my two
biggest concerns for the Markets are (1) declining profit and valuation
estimates resulting from the economic effects of a slowing global economy and
(2) the unwinding of the gross mispricing and misallocation of assets caused by
the Fed’s wildly unsuccessful, experimental QE policy.
Bottom line: the
assumptions in our Economic Model are unchanged. If they are anywhere near correct, they will
almost assuredly result in changes in Street models that will have to take their
consensus Fair Value down for equities. Near
term that could be influenced by Brexit.
The assumptions
in our Valuation Model have not changed either; though at this moment, there
appears to be more events (greater than expected decline in Chinese economic
activity; turmoil in the emerging markets and commodities; miscalculations by
one or more central banks that would upset markets; an EU banking crisis [which
may be occurring now]; a potential escalation of violence in the Middle East
and around the world) that could lower those assumptions than raise them. That said, our Model’s current calculated Fair
Values under the best assumptions are so far below current valuations that a
simple process of mean reversion is all that is necessary to bring Market
prices down significantly.
DJIA S&P
Current 2016 Year End Fair Value* 12700
1570
Fair Value as of 7/31/16 12543
1550
Close this week 18570 2175
Over Valuation vs. 7/31 Close
5% overvalued 13170 1627
10%
overvalued 13797 1705
15%
overvalued 14424 1782
20%
overvalued 15051 1860
25%
overvalued 15678 1937
30%
overvalued 16305 2015
35%
overvalued 16933 2092
40%
overvalued 17560 2170
45%
overvalued 18187 2247
50%
overvalued 18814 2325
Under Valuation vs. 7/31 Close
5%
undervalued 11915
1472
10%undervalued 11288 1395
15%undervalued 10661 1317
* 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 hard way.
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