9/24/16
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 18033-19767
Intermediate Term Uptrend 11420-24247
Long Term Uptrend 5541-19431
2015 Year End Fair Value
12200-12400
2016 Year End Fair Value
12600-12800
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Uptrend 2122-2358
Intermediate
Term Uptrend 1946-2548
Long Term Uptrend 862-2400
2015 Year End Fair Value
1515-1535
2016
Year End Fair Value 1560-1580
Percentage
Cash in Our Portfolios
Dividend Growth
Portfolio 55%
High
Yield Portfolio 54%
Aggressive
Growth Portfolio 55%
Economics/Politics
The
economy provides no upward bias to equity valuations. It was
a slow week for data, but what we got
was negative: above estimates: the
September housing index and weekly jobless claims; below estimates: weekly
mortgage and purchase applications, August housing starts and building permits,
August existing home sales, month to date retail chain store sales, September
consumer sentiment, the August Chicago national activity index, August CPI and
the August leading economic indicators; in line with estimates: none.
In addition, the
primary indicators were awful: August housing starts and building permits (-),
August existing home sales (-) and August leading economic indicators. The score is now: in the last 53 weeks, fifteen
were positive, thirty-five negative and three neutral. In addition, both the Atlanta and New York Fed’s
released their latest update on GDP growth---and they are lower. Sounds awfully supportive of our forecast.
Overseas, there
was virtually no stats---only two datapoints: Chinese loan demand fell to all-time
lows and the Markit EU Composite PMI was below estimates.
Of course, the
Bank of Japan and the Fed were center stage this week. Both basically did nothing though there were
some telling nuances in their messages: the BOJ attempting to reverse some of
the ill effects of its QEInfinity policy; the Fed telling us everything is
awesome, but providing multiple examples of why it is not. I would think that this would begin to raise
doubts among investors that these guys have a clue. But not so.
All seem overjoyed just to have another couple of months of easy money.
In summary, this
week’s US economic stats were really poor, while the international data was nonexistent. The Fed continued its strategy of talking a
lot, doing nothing, masking it with double talk and praying for a miracle to
extract it from the hole in which it has dug itself. The yellow warning light for change is flashing
much slower.
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.
This discussion
of the high level of private debt builds on Rogoff and Reinhart’s thesis that
high government debt levels inhibit economic growth. It suggests that global economic growth will
be impaired in the foreseeable future.
The
negatives:
(1)
a vulnerable global banking system. This week featured Wells Fargo as the latest
bankster which attempted to defraud the public:
The Brookings Institute
asks and answers the question: are US banks really any safer today than before
Dodd Frank?
In addition,
German and Italian banks remained in the headlines:
Can
Deutschebank avoid a state bailout?
German politicians
are now starting to worry (medium):
Update on Italy’s
banking crisis (medium):
The unintended
consequences of higher bank capital requirements. This is interesting (medium):
The UN fears a third leg of the financial crisis (medium):
(2) fiscal/regulatory
policy. What fiscal policy?
(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 noted above,
the BOJ and FOMC met this week, did nothing but altered the tone of their messages. I pounded them hard enough in Thursday’s Morning
Call that I don’t need to add anything else to make my position clear. But I will include my bottom line:
‘the BOJ and FOMC did roughly what I had
expected; although judging by the pin action, others were clearly worried about
a more hawkish tilt in policy. QEForever
remains the underlying investment theme; as such, the assumption has to be that
stocks are going higher.
That said, there is some cognitive
dissonance starting to creep into this story.
(1) the BOJ all but admitted that its QE, NIRP and ZIRP haven’t produced
the results that were anticipated, (2) the Fed’s ‘the economy is doing great’
narrative is not quite as solid as it has been because the Fed itself is
producing forecasts that suggest that the economy is not doing so great, (3) even
Fed supporters like CNBC’s Steve Leisman, are asking, ‘if the economy is so
great, why aren’t you raising rates?’ and (4) the number of policy dissenters
on the FOMC is growing.
Whether this is a temporary phenomenon or a
sign of things to come is anyone’s guess.
I will say that I have maintained that this drunken Market binge will
likely come to an end when either some major exogenous event reveals that the
central bankers are naked or the cumulative evidence of central bankers’ hubris,
poor judgement and lack of courage becomes obvious to all but themselves. The above examples could be the first sign of
the latter---emphasis on ‘could be’.’
Here is a
better assessment from a much smarter guy than me (today’s must read):
(4) geopolitical
risks: after an ineffective cease fire, Syria is heating up again.
Why Syria
matters (medium):
(5)
economic difficulties in Europe and around the globe. As noted above, there were only two international
economic stats---Chinese loan demand and the EU Markit Composite Flash PMI---both
of which were negative.
This on
Chinese bad debt:
This on
the ECB’s QE failure:
This is hardly a reason to pound a bearish drum; but it is
a continuation of what has been an abysmal trend. And when coupled with the
banking problems in Italy and Germany, it hardly provides a hopeful sign of support
from the global economy.
Bottom line: the US economy has gotten weaker in the last
four weeks, calling into question any thought that it could be
stabilizing. Moreover, there is little aid
coming from the global economy. Meanwhile,
our Fed remains inconsistent, further increasing the loss of central bank
credibility; 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: weekly mortgage and purchase applications were
down; August housing starts and building permits were very disappointing as
were August existing home sales; the September housing market index was very
upbeat,
(2)
consumer: month to date retail chain store sales growth
was down from the prior week; weekly jobless claims fell more than anticipated,
the preliminary September consumer sentiment was below expectations,
(3)
industry: the August Chicago national activity index
was down versus estimates that it would be up,
(4)
macroeconomic: August leading economic indicators were
below forecast; August CPI came in higher than forecast.
The
Market-Disciplined Investing
Technical
On Friday, the
indices (DJIA 18261, S&P 2164) sold off, ending a volatile week mostly
driven by the central banks. Volume rose but was still quite low; breadth
weakened after a strong week. The VIX was
up modestly also having experienced a very unstable week; still in the end, its
pin action was a plus for stocks.
The Dow ended
[a] above rising 100 day moving average, now support, [b] above its 200 day
moving average, now support, [c] within a short term uptrend {18033-19767}, [c]
in an intermediate term uptrend {11420-24247} 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 {2122-2358},
[d] in an intermediate uptrend {1946-2548} and [e] in a long term uptrend
{862-2400}.
The long
Treasury declined after an upbeat week, ending above its 100 day moving average
and well within very short term, intermediate term and long term uptrends.
GLD also had a
good week, finishing above its 100 day moving average and within a short term
trading range. While it successfully challenged
a short term uptrend, it recovered back above the lower boundary of that
uptrend two days after the break. Since
then, it has been rising along with that lower boundary. If it can pull away from this trend line, I will
likely reinstate the uptrend.
Bottom line: the
charts of the Averages remain solidly to the upside, trading above their key
moving averages and within uptrends across all timeframes. This week their advance was driven by the continuing
hope for accommodative central bank monetary policy. That investment theme will likely be in place
for another couple of months, so the assumption has to be that prices are
headed higher.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (18261)
finished this week about 44.7% above Fair Value (12616) while the S&P (2164)
closed 38.8% overvalued (1559). 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
data continued a four week string of really poor numbers, diminishing the
prospect that rate of decline in growth could be any slowing.
The good news is
that the dataflow from overseas, which has been awful for as long as I can
remember, was at a trickle. The bad news
is that there were signs of mounting problems in the Chinese, German and
Italian banking systems. ‘Muddle
through’ continues to be our scenario for the global economy; but that is
increasingly looks like a bad assumption.
What concerns me
about all this is that, (1) most Street forecasts for the moment are more
optimistic regarding the economy and corporate earnings than either the numbers
imply or our own outlook suggests 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.
Of course, the
main headlines this week were once again central bank related; and as usual, they
were incomprehensible as ever. The Bank
of Japan left rates unchanged while it continued to talk up QE. However, it took a big step towards admitting
that its policies haven’t worked when it stated that it would begin targeting
the government bond yield curve---a concession to Japanese financial
institutions that are getting hammered by current policy.
Our own Fed also
left rates unchanged but this time omitted its usual ‘on the one hand, on the
other hand’ narrative to justify doing nothing---it just did nothing. In addition, it said that everything was
awesome, then proceeded to lower its forecast for GDP growth, suggesting
everything isn’t awesome.
That said, the
Markets were positively ecstatic over these non-moves. As hard as that is for me to understand, the
fact remains that investor psychology is a slave to an accommodative Fed
irrespective of how poorly the US economy is performing---this week’s data, the
Fed policy statement and the Market performance being a perfect example.
When ultimately the
irrational linkage ends of a weak economy = easy Fed = rising stock market
breaks is anyone’s guess. Clearly, I have
been wrong on the timing; but sooner or later, the math of that equation will cease
to make any sense to enough investors that it will change. Either that or the historical framework for
investment decision making completely changes.
You can decide if that is a good or bad thing. I suggest the latter.
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.
Use the current price
strength to sell a portion of your winners and all of your losers.
DJIA S&P
Current 2016 Year End Fair Value*
12700 1570
Fair Value as of 9/30/16 12616
1559
Close this week 18261 2164
Over Valuation vs. 9/30 Close
5% overvalued 13246 1636
10%
overvalued 13877 1714
15%
overvalued 14504 1792
20%
overvalued 15139 1870
25%
overvalued 15770 1948
30%
overvalued 16400 2026
35%
overvalued 17031 2104
40%
overvalued 17662 2182
45%
overvalued 18293 2260
50%
overvalued 18924 2338
Under Valuation vs. 9/30 Close
5%
undervalued 11985
1481
10%undervalued 11354 1403
15%undervalued 10723 1325
* 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.
