The Closing Bell
10/1/16
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 18144-19848
Intermediate Term Uptrend 11437-24282
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 2133-2369
Intermediate
Term Uptrend 1949-2551
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 busy week for the statisticians and a
positive one for the data: above
estimates: August new home sales, weekly mortgage applications, September
consumer confidence and consumer sentiment, weekly jobless claims, September
Markit Services flash PMI, Chicago PMI, August durable goods orders, the
September Dallas and Richmond Fed manufacturing indices, second quarter GDP and
the August trade deficit; below estimates: the July Case Shiller home price
index, August pending home sales and August personal spending; in line with
estimates: month to date retail chain store sales, August personal income.
In addition, the
primary indicators were upbeat: August new home sales (+), August durable goods
orders (+), second quarter GDP (+), August personal spending (-) and August
personal income (0). On the other hand
on Friday, the Atlanta Fed revised its third quarter GDP growth estimate down
again to 2.4%. Nevertheless, in total,
the stats were quite positive---so the score is now: in the last 54 weeks, sixteen
were positive, thirty-five negative and three neutral.
Overseas, the
data was mixed and some of it of questionable value. Still it is better than being all negative,
so I have to count that as a plus.
Outside of the potential OPEC production cut, the weight of evidence
continues to point to a struggling global economy.
As to that OPEC
cut, it would clearly be a positive if (1) it is actually enacted [to that
point, within two days of the announcement, several members began tossing
monkey wrenches into the plans, raising questions on whether this proposal will
ever get off the ground], (2) there is no cheating and (3) the non OPEC don’t
spoil the party by jacking up production to fill the gap and (4) demand doesn’t
fall due to declining global economic activity.
Unfortunately,
the solvency of Deutschebank remains center stage; and if history repeats
itself, the longer it remains there and the more denials of problems there are
(three this week), the more likely it is that there is something rotten in
Denmark. To be sure, a settlement with
the Justice Department on the $14 billion fine would be a major plus; and rumors
of such is precisely what we got on Friday.
I await the confirmation.
In summary, this
week’s US economic stats were improved, while the international data was mixed. And rejoice, rejoice, the central banks were relatively
quiet this week. This is was enough to
keep a stabilizing global economy on the table as a possibility, but not enough
the raise the odds of its occurrence. The
yellow warning light for change continues to flash slowly.
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 held the headlines this week as
Merkel publicly stated that the government would not bail out the bank in case
of insolvency.
That was followed by rumors that financial authorities
were working on a plan to aid the bank if it failed to raise the necessary capital
to pay the $14 billion US fine. Whether
this is all political rhetoric or statements of fact is a big question to which
only the German political class knows the answer---and they might not even know.
Then on Friday, the rumors circulated that the Justice
Department and Deutschebank were close to a settlement of $5.4 billion.
Clearly this is a very fluid situation; so any
conclusion would be highly suspect. But
to summarize, what we don’t know is [a] whether financial authorities are
working to come to Deutschebank’s aid and [b] whether a much reduced settlement
with the US DOJ is in the making.
What we do know is that Deutschebank [a] has a very
weak balance sheet, [b] has a giant notional position in derivatives which we
have no clue about the inherent risk, [c] to that point, on Thursday, several
hedge funds began withdrawing funds from their accounts at Deutschebank and on
Friday, the same group began aggressively hedging its counterparty risk [d] but
none of which have as yet put the bank’s solvency in question.
(2) fiscal/regulatory
policy. What fiscal policy? Aside from a temporary funding measure to
keep the government open a couple more months, deadlock remains the
theme---which, of course, is the good news; because the bad news is that these
morons get to together and agree on some measure that further screws the
electorate/taxpayers.
(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.
Thankfully, the
universe got something of a respite this week from more central bank
malfeasance. There was, of course, an
ongoing debate in the media about the ultimate meaning of last week’s BOJ and
Fed {in} actions. But it is only natural
that investors/Markets would be uncertain since the central bankers don’t have
a clue---the most obvious example of which is their rhetoric [everything is
awesome] versus the facts [the economic numbers are lousy].
But we couldn’t
get through the entire week without some bit lunacy. This week the prize goes once again to Yellen
who suggested, not once but twice, that the Fed could begin buying corporate
bonds and stocks if the economy turns south again---because just look at how
well it has worked in Japan.
Some advice
from one of my favorites---Rick Santelli (3 minute video):
My bottom line
here is that I doubt any tightening measures are forthcoming in the foreseeable
future.
(4) geopolitical
risks: Syria just keeps getting worse,
http://www.zerohedge.com/news/2016-09-29/us-suspend-syria-diplomacy-russia-prepares-military-options
(5)
economic difficulties in Europe and around the globe. This week:
[a] September
EU and German business confidence were strong; German unemployment rose, EU
inflation and unemployment were in line, second quarter UK economy was better
than expected,
[b]
August Chinese industrial profits were up 19% {remember these guys lie}, the
September Markit manufacturing index was flat,
[c]
September Japanese inflation declined, unemployment rose and household spending
fell,
[d] the
World Trade Organization lowered its estimates for 2016 global economic growth and
for 2016/2017 global trade.
The big news of
the week was the tentative OPEC decision to cut oil production, though no a
formal agreement has been made. While
clearly a potential positive, the hard part still lies ahead, because there has
been no allocation as yet as who has to absorb the cut and by how much. Plus remember that even if an agreement is
reached, OPEC members have a history of cheating and there are a lot of non-OPEC
producers in the world that will more than likely jack up production to fill
the gap.
Net, net, it all wasn’t bad news though I would put an
asterisk on that Chinese profits number indicating doubt and remind you that
the oil production cuts are not a done deal.
The WTO’s downwardly revised world trade and economic growth forecasts
are important datapoints, suggesting that the trend in downbeat global stats is
not about to end anytime soon. 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 remains weak with
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 applications were down while purchase
applications were up; August new home sales fell less than expected, while
pending home sales was very disappointing; the July Case Shiller home price
index was lower than forecasts,
(2)
consumer: month to date retail chain store sales growth
was flat with the prior week; weekly jobless claims rose less than consensus; August
personal income rose but spending was flat; both September consumer confidence and
consumer sentiment were above projections,
(3)
industry: August durable goods orders were better than anticipated;
the September Markit Services Flash PMI was stronger than forecast as was the
September Chicago PMI; the September Dallas and Richmond Fed’s manufacturing
indices were down but less than estimates,
(4)
macroeconomic: the final reading for second quarter GDP
was slightly better than consensus while corporate profits slid a bit less than
projections; the August trade deficit was less than expected.
I want to do a
sidebar here: a commonly accepted truism
of the Market is that it ‘climbs a wall of worry’---which we continue to hear
from Market pundits. The above list of
risk represent those worries. I list
them generally every week to verbalize where I think our forecast could be
wrong. So in times of Market undervaluation,
fair valuation or even moderate overvaluation, they are the ‘wall of worry’. In this Market cycle, that would have been
the case until early 2014 when the S&P began to ascend above the 15% overvalued
level. Once the S&P pushed past
1800, it entered grossly overvalued territory and those worries become something
more---they become potential trigger mechanisms. And that is where we are now. I think it misguided to assume the ‘wall of
worry’ aphorism carries the same degree of truth from the bottom of a Market
cycle until the day before stock prices rollover. It just can’t.
The
Market-Disciplined Investing
Technical
Proving once
again that nothing can keep this Market down, the indices (DJIA 18308, S&P
2168) rebounded sharply Friday. Volume
picked up and breadth improved. The VIX fell
5%, closing below its 100 day moving average and in a short term downtrend---which
remains supportive of stocks.
Nonetheless, it is still in a very short term uptrend---a negative.
The Dow ended
[a] above its 100 day moving average,
now support, [b] above its 200 day moving average, now support, [c] within a
short term uptrend {18114-19848}, [c] in an intermediate term uptrend {11437-24282}
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 {2133-2369},
[d] in an intermediate uptrend {1949-2551} and [e] in a long term uptrend
{862-2400}.
The long
Treasury had its worse day in a couple of weeks, likely reflecting an unwinding
of the safety trade following the rumors of a DOJ/Deutschebank reduced
settlement. Still it remained above its
100 day moving average and well within very short term, intermediate term and
long term uptrends.
GLD fell again, finishing
below its 100 day moving average and within a short term trading range. It has now made a fourth lower high. This is not a healthy chart and it is getting
more unhealthy---not a plus for our GDX holding,
Bottom line: the
Averages staged a sharp rebound on decent volume on Friday. As I noted there was an upbeat rumor on
Deutschebank which seemed to fuel it.
This Market continues to demonstrate tremendous resiliency. As long as it does, look for a challenge of the
indices former all-time highs (18668/2194).
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (18308)
finished this week about 44.7% above Fair Value (12644) while the S&P (2168)
closed 38.8% overvalued (1562). 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 improved though much of the data can be characterized as being less bad
rather than more positive. Still I give it
a plus rating though I don’t believe it helped the odds of no recession.
The global stats
also carried a firmer tone. However, it
was largely due to the surprise announcement from OPEC of a potential oil
production cut. Unfortunately, there are
a number of factors that could cause a slip between the cup and the lip; so I am
not sure just how positive this development is at this time---save for the
initial upbeat response from oil prices.
This bit of
possibly good news was offset by the mounting signs of problems at
Deutschebank. Aside from the numbers
themselves, this situation was exacerbated by (1) denials from multiple sources
that there was no problem---a sure sign that the powers that be are wee weeing
in their pants and (2) multiple actions by institutional investors to reduce
their exposure to the bank. On the other
hand, a reduced settlement with the DOJ would be a big help.
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.
Thankfully, the
central banks were on hold this week---a part from Draghi’s disavowal of any
responsibility for the Deutschebank mess and Yellen’s hinting that the Fed
might want to buy stocks sometime in the future. Which is good because every time they do or
say something, their cluelessness becomes all the more apparent.
That said, investor
psychology remains a slave to an accommodative Fed irrespective of how poorly
the US economy is performing. ‘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.
I would use the current
price strength to sell a portion of your winners and all of your losers.
The latest from Lance
Roberts (medium):
For the optimists
(medium):
DJIA S&P
Current 2016 Year End Fair Value*
12700 1570
Fair Value as of 10/31/16 12644
1562
Close this week 18308 2168
Over Valuation vs. 10/31 Close
5% overvalued 13276 1640
10%
overvalued 13908 1718
15%
overvalued 14540 1796
20%
overvalued 15172 1874
25%
overvalued 15805 1952
30%
overvalued 16432 2030
35%
overvalued 17069 2108
40%
overvalued 17701 2186
45%
overvalued 18333 2264
50%
overvalued 18966 2343
Under Valuation vs. 10/31 Close
5%
undervalued 12011
1483
10%undervalued 11379 1405
15%undervalued 10747 1327
* 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.
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