11/19/16
As usual, I am taking off Thanksgiving week to enjoy family and
friends. I will be checking the Market;
so if anything noteworthy occurs, I will be in touch. Have a great holiday.
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 18000-20057
Intermediate Term Uptrend 11544-24394
Long Term Uptrend 5541-20148
2015 Year End Fair Value
12200-12400
2016 Year End Fair Value
12600-12800
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Trading Range 1995-2103
Intermediate
Term Uptrend 1986-2588
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 Trump
economy will likely provide am upward bias to equity valuations. This
week’s data was positive: above
estimates: October housing starts, weekly jobless claims, October retail sales,
month to date retail chain store sales, the November NY Fed manufacturing index,
September business inventories and sales, October PPI; below estimates: weekly
mortgage and purchase applications, October industrial production, the November
Kansas City and Philly Fed manufacturing indices, October import/export prices;
in line with estimates: October leading economic indicators, November homebuilders
confidence, October CPI.
The primary
indicators were also a plus: October retail sales (+), October housing starts (+)
October industrial production (-) and October leading economic indicators (0). Overall an upbeat week. The score is now: in the last 59 weeks, nineteen
were positive, thirty-six negative and four neutral. This score is hardly indicative of anything other
than an economy struggling to keep its head above water. Although in fairness, the trend of late has
contained a higher number of mixed to positive weeks, suggesting the economy
may be improving on its own.
However, I think
it important to note that virtually all these stats predate the election; and
given the significant improvement in sentiment, it seems reasonable to assume
that we could likely see some upward bias in the data short term as consumers and
businesses feel more comfortable spending and investing. And that says nothing about the long term economic
impact of new fiscal/regulatory policies.
As you know, the result is that I have put our somewhat dreary forecast
on hold.
Overseas, the
data remained negative; and for better or worse, sentiment there is less upbeat
than here. Increased global economic turmoil
is one of those potential negative consequences (trade issues, a strong dollar)
of the Trump victory. So our global ‘muddle
through’ forecast remains intact.
Other factors
figuring into the global outlook:
(1) the
hope for an OPEC production cut was revived this week by another series of
bulls**t comments about achieving some sort of agreement, then immediately had
cold water dumped on it as oil ministers from several countries declined to
attend next week’s meeting. And as a
reminder: ‘….it would clearly be a
positive if (1) it is actually enacted…., (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.’
(2) the
solvency of Deutschebank. ‘No news this week, though the potential
exists that the revolt against the establishment symbolized by the Brexit and
Trump’s election could spell trouble for the bailout of overleveraged banks
with too many bad loans and too many speculative investments.’
(3) China’s
currency [along with a lot of others] continued to decline helped along by a
soaring dollar. This turmoil in the
currency markets can potentially exacerbate trade relations [a] not only with
the US, if we believe the Donald [b] but also amongst themselves. If it continues, it will not be good for
anybody and will almost assuredly negatively impact US corporate profitability.
Finally, on the
monetary front, Yellen virtually guaranteed a December rate hike. Meanwhile, Draghi virtually guaranteed the
extension of the ECB’s bond buying program.
This divergence in policies will only make trade discussions more
difficult and exacerbate the global dollar funding problem.
And:
In summary, this
week’s US economic stats were upbeat, though I think that the data flow has
less relevance at the moment than it will when it starts to reflect the likely
coming changes in fiscal/regulatory policies.
However, if the Trump fiscal agenda is enacted, I will almost certainly
revise up our 2017 economic forecast and quite possibly the long term secular
economic growth rate in our Models.
The global
numbers remained in their negative long term trend. A diverging global economy would either be
good news for the rest of the world (as the US pulls it out of decline) or bad
news for the US (as the rest of the world stymies progress in the US).
Our forecast:
I am still attempting
to get my arms around what appears to be a sudden and positive shift in the
long term secular growth rate of the economy.
I am presently without any firm conclusions other than the
generalization that the growth rate will pick up. My hang up is on the timing and
magnitude.
For those who
didn’t read last week’s Closing Bell, here is a more detailed repeat of my
thoughts on the subject:
‘Given the likely changes coming in fiscal
policy and the probable impact of those changes, some revision in our forecast
will be needed. Assuming that tax rates
will be lowered and simplified, they will almost certainly provide a lift to
economic growth. A vastly reformed
regulatory regime should also provide a boost.
Ditto the reform of Obamacare.
Increased spending poses more of a problem. Little doubt that it initially will stimulate
economic activity. Longer term, however,
its effect on interest rates, especially if the Fed starts normalizing monetary
policy could be deleterious. All that
said, it is way too soon to start quantifying all this. So I am going to make a qualitative change (i.e.
an improving economy) and wait to see exactly what is enacted before putting
any numbers on it.
On the other hand, the issue of a woefully
misguided monetary policy will not be helped.
Indeed, it is apt to get worse as the Fed (hopefully) will begin the
process of normalization. That means the
start of the unwinding of asset mispricing and misallocation. While no one knows exactly how this will
look, I am assuming that while it will have little impact on the economy
(because QE/ZIRP never really helped) it will almost certainly involved the
reversal of the asset pricing euphoria that accompanied it.
In addition, I am unsure just how revised
trade agreements, a stronger dollar and higher interest rates will play out in
the global economy. Certainly the
initial impact on the emerging markets has not been positive. In addition, there is the issue of rising
international populism as exemplified by Brexit and the Trump victory. This movement, if strengthen by these two
votes, could spell real problems for the EU and its heavily leveraged banking
system.’
Bottom line: the
stats over the last month or so have reflected more of a mixed picture than
purely a negative one. I am not saying that it is improving but it is a
possibility. That said, the more
important factors are (1) improving sentiment which itself could be a spur to
growth and (2) the likely net positive impact of the Trump fiscal/regulatory
policies. That said, I have no idea how
much until we see exactly what is enacted.
The problems of an irresponsible monetary policy and global economic
weakness remain.
The
negatives:
(1)
a vulnerable global banking system. This week:
[a] JP Morgan was fined $200 million plus from bribing
Chinese officials.
[b] speaking of Chinese, there were warnings signals
coming out of the Chinese financial system (medium):
[c] longer term, as I have noted, the Brexit/Trump
combo may not portend good news for the weak EU banking system.
(2) fiscal/regulatory
policy. I have beat this dead horse
enough; so at the moment, suffice to say that the proposed Trump fiscal/regulatory
agenda has both positive and negative implications for the economy with the net
being a plus. There is still much we don’t
know which will determine the timing and order of magnitude of the coming
changes. Stay tuned and don’t worry be happy.
Will the GOP
repeat the mistakes it made under Bush II (medium):
(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.
Again, I don’t
want to be repetitious; but the bottom line is that an aggressive fiscal program
will relieve the Fed of assuming that it has to carry the load of economic
stimulation; in other words, it can began to normalize monetary policy. As I noted above, Yellen signaled at least a
start of the process in her congressional testimony this week. While I doubt a normalization of monetary
policy will have much impact on the economy, I believe that it will
dramatically effect asset repricing and reallocation---which are already beginning
to occur ahead of any Fed change in policy.
The best thing the Fed can do is get out of the way of the Markets (i.e.
don’t fight the rise in rates) and don’t f**k up a return to normalcy---a task unfortunately
at which it has an abysmal record of success.
On Friday,
Draghi signaled the likely extension of the ECB bond buying program, meaning
that the ECB will continue to ease as the Fed is tightening. I am not an expert in currencies but I believe
that this will put further upward pressure on the dollar which could exacerbate
any forthcoming trade talks.
My bottom line
is that [a} given Yellen’s rather hawkish tone, a December hike seems almost
assured, but [b] a divergence in central bank monetary policies is not likely a
plus for trade discussions.
(4) geopolitical
risks: Syria is getting worse; but I think that a Trump presidency lessens the
odds of any kind of US/Russian conflict.
He has criticized the international adventurism of the Bush/Obama
administrations; so we should have less of that---which in my opinion is good
for the economy and good for the youth of this country who have had to bear the
weight of the last 16 years of neocon driven foreign policy.
(5)
economic difficulties in Europe and around the globe. This week:
[a] third
quarter EU GDP grew in line with estimates while household spending and capital
investment were flat; German GDP was below projections; UK inflation was lower
than forecast,
[b] the
October Chinese retail sales and industrial output were below expectations
while fixed asset investment was in line.
[c]
third quarter Japanese GDP came in ahead of estimates while household spending
and capital investment were flat.
This
week’s downbeat stats supported our global ‘muddle through’ scenario. Unfortunately, this set of numbers are not
apt to be helped by a more aggressive Trump trade policy and divergent monetary
policies.
Neither
will the internal cohesion of the EU following Brexit and the Trump election. It is way too soon to be making judgments
about what this could mean; but again it is has to be watched as a potential
sign of more falling global economic activity.
OPEC and its on
again, off again production cut was back in the headlines this week as its propaganda
machine ramped up speculation that some agreement will be reached which was
immediately trashed as three members said that they wouldn’t attend next week’s
meeting.
‘Even if OPEC is successful in achieving an
agreement, the hard part still lies ahead, because [a] there has been no
allocation as yet as who has to absorb the cut and by how much, [b] OPEC
members have a history of cheating’ and [c] there are a lot of non-OPEC
producers in the world that will more than likely jack up production to fill
the gap.’
Bottom
line: the US economic stats were upbeat
this week, though the global economic numbers certainly didn’t help. 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 early 2017,
which offers promise of not only better data but a normalization of Fed
monetary policy (and a December rate hike). 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. Hence, my concern about recession is in
abeyance as are the other aspects of our former forecast; although it is simply
too early to know the timing or magnitude of any change.
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: October housing starts exploded to the upside;
weekly mortgage and purchase applications were down; November homebuilder
confidence was in line,
(2)
consumer: October retail sales were above expectations;
month to date retail chain store sales improved from the prior week; weekly
jobless claims were down versus consensus of being up,
(3)
industry: October industrial production was below projections;
the November New York Fed manufacturing index was well ahead of estimates while
the Philly and Kansas City Feds’ indices were below; September business
inventories were down slightly but largely the result of stronger sales,
(4)
macroeconomic: October leading economic indicators were
in line; October PPI was more benign than forecast, while CPI was in line; October
import and export prices advanced more than anticipated.
The
Market-Disciplined Investing
Technical
The indices
(DJIA 18867, S&P 2181) tried again to work off an overbought condition
yesterday; but again it was a pretty pathetic attempt. Volume was up and breadth continued strong.
The VIX was down
3% (on a down day), closing below its 100 day moving average (now resistance),
below its 200 day moving average for the fourth day, reverting to resistance and
below the lower boundary of a very short term uptrend. The latter carries some technical
significance since the VIX has bounced off this trend eight times. It is a plus for stocks.
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 {18000-20057}, [c] in
an intermediate term uptrend {11544-24389} and [d] in a long term uptrend
{5541-20148}.
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 trading range
{1995-2193}, [d] in an intermediate uptrend {1986-2588} and [e] in a long term
uptrend {862-2400}.
The long
Treasury continued its decline on volume, finishing below its 100 day moving
average (now resistance), below its 200 day moving average (now resistance),
below a key Fibonacci level, in a developing a very short term downtrend, in a
short term trading range and in an intermediate term trading range. It is now quite oversold, so a near term
bounce is likely.
GLD fell 1%, ending
below its 100 day moving average (now resistance), below its 200 day moving
average (now resistance) and below the lower boundary of its short term
downtrend.
The dollar blew
through the upper boundary of its short term trading range. If it remains there through the close on
Tuesday, it will reset to an uptrend.
Bottom line: the
Averages are struggling to advance while in an overbought condition. That may mean a slowdown in momentum short
term; but I am still assuming that the S&P will at least try to challenge
the upper boundary of its short term trading range. The key at the moment remains how the indices
current divergence gets resolved. I await.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (18867)
finished this week about 48.8% above Fair Value (12672) while the S&P (2181)
closed 39.2% overvalued (1566). ‘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 will still reflect 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 quite positive while the global stats were again poor. But they are both secondary considerations as
we try to figure out what a Trump presidency/GOP sweep means for the economy
and the Markets.
As I noted last
week, with fiscal and regulatory polices likely to change, this past data will
mean less than it otherwise would in the absence of those changes. My problem is I just don’t know by how
much---and that clearly is 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 the outcome of altered trade relations and a big increase in
deficit spending. Nonetheless, from a
qualitative point of view, 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 consequences
of some of the new policies, 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.
Plus if that fiscal policy reignites inflation, it will only push the
Fed harder and that, in turn, likely speed up the whole process. Once real price discovery returns, I believe
it will not be favorable to stock prices.
Net, net, my
biggest concern for the Market is the unwinding of the gross mispricing and
misallocation of assets caused by the Fed’s wildly unsuccessful, experimental
QE policy. 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.
The assumptions
in 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.
I would 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 11/30/16 12672
1566
Close this week 18867 2181
Over Valuation vs. 11/30 Close
5% overvalued 13305 1644
10%
overvalued 13939 1722
15%
overvalued 14572 1800
20%
overvalued 15206 1879
25%
overvalued 15840 1957
30%
overvalued 16473 2035
35%
overvalued 17107 2114
40%
overvalued 17740 2192
45%
overvalued 18374 2270
50%
overvalued 19008 2349
Under Valuation vs. 11/30 Close
5%
undervalued 12038
1487
10%undervalued 11404 1409
15%undervalued 10771 1331
* 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.
