The Closing Bell
11/12/16
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 Trading Range 17092-18693 (?)
Intermediate Term Uptrend 11544-24394
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 Trading Range 1995-2103
Intermediate
Term Uptrend 1981-2583
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 was about as slow as it could get, at least as it applies to the US
dataflow. Nevertheless, while it consisted
entirely of secondary indicators, the bulk of the data was positive: above estimates: weekly purchase applications,
month to date retail chain store sales, weekly jobless claims, preliminary
November consumer sentiment, the October small business optimism index,
September wholesale sales; below estimates: weekly mortgage applications,
September wholesale inventories; in line with estimates: none.
There were no
primary indicators released; so the net here is a lot of secondary indicators
mostly positive with no big numbers. I
am going to score this as a plus but caution that the informational value of
this week’s stats is quite low. This week the score is: in the last 58 weeks,
eighteen were positive, thirty-six negative and four neutral.
Overseas, the
data turned negative, ending a month or so run of mixed to upbeat numbers. So they did little to help our global ‘muddle
through’ scenario.
Other factors
figuring into the global outlook:
(1) the
hope for an OPEC production cut continues to fade as Saudi Arabia and Iran
squared off in last weekend’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 continued to decline. This may
be good for the Chinese economy but not so much for the rest of the world; and
given Trump’s prior statements regarding Chinese trade policies, this is apt to
become a much more pronounced point of friction.
Finally, on the
monetary front, there was little news this week. However, given Trump’s fiscal agenda and its
very positive reception by the Market, I now believe that the Fed will raise
rates in December, barring some catastrophic exogenous event.
In summary, this
week’s US economic stats hardly moved the needle on the economy’s direction
while the global numbers returned to their negative long term trend. That said, 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.
Meanwhile, there was little news out of the central
banks, though I think that the Trump victory raises the odds of the December
rate hike well above 50/50. As you know,
I am a big supporter of such a move though I caution that a move towards a
normalized monetary policy is also a move toward undoing the mispricing and
misallocation of assets.
Our forecast:
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
economy is apt to show increased growth, I have no idea how much until we see
exactly what is enacted; but the problems of an irresponsible monetary policy and
global economic weakness have not been helped.
The
negatives:
(1)
a vulnerable global banking system. There was very little news on this factor
this week. However, as I noted above the
Brexit/Trump combo may not portend good news for the weak EU banking system.
(2) fiscal/regulatory
policy. Clearly, times they are a
‘changing. It certainly is too soon to be making predictions on the outcomes of
a Trump presidency. However, there are a
number of factors, mostly positive, to be watching that will tell us how a
potentially new fiscal policy will impact the economy. Some of the following is repetitious of this
week’s Morning Calls; but it will serve to consolidate in a more coherent
pattern many of my comments.
[a] if
Trump does ‘what he said he would do’ with respect to economic policy, then his
election will almost certainly have an initial ‘positive impact’. Among those measures: lower taxes and
simplify the tax code, repeal Obamacare, reverse a burdensome regulatory
environment, repatriating trillions of dollars held overseas by US
corporations. I stress ‘what he said he
would do’ because the rubber has yet to meet the road; though to be fair the
odds of enactment seem quite high,
[b] however,
some of his policies have negative economic implications. First, one of the things he said that he
would do was revamp the US trade policy.
While short on details, too hard a line on trade would only exacerbate
global economic weakness {I refer you to the turmoil in the emerging markets
occurring as we speak.} He has also said
he wants to raise spending {while also cutting taxes}, i.e. increase the
deficit and national debt. This on top
of the trillions frittered away by Bush and Obama. This will only push the US to the brink
theorized by Reinhart/Rogoff in which too much debt inhibits growth---like we
need that.
[c]
while it was all hugs and kisses initially as Ryan, Clinton, McConnell, Obama
and Trump himself pledged cooperation, nothing has happened so far but talk. Let’s not forget that Trump has vowed to put
Hillary in jail and the republican house to commence numerous investigation of
her alleged wrongdoings. How long do you
think this big pot of love stew is going to simmer in that atmosphere? Furthermore, if you haven’t checked the news
lately, Hillary’s supporters aren’t being quite as gracious as she was, as
riots have broken out all across the US.
Here is a
review from a former Carter staffer on Trump’s task of controlling the federal
bureaucracy (medium):
[d] don’t get
me wrong, strictly from the economic point of view, Trump was by far the better
choice and I have little doubt that measures will be enacted that should
stimulate the economy. I am simply
pointing out that it may not be as easy as many think and there are consequences
to these actions not all of which are positive.
[e] finally, I
have said numerous times in these notes that political gridlock has always been
my preference for governance. It remains
so; and the GOP sweep is the potential bad news segment of these comments. The last time a GOP president had a compliant
congress {Bush 2}, they loaded the budget with pork. Granted, Trump and congress are not exactly
on the same page; plus republicans have professed to have found fiscal religion. But I am a bit hesitant to proclaim budgetary
Nirvana.
Nothing has
changed---yet (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.
This week, the
central banks stayed under cover.
However, again under the category of ‘times they are a ‘changing’, the
Trump presidency is apt to bring changes in monetary policy. Most important is that an invigorated fiscal
policy will relieve the pressure on the Fed of assuming that it has to carry
the load of economic stimulation; in other words, it can began to normalize
monetary policy. I don’t have to tell you
how happy I am about that---assuming that the Fed has the balls to actually do
it.
{i} however if
it does, then the whole QE/ZIRP misguided effort that led to the gross
mispricing and misallocation of assets will end.
I remind you
that all those mispriced assets will have to be repriced and all of those
misallocated assets will have to be reallocated (scraped). I have no idea of what the ‘price to be paid’
is because this kind of thing has never happened before. However, not to be repetitious, I am assuming
that the economic impact will be small, since QE/ZIRP did little to promote
growth. But because they did have an
enormous effect on equity prices, I am assuming that their absence will have an
equal but deleterious impact.
{ii} if it
doesn’t and attempts to assist the financing of a mounting deficit, then that should
accelerate the rise in inflation that will likely occur anyway as a result of
tax cuts and increased spending. I know
that many (Keynesians) believe a little inflation is a great thing for the
economy. And maybe it is; I am not going
to argue the point. But the Fed has
proven time and time again that it can’t manage a little inflation and there is
no reason to assume that it will in the future.
Hence, this
would only add to my recently expressed concern about rising inflation and a
shrinking money supply [down again this week].
My bottom line
is that [a] short term, given Trump’s proposed fiscal policy along with its
enthusiastic reception by the Market, I now believe that the Fed will raise
rates in December, [b] but long term, the risk is starting to shift toward
rising inflation.
(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] October
EU corporate profits declined, German industrial output fell but UK factory
output rose,
[b] the
October Chinese exports declined while PPI was hotter than anticipated.
Like the
US, not much data. Unlike the US, it was
mostly downbeat. So not helping our
global ‘muddle through’ scenario. Again,
back to the subject of Trump. If he
pushes toward less free trade, this will hurt not only the US but the rest of
the world. 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 got lost in the news shuffle this week; although
the Saudi’s and Iranian did manage to disagree publicly on quotas. In addition, the Saudi’s released a study
forecasting lower prices for longer.
‘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.’
A last
observation: the Trump victory on top of the Brexit vote has a lot of the
anti-EU parties in member states very excited.
I have no idea if this will lead to anything. But assuming the British and American
electorates fairly represent those in the EU, then the eurozone could be facing
some very difficult political as well as economically disruptive times.
Bottom
line: the US economy continued weak not
helped by the global economic numbers.
Nevertheless, 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).
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: weekly mortgage applications were down but
purchase applications were up,
(2)
consumer: month to date retail chain store sales growth
was up slightly versus the prior week; weekly jobless claims declined more than
estimates; preliminary November consumer sentiment was up nicely,
(3)
industry: the October small business optimism was
better than expected; September wholesale inventories rose less than consensus
but sales were better,
(4)
macroeconomic: none.
The
Market-Disciplined Investing
Technical
The indices
(DJIA 18847, S&P 2164) had another mixed day of sort---Dow up huge, S&P
down. But it was much less volatile than
earlier in the week and volume declined.
Breadth improved some more, pushing it further into overbought
territory. So a correction near term should be expected. The VIX fell, closing below its 100 day
moving average, for the third day, reverting to resistance, below its 200 day
moving average (now support; if it remains there through the close on
Wednesday, it will revert to resistance).
However, it remains in a very short term uptrend. If that trend holds, then stocks will likely
have seen their best days.
The Dow ended
[a] above on its 100 day moving average, now support, [b] above its 200 day
moving average, now support, [c] above the upper boundary of its short term
trading range for the second day {17092-18693; if it remains there through the
close on Monday, it will reset to an uptrend}, [c] in an intermediate term
uptrend {11544-24389} and [d] in a long term uptrend {5541-19431}.
The S&P
finished [a] above its 100 day moving average for the third day, reverting to
support, [b] above its 200 day moving average, now support, [c] within a short
term trading range {1995-2193}, [d] in an intermediate uptrend {1981-2583} and
[e] in a long term uptrend {862-2400}.
However, it still has a way to go before it challenges its all-time
high.
The long
Treasury kept diving on huge volume, closing 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 and below the
lower boundary of its short term uptrend for a third day, resetting to a
trading range and below the lower boundary of its intermediate term uptrend for
a third day (if it remains there through the close next Monday, it will reset
to a trading range).
GLD got pounded
again (down 2 ½%), finishing below its 100 day moving average (now resistance),
below its 200 day moving average for the fourth day, reverting to resistance
and in a short term downtrend. This
chart continues to deteriorate.
Bottom line: the
upside momentum of the Averages slowed on Friday; but given how overbought they
are, that is not surprising. Neither
would a period of consolidation. The Dow is one day away from resetting to a
short term uptrend. But the S&P
still has a ways to go; so Monday we may be in a situation where their pin action
is divergent. At that point, the
technical picture gets even murkier than normal and we just have to wait for
one or the other to confirm an overall trend.
Meanwhile, bonds
and gold are getting beaten to a pulp.
The pin action in bonds is a bit concerning because the worse it gets,
the more impactful it will be on the equity discount factor.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (18847)
finished this week about 48.7% above Fair Value (12672) while the S&P (2164)
closed 38.1% overvalued (1566). ‘Fair
Value’ will likely be changing based on a new fiscal policy which will lead to
an 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 sparse but positive while the global stats were very lousy. But they are both secondary considerations as
we try to figure out what a Trump presidency/GOP sweep means for the
Markets. As we all know, Tuesday night’s
fright fest aside, the initial reaction in the stock market has been very
upbeat. While I agree with the notion
that most of the economic proposals the Donald has made would be good for the
economy (see above), we don’t invest in the economy, we invest in the
Markets. So here are my problems (again
some of this is bit repetitious, but it consolidates a week’s worth in daily
posts):
(1) first
of all, as I noted above, not all of the Trump economic proposals will likely
have a positive impact. I mentioned his
statements on trade as well as cutting taxes/raising spending as examples. Now we have no idea what will get implemented
and what won’t---either the positives or the negatives. But the point is that for the Market to
seemingly only be focused on the good things is a bit short sighted.
(2) the
above caveat aside, I am acknowledge that the sum total of Trump’s proposals,
if put in place, would likely improve growth and corporate profitability. The latter raising the ‘E’ portion of the P/E
valuation. However,
[a] 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 Fair Values. In other words, our current Fair Values
already incorporate a higher ‘E’. So
while it may influence others valuation, it will impact ours less---said
differently, current Street Valuations require a substantial improvement in
earnings just validate those Valuations.
[b] remember
that in the last four years, corporate management has milked its balance sheet
of every nickel in order to push earnings higher {i.e. stock buybacks financed
by cheap debt, declining fixed investments, reducing labor costs}. If the economy is going to start growing then
all those accounting ploys are going to be reversed; in other words, they will
put downward pressure on earnings growth.
So profits per share {‘E’} may grow but not as robustly as many may be
assuming,
[c] another of
the likely consequences of the Trump fiscal revolution is upward pressure on
interest rates not just from higher government financing needs but from a Fed
that will {should} be normalizing monetary policy. That will have two consequences {i} with
corporate America more leverage than ever, increased interest costs will have
an adverse effect on earnings and {ii} higher interest rates lower the rate at
which earnings growth gets discounted (the P/E). The point is that while I agree that
corporate profits may improve, perhaps it won’t be as much as many hope and the
P/E being applied to those better earnings will be lower.
The
problem higher rates pose (medium):
[d] finally, the
Market’s problem right now is not growth, it 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. Plus if that
fiscal policy reignites inflation, it will only push the Fed harder and that,
in turn should reintroduce price discovery.
Once real price discovery returns to the bond markets, stocks are not
likely far behind.
To be clear,
normally, in an improving economy, stock prices and bond yields can rise
together. So on the surface there is
nothing unusual or sinister in this pin action.
But these are not normal times.
Price discovery in the fixed income market has been distorted by QE,
ZIRP etc.; and Trump has made it clear that he views that as a negative. So if monetary policy is headed for
normalization and the Fed gets out of the way of interest rate price discovery,
I am assuming a reversal of asset mispricing and misallocation. This has been a
potential negative that I have emphasized continuously over the last four
years.
(3) as
I mentioned above, the Trump victory in combination with the Brexit vote could
lead to further tensions within the EU and possibly lead to its serious
fracturing---something that would not be good for global growth or many of the
highly leveraged financial institutions.
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 the accompanying acceleration in economic
growth and corporate profitability until we have a better idea of what and how new
policies will be implemented.
‘Just to be clear where I stand: Trump’s
proposed economic agenda will have a positive impact on the economy. I will almost assuredly revise our 2017
forecast up. I might even have to revise
the long term secular economic growth rate assumption in our Models. And that in turn would shift up our Fair
Value calculations for the Averages and individual stocks. The problem is, even if I did all of that,
current Market valuations are still way too high largely as a result of central
bank malfeasance. My thesis has been and
remains that once that malfeasance is corrected, equities will get
repriced---down’.
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 18847 2164
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.
By knowing how the market has performed traders are in a better position to deal with it and also manage risk and returns effectively. Financial Advisory Services like trading tips can be useful for earning high returns.
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