The Closing Bell
12/3/16
Statistical
Summary
Current Economic Forecast
2016 estimates
Real
Growth in Gross Domestic Product -1.25-+0.5%
Inflation
(revised) 0.5-1.5%
Corporate
Profits (revised) -15-0%
2017 estimates
Real
Growth in Gross Domestic Product 1.0-+2.5%
Inflation 1.0-2.0%
Corporate
Profits +5-+10%
Current Market Forecast
Dow
Jones Industrial Average
Current Trend (revised):
Short
Term Uptrend 18104-20164
Intermediate Term Uptrend 11575-24425
Long Term Uptrend 5541-20148
2016 Year End Fair Value
12600-12800
2017 Year End Fair Value
13100-13300
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Uptrend 2111-2455
Intermediate
Term Uptrend 1995-2597
Long Term Uptrend 881-2419
2016 Year End Fair Value
1560-1580
2017
Year End Fair Value 1620-1640
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: month to date retail chain store sales, November consumer
confidence, the November ADP private payrolls report, October personal income, the
November Markit manufacturing PMI, the November ISM manufacturing index, the November
Chicago PMI, November Dallas Fed manufacturing index, third quarter revised GDP
and corporate profits; below estimates: weekly mortgage and purchase
applications, October pending home sales, weekly jobless claims, October personal
spending, November light vehicle sales, November retail chain store sales and
October construction spending; in line with estimates: the September Case
Shiller home price index and October/November nonfarm payrolls.
The primary
indicators were also a plus: October personal income (+), third quarter GDP (+),
third quarter corporate profits (+), October personal spending (-), October
construction spending (-) and October/November nonfarm payrolls (0).
Other indicators
included: (1) the latest Fed Beige Book was not quite as upbeat as the prior
edition and (2) the Atlanta Fed substantially lowered its projected fourth
quarter GDP growth estimate.
The
latter two suggest an overall neutral reading for the week. But since this accounting has always focused
on specific data, I am scoring it an upbeat week. The score is now: in the last 61 weeks, twenty-one
were positive, thirty-six negative and four neutral.
We are now
rounding the corner into the post Trump election period where the numbers could
start to reflect what has been a dramatic rise in sentiment. So if the stats follow sentiment, we should
only see further improvement from here.
I have previously noted, in the absence of the election, the data was
already showing some signs of progress; but all things being equal, it would
still be too soon to alter our forecast of zero to negative growth rate in the
economy. Of course, all things are not
equal. The aforementioned improvement in
psychology is likely to have some positive impact on spending and
investment. More importantly, if the GOP
enacts the fiscal program that it has promised, it will almost certainly be a plus
for the long term growth prospects for the economy. Hence, the upcoming revision to our forecast.
Overseas, the
data was mixed; and for better or worse, sentiment there is less upbeat than
here. The Italian referendum doesn’t
help nor does a rocketing dollar nor does the potential for increased global
economic turmoil due to a change in US trade policy. So our global ‘muddle through’ forecast
remains intact.
Other factors
figuring into the global outlook:
(1) the
wish for an OPEC production cut was granted this week. But there was a lot of funny business in the
math of the quotas. Plus US frackers are
said to be gearing up to increase production.
And that says nothing about the rampant cheating that historically occurred
within the group.
Yeah, the
price of oil may lift near term but I wouldn’t count on it holding, barring a
dramatic increase in growth in the world economy.
Or will OPEC
get lucky and US/Iran deal fall apart?
(2) according
to Draghi, the Italian banks hold a third of all EU nonperforming loans. If that is not bad enough, a negative vote in
this weekend’s referendum could impact the government’s ability to arrange their
recapitalization which they are in desperate need of---an unhappy consequence
for not just the Italian banks but potentially for other weak links in the EU
financial system [Spanish, Portuguese, English and German banks].
(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.
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 be when it starts to reflect the
likely coming changes in fiscal/regulatory policies. For the moment, I am revising our short term
forecast but will wait until we see any concrete changes in the Trump/GOP
fiscal agenda before altering the long term secular economic growth rate in our
Models.
Our (new and
improved) forecast:
a possible pick
up in the long term secular economic growth rate based on lower taxes, less
government regulation and an increase in capital investment resulting from a more
confident business community. However,
there are still a number of potential negative unknowns including a more
restrictive trade policy, a possible dramatic increase in the federal budget
deficit, a Fed with a proven record of failure and even whether or not the
aforementioned tax and regulatory reforms can be enacted.
It is important
to note that this change in our forecast is all ‘on the come’ and hence made
with a good deal less confidence than normal.
Nonetheless, I have made an initial attempt to quantify this amended
outlook with the caveat that it will almost surely be revised.
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 reflects an improving economy but
it is a possibility. That said, the more
important factors are (1) an upturn in sentiment which itself could be a spur
to growth and (2) the likely net positive impact of the Trump fiscal/regulatory
policies. Unfortunately, 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] Italians vote this weekend on a constitutional
referendum that among other things has implications for their distressed
banking system---a ‘no’ vote would raise concerns about a financial meltdown {the
Italian banks need recapitalizing; political turmoil could slow down or even
exacerbate this problem}. To give you an
idea of the size of this problem, the ECB reported this week that one third of
all EU nonperforming loans were held by Italian banks. I am not predicting a horror scenario, just
its possibility---there are a lot of ‘ifs’ in the bad news scenario. But were it to occur, it could infect the
entire EU banking system.
Here is a more detailed explanation (medium):
[b] as an illustration, the Bank of England reported this
week that three major banks had failed their most recent ‘stress test’,
[c] not to mention the continuing trials and
tribulations at Deutschebank. The
latest:
[d] in addition, there is yet a potentially
undetermined effect of the growing anti-establishment sentiment among voters,
as reflected in the Trump/Brexit votes.
Any further challenge to the current EU economic structure would almost
surely negatively impact its overleveraged banking system,
[e] finally, Chinese rates have been soaring of late
based apparently on a shortage of dollars.
This is a liquidity issue that could have adverse effect not just on that
country’s banking system but globally (medium and a must read).
(2) fiscal/regulatory
policy. This is slowly becoming much
less of a negative. Of course, it all
depends on the Donald’s follow through on the tax and regulatory policies that
he has promised. But clearly, his
nominees for Treasury and Commerce forward his agenda. If he/the GOP deliver, this factor could turn
to a positive. But we need to await the
delivery to do that. Further, there is
still the issue of trade and its possible negative impact if the Donald gets as
aggressive as he sounded in the campaign.
Trump and the new
economic order (medium):
Closing the
Obama growth gap (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 have previously noted, the
Fed will likely signal at least a start of the process in its December FOMC
meeting [i.e. rate hike]. 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 in bonds 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.
This week, the
ECB suggested that its bond buying program had a terminal date, which is to
say, it too intends to begin normalizing its monetary policy. Of course, nothing is happening near
term. But I still thought it odd to make
such a statement in front of the Italian referendum which could cause
disruptions in the financial market and to which the ECB will almost certainly
come to the rescue. Nevertheless, long
term, it says its intent is to begin tapering its bond buying program.
On the other
side of the globe, the Bank of China has its hands full with a declining yuan
exchange rate and a dollar funding problem allegedly the result of the strong
dollar---necessitating a number of restrictions [among them tightening monetary
policy] to stem the outflow of dollars. That makes three.
Now the
question becomes, can all this get done without severely disrupting the
Markets? See above for my answer.
Who benefited
from the decade of negative real interest rates? (medium):
(4) geopolitical
risks: Syria is getting worse. This week
Turkey threatened to invade Syria which would clearly turn up the heat in that
conflict. On the other hand, 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] France’s
third quarter GDP was in line while October consumer income and spending were
ahead of estimates; November EU economic and industrial confidence were below
consensus while consumer confidence and the manufacturing PMI were in line, November
EU inflation rose but at a rate still below the 2% goal, the UK manufacturing PMI
was below estimates,
[b] November
Chinese manufacturing and services PMI’s were better than anticipated
Another
week of mixed stats; that is the third week in a row of not-so-negative
data. Hardly a sign that a bottom has
been reached but it does continue to support to our global ‘muddle through’
scenario. Unfortunately, this set of
numbers are not apt to be helped by a continually rising dollar, a more
restrictive Chinese monetary policy or the potential further weakening of the
Eurozone’s economic/political system that could result from a negative vote in
the Italian referendum.
Bottom
line: the US economic stats were upbeat
this week, while the global economic numbers were once again in no man’s land. 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 new (tentative) forecast.
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 and purchase applications
fell; the September Case Shiller home price index was in line; October pending
home sales were well short of estimates,
(2)
consumer: October personal income was above projections
while personal spending was below; month to date retail chain store sales
improved from the prior week while November sales grew less than in October; November
light vehicle sales were below forecast; November consumer confidence jumped
markedly; November nonfarm payrolls increased more than estimates, but the
October number was revised down substantially; the November ADP private payroll
report was much better than anticipated; weekly jobless claims were
disappointing,
(3)
industry: the November Markit manufacturing PMI and the
November ISM manufacturing index were better than expected; October
construction spending was less than projected; the November Dallas Fed
manufacturing index was well ahead of estimates; the November Chicago PMI was
outstanding,
(4)
macroeconomic: the revised estimate for third quarter
GDP growth was ahead of forecasts while corporate profits improved from the
prior reading.
The
Market-Disciplined Investing
Technical
The indices’
(DJIA 19170, S&P 2191) pin action continued to diverge (Dow down, S&P flat). Volume declined; breadth strengthened keeping
it at very overbought levels. The VIX fell
fractionally. While it remained below
its 100 day moving average and in a short term downtrend, it closed above its
200 day moving average for the second day (if it remains there through the
close on Tuesday, it will revert to support).
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 {18104-20163}, [c] in
an intermediate term uptrend {11568-24418} 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 uptrend {2111-2453},
[d] in an intermediate uptrend {1995-2597} and [e] in a long term uptrend {881-2419}.
The long
Treasury bounced after a couple of very poor days, but still closed below its
100 day moving average (now resistance), below its 200 day moving average (now
resistance), below a key Fibonacci level and in a very short term downtrend. It remains poised to challenge its short term
trading range, with the lower boundary of its intermediate term trading range not
that much further down.
GLD rose
slightly, but enough to end back above the Fibonacci level it pushed through
Thursday (small comfort). Still it
finished 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 sold
off for a second day, finishing below the upper boundary of its former short
term trading range (it had reset on Monday, then fell back below it Tuesday,
then pushed over it on Wednesday and is now back below it), leaving the
challenge of the short term trading range in question.
Bottom line: the
Averages continue to their sideways consolidation from the recent post-election
run up. To date, it has been a bull’s
dream (sideways action versus a sharp decline).
The only points of concern are a rallying in the VIX and the S&P has
retreated below its former high, raising the question, was this recent breakout
a false flag? My current assumption is
no and that a challenge of the upper boundaries of both indices long term
uptrends is in our future.
The sharp
retreat in bond prices is a growing concern in that, the higher rates go, the
bigger challenge they pose to stock valuations.
If TLT successfully challenges the lower boundaries of its short and
intermediate term trading ranges, I think that equities will pick up a
headwind.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (19170)
finished this week about 50.9% above Fair Value (12700) while the S&P (2191)
closed 39.5% overvalued (1570). ‘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 positive while the global stats were again mixed. 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 have
repeatedly noted, with fiscal and regulatory polices likely to change, the
current data means less than it otherwise would in the absence of those
changes. My problem is I just don’t know
by how much change is in the cards---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.
Not Bill Gross
(medium):
‘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 elements,
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---which is now happening in spades,
(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 the
unwinding of QE appears to be happening in China and Europe which could 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 (and the rest of the world’s
central banks) 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.
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 12/31/16 12700
1570
Close this week 19170 2191
Over Valuation vs. 12/31 Close
5% overvalued 13335 1648
10%
overvalued 13970 1727
15%
overvalued 14604 1805
20%
overvalued 15240 1884
25%
overvalued 15875 1962
30%
overvalued 16510 2041
35%
overvalued 17145 2119
40%
overvalued 17780 2198
45%
overvalued 18415 2276
50%
overvalued 19050 2355
Under Valuation vs. 12/31 Close
5%
undervalued 12065
1491
10%undervalued 11430 1413
15%undervalued 10795 1334
* 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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