1/28/17
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 18560-20600
Intermediate Term Uptrend 11708-24558
Long Term Uptrend 5730-20736
2016 Year End Fair Value
12600-12800
2017 Year End Fair Value
13100-13300
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Uptrend 2174-2517
Intermediate
Term Uptrend 2032-2633
Long Term Uptrend 881-2500
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 an upward bias to equity valuations. However,
this week’s data was negative, again: above
estimates: weekly mortgage and purchase applications, January consumer
sentiment, the January Markit flash manufacturing and services PMI’s, the
January Richmond Fed manufacturing index and the Chicago national activity
index; below estimates: December new and existing home sales, weekly jobless
claims, December durable goods orders, the January Markit flash composite PMI
and fourth quarter GDP; in line with estimates: month to date retail chain
store sales, the Kansas City Fed manufacturing index, December leading economic
indicators and the December trade deficit.
The primary
indicators were also negative: December leading economic indicators (0), December
new home sales (-), December existing home sales (-), December durable goods
orders (-) and fourth quarter GDP (-).
In short, a rough week for the dataflow.
The score: in the last 69 weeks, twenty-two were positive, forty-two
negative and five neutral.
I noted previously
that we should start seeing a pick up in the numbers if the improved post-election
Market sentiment was going to be translated into an increase in consumer
spending and capital expenditures. That
is not occurring.
However, give
him credit, Trump hit the ground running, issuing executive orders limiting
agencies awarding contracts, building the Keystone pipeline, building the wall,
cutting federal funds to sanctuary cities and enhancing the vetting of
immigrants. While all were on his ‘to do’
list, none, save perhaps limiting agency contracts, will have a major impact on
the economy. Unfortunately, the policies
that he is following that will have a significant effect are not positives:
corporate renditions, talking down the dollar and tariffs/border taxes.
In addition, the
800 pound gorilla in the economic policy room is his promises on taxes and
infrastructure spending. And on this
score, the math makes the numbers hard to work, meaning that I seriously doubt
that he will be able to deliver to the implied extent of his pledges. In short, the Donald is delivering on his social
policy agenda but I am disappointed about the economic policies to date. That may change; but for the moment, the economy
continues to struggle and nothing has occurred that would alter that.
Overseas, the
data, especially out of the EU, continued to recover. Another couple of weeks of this kind of
performance and the ‘muddle through’ scenario gets replaced by an improving economy. That said, there are still problems out
there: the Monte Paschi bailout, the Brexit, currency turmoil in China, Mexico
and Turkey, the potential impact of a Trump anti- free trade agenda and
Greece’s bailout difficulties. Along
those lines, this week, China strengthen its currency controls and the Greeks
and their creditors could not reach an agreement on the next step in that
country’s bailout. Net, net I am not altering our ‘muddling through’ forecast,
but I am getting closer.
In summary, this
week’s US economic stats were really bad which doesn’t support the notions that
either the economy is improving or is about to improve based on increasing
investor sentiment. However, with the Donald
issuing executive orders left and right that maybe about to change; and the better
global dataflow could help.
I am sticking
with my revised tentative 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
data trend turned negative a month ago, raising (once again) the question of
whether the prior period of more positive stats was only temporary. In addition, the post Trump Market euphoria
is not showing up in the numbers, at least not yet. In the meantime, investor optimism
notwithstanding, we are in an economy (1) that isn’t making much headway, (2)
in which the known Trump policy changes are not that encouraging [‘border’ tax;
currency valuation], (3) the unknown [tax cuts and infrastructure spending]
policies are not being discussed, but (4) all of which may be about to change. In short, a very fluid environment.
The
negatives:
(1)
a vulnerable global banking system. Nothing this week.
(2) fiscal/regulatory
policy. I continue to be hopeful that
this potential negative goes away, given the Donald’s campaign promises. However, to date, it has been a bit of a
mixed bag. On the plus side, Trump has
issued executive orders barring the EPA from awarding any new contracts, advancing
the construction of the Keystone and Dakota pipelines, authorizing the building
of the wall on our southern border, cutting funds to sanctuary cities and the enhanced
vetting of immigrants [potential terrorists].
A regulatory
game changer. Let’s see how far congress
is willing to go (medium and a must read):
However, there are also negatives which include another
attempt at muscling the auto industry to build American, the Secretary of the
Treasury talking the dollar down, Trump and Mexico getting into a pissing
contest over ‘the wall’ and the continuing failure to address taxes and
infrastructure spending.
The
numbers on US Mexican trade (medium):
With regard to
the latter, given the level of both the federal debt and the budget deficit,
Trump is going to have a tough time making the math work on any tax
cut/infrastructure spending. Certainly,
he can cut federal employment as an offset.
But the spending elephant in the room is entitlements, particularly
social security and Medicare. McConnell
has already said that additional deficit spending is a nonstarter. So I am not sure of the extent to which Trump
can deliver on what were, economically speaking, his most important campaign
promises.
(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.
The central
bankers remained relatively quiet this week.
However, global monetary policy could be moving rather rapidly toward a
showdown with fiscal policy. If Trump
does get his way on tax and infrastructure spending, that is going to put
upward pressure on inflation. Which
should in turn elicit a more aggressive monetary tightening from the Fed,
meaning sharply higher interest rates.
Of course, the Fed could follow its traditional timid approach and allow
inflation to get out of hand before responding.
Whichever occurs, the economy could be facing higher interest rates,
higher inflation or both.
But that is
just speculation at this point. For the
moment we are in a struggling economy and I have serious doubts that we will
get the kind of massive tax and spending programs promised by Trump. In which case, the central banks can continue
their dovish approach to monetary policy, i.e. do nothing to correct to
residual problems [i.e. asset mispricing and misallocation] created by QE, ZIRP
and NIRP---and they are not going away.
(4) geopolitical
risks: the Donald seems intent on scaring the s**t out of or pissing off almost
every global leader save Putin. I am not
sure where this is going; but I don’t think it an understatement to say that
geopolitical risks are increasing.
The Trump/May
news conference (medium):
(5)
economic difficulties in Europe and around the globe. This week:
[a] January
German investor confidence soared; UK inflation rose, retail sales fell and
fourth quarter GDP was flat with the third quarter; EU auto sales hit a nine
year high,
[b] fourth
quarter Chinese GDP, industrial production and retail sales were mixed; home
prices rose less than anticipated,
[c] the January
Japanese Markit flash manufacturing PMI was up; December CPI declined.
So this
week’s data turned back to a modestly upbeat tone. The stats continue to improve sufficiently to
suggest that the global economy may be stabilizing---enough so that another
couple of weeks of better numbers will warrant a change in our forecast. Holding
me back are the potential economic/financial problems in Italy, Greece, China,
Mexico, Turkey and the UK.
Bottom
line: the US economic stats were lousy---meaning
that the data is not supporting the notion that the economy is currently improving. And of course, that doesn’t help my short
term forecast that economic conditions will get better as the result of rising
optimism. In the meantime, we have precious
little on any fiscal/regulatory policies that could have a material impact on
the economy.
Foreign economic
data also improved. I just need a bit
more of the same before considering any revisions to our ‘muddle through’
scenario.
This week’s
data:
(1)
housing: December existing home sales fell short of
projections; December new home declined versus consensus of being flat; weekly mortgage
and purchase applications were up,
(2)
consumer: weekly jobless claims rose twice what was
expected; growth in month to date retail chain store sales was unchanged from
the prior week; January consumer sentiment was slightly better than anticipated,
(3)
industry: December durable goods orders fell off a
cliff, but that was mostly due to a decline in transportation orders; the
January Market flash composite PMI was slightly below forecast, while the
manufacturing services PMI’s were better than expected; the January Richmond
Fed manufacturing index was above estimates while the Kansas City index was
flat as was the December Chicago national activity index,
(4)
macroeconomic: the December leading economic indicators
were flat, in line; the initial fourth quarter GDP growth estimate was short of
consensus; the December trade deficit was fractionally less than anticipated.
The
Market-Disciplined Investing
Technical
The indices
(DJIA 20093, S&P 2294) continued to flat line following the Dow’s break of
20000. The S&P remains unable to
meet the challenge of its 2300 level. Volume declined, but remains at elevated
levels; breadth was mixed. The VIX (10.6)
fell slightly, closing below the upper boundary of a very short term downtrend,
below its 100 and 200 day moving averages (now resistance), in a short term
downtrend and is drawing ever nearer the lower boundary of its intermediate
term trading range (10.3).
The Dow ended
[a] above its 100 day moving average, now support, [b] above its 200 day moving
average, now support, [c] in a short term uptrend {18560-20600}, [c] in an
intermediate term uptrend {11708-24558} and [d] in a long term uptrend
{5730-20736}.
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 {2174-2517},
[d] in an intermediate uptrend {2032-2633} and [e] in a long term uptrend
{881-2500}.
The long
Treasury was up slightly, closing in a very short term downtrend, in a short
term trading range and below the 100 day moving average (now resistance),
falling further below its 200 day moving average (now resistance).
GLD rebounded
but ended in a short term downtrend and below its 100 day moving average (now
resistance) which continues to push further below its 200 day moving average
(now resistance). It was unable to
regain the lower boundary of its former very short term uptrend.
The dollar rose,
finishing above its 100 or 200 day moving averages (now support) and in a short
term uptrend. However, it continues to develop
a very short term downtrend and is near its 100 day moving average.
Bottom line: the
Averages’ performance remain divergent---the Dow having successfully challenged
20000 but the S&P again falling short of 2300. However, it is close enough that one solid up
day could push it through that level.
But until it does, in my opinion, it lessens the significance of the Dow’s
achievement. The big question is, does
the Dow pull the S&P up or vice versa.
The answer should provide meaningful directional information.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (20093)
finished this week about 57.7% above Fair Value (12741) while the S&P (2294)
closed 45.6% overvalued (1575). ‘Fair
Value’ will likely be changing based on a new set of fiscal/regulatory policies
which may lead to an as yet undetermined improvement in the historically low
long term secular growth rate of the economy but it still reflects 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 very bad and continued to show little evidence that post Trump
election Market euphoria was translating into higher consumer spending or
business investment.
That said, Trump
has started off with a bang, signing multiple executive orders that fulfill
some of his campaign promises. Generally
though, they tended to have a greater impact on social versus economic
policy. That in itself is not that
bad. But regrettably his economic
actions to date have been less than positive: muscling corporations, talking down
the dollar and threats of tariff. In
addition, all we have now is talk with respect to the major economic pillars of
his campaign pledges: tax cuts and infrastructure spending. And as I have opined throughout this
narrative, he may have real problems implementing any such policies that would
significantly enhance economic expansion.
So while the regulatory
landscape is likely to change dramatically this year, there are many unknowns
on the economic side. The extent to
which they may alter the numbers and expectations is still a question.
This week’s
international stats were upbeat, increasing the odds that I will upgrade our
‘muddle through’ forecast. However, I am
still worried about a number major problems (Brexit, currency problems, free
trade issues) looming out there.
Net, net, in
general, my expectations for some improvement in the economic outlook remain
high (‘some’ being the operative word).
However, I am not sure how much it will impact the assumptions in our
Models. Remember, those assumptions are
calculated more on long term trend basis and less on what is likely to happen
the coming 12 months. Currently, they
show a higher economic growth rate than now exists; so a modest pickup in growth
will not alter the assumptions.
Trump/GOP will need to up their game to have any impact on the Models. The point being, current euphoria notwithstanding,
nothing has happened yet to change our Fair Value estimates. I would love to see policies that would.
All that being
said, you know that my negative outlook for stocks has little to do with the
progress or lack thereof for the economy/corporate profits and is directly
related to the irresponsibly aggressive global central bank monetary policy
which has led to the gross misallocation and mispricing of assets. The Fed has $4 trillion on its balance sheet
which it has no clue how to get rid of.
And Draghi just said that EU QE isn’t going away anytime soon.
To be sure, a big
pickup in economic/profit growth could have a positive impact on Fair Value in
our Model. But current equity valuations
are so distorted to the upside that this will likely prove small comfort when
the mean reversion process begins.
Nonetheless,
there is still the problem of quantifying the elements of the new
fiscal/regulatory changes---which are clearly a determinant of Fair Value. To be sure many of the promised shifts in
policy would likely have a positive impact; though as I have noted, Trump/GOP
may have a lot tougher time implementing those changes than seems popular consensus
at the moment. In addition, right now,
everything is not coming up roses (talking dollar down, threatening tariffs). So while I wait for clarity in order to
attempt to quantify these changes, I have to settle for a qualitative statement
that I believe that the net effect will be positive for both our economic
forecast and possibly, on the margin, stock Fair Value.
‘That said, at current levels 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,
(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.’
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 encouraged about the
potential changes coming in fiscal/regulatory policy, I caution investors not
to get too jiggy about 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.
Everyone’s a
genius (medium and a must read):
Bottom line: the
assumptions in our Economic Model may very well improve as we learn about the
new fiscal policies and their magnitude.
However, unless they lead to explosive growth they will change
little. That suggests that Street models
will undoubtedly remain more optimistic than our own which means that ultimately
they will have to take their consensus Fair Value down for equities.
Our Valuation
Model could 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 at least partially 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.
As a long term investor, I
would use the current price strength to sell a portion of your winners and all
of your losers. If I were a trader, I
would consider buying a Market ETF (VIG, VYM), using a very tight stop.
DJIA S&P
Current 2017 Year End Fair Value*
13200 1630
Fair Value as of 1/31/17 12741
1575
Close this week 20093 2294
Over Valuation vs. 1/31 Close
5% overvalued 13378 1653
10%
overvalued 14015 1732
15%
overvalued 14652 1811
20%
overvalued 15289 1890
25%
overvalued 15926 1968
30%
overvalued 16563 2047
35%
overvalued 17200 2126
40%
overvalued 17837 2205
45%
overvalued 18474 2283
50%
overvalued 19111 2362
55%overvalued 19748 2441
60%overvalued 20385 2520
Under Valuation vs. 1/31 Close
5%
undervalued 12103
1496
10%undervalued 11466 1417
15%undervalued 10829 1338
* 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 hard way.
