The Closing Bell
1/7/17
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 18392-21442
Intermediate Term Uptrend 11662-24512
Long Term Uptrend 5730-20318
2016 Year End Fair Value
12600-12800
2017 Year End Fair Value
13100-13300
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Uptrend 2149-2493
Intermediate
Term Uptrend 2019-2621
Long Term Uptrend 881-2435
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 overwhelmingly positive: above estimates: month to date retail chain
store sales, weekly jobless claims, December light vehicle sales, November
factory orders, the December Markit manufacturing PMI, the December ISM
manufacturing and nonmanufacturing indices, November construction spending;
below estimates: weekly mortgage and purchase applications, the December ADP
private payroll report, the December Markit services PMI and the November US
trade deficit; in line with estimates: November/December nonfarm payrolls.
In addition, the
primary indicators were positive: November construction spending (+), November
factory orders, though they were still down a lot (+) and December/November
nonfarm payrolls combo (0). The score is
now: in the last 66 weeks, twenty-two were positive, forty negative and four
neutral.
Overseas, the
data continued to improve. Indeed, it is
time to start considering that the global economy may be stabilizing. I am not
altering our ‘muddling through’ forecast, but the numbers have been good enough
to begin challenging it. However, a big
constraining factor is the as yet unresolved problems stemming from the Monte
Paschi bailout, the Brexit, and Greece’s bailout difficulties. So our global ‘muddle through’ forecast
remains intact.
Other factors
figuring into the global outlook:
(1) complaints
are already arising about cheating [Kurdish Iraq] on the OPEC production
quotas---which supports my thought that the production cut agreement won’t have
a lasting positive impact on oil prices,
(2) the
Bank of China continues to have problems stabilizing the yuan. To date, some of its countermeasures have
included raising rates internally and selling US Treasuries both of which put
upward pressure on global interest rates,
(3) the
Donald’s trade policy. All we have so
far is words. But if he does what he
says that he is going to do, it could have a negative impact on global trade
which already has a problem in the form of a soaring dollar and a depreciating
yuan.
In summary, this
week’s US economic stats were upbeat following several negative weeks. However, those results notwithstanding, the recent
trend back to negative numbers is a little concerning in the sense that the
economy may be weaker (than it seemed to be trending four weeks ago) going into
what I anticipate as a more positive fiscal/regulatory environment. Meaning that it might take more aggressive
action to overcome a weakening economy than a slowly improving one.
That said, we could
start seeing some more positive data if the Trump sentiment improvement gets
reflected in the numbers. If that
happens, the questions become (1) how quickly can new fiscal/regulatory
policies be put in place and (2) can improved sentiment sustain any increase in
economic activity long enough for those policy changes start to have an
impact?
For the moment,
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.
Update on big
four economic indicators.
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 temporary or the sign of a
real improvement in economic activity. Clearly
this week’s numbers suggest the latter.
However, whatever the trend, we should soon start to see any impact that
an upturn in sentiment might have---assuming that there is one. By the time we get the February economic data
we should know how the economy if behaving, ex a new fiscal/regulatory
agenda. And at that point we should
have some feel as to the shape of the new policies and how rapidly they will
take effect. In the meantime, Market
euphoria notwithstanding, we are stuck in a period in which the economic uncertainties
are higher than usual.
The problems of monetary
policy and global economic weakness remain, though this week’s international
data provides some hope that this could be changing.
The
negatives:
(1)
a vulnerable global banking system. This week a report on global debt estimated
that it had reached 325% of world GDP with much of it housed in the banking
system. While that doesn’t necessarily
mean a financial disaster, it does suggest that [a] the level of nonperforming
debt is also growing as a percent of world GDP and [b] the ability of the
financial system to fund future investment and consumer spending is being
reduced.
(2) fiscal/regulatory
policy. I continue to be hopeful that
this potential negative goes away, given the Donald’s campaign promises. This week, there were more developments that
supports that notion: the senate initiating steps to repeal and replace
Obamacare and Trump’s moves to do away with many immigration executive orders. Another plus that has been below the radar is
the movement through congress of the ‘Reins Act’ which will serve to restrict
the issuance of executive orders by the White House.
That said, the
president-elect has already gotten push back on fiscal issues from GOP senate
leader McConnell and this week the chorus was joined by Speaker Ryan [no new
tariffs] and senate democratic leader Schumer [no new anything]. So the questions of how soon and how dramatic
the change in policies are there.
In
addition, as a free market advocate, I am not happy with the [soon to be]
president threatening companies that are legally pursuing the best interest of
their shareholders. If Trump wants to
change the law---give it a shot. But his
actions are no different from Obama’s outrageous [and I believe unconstitutional]
legislating by executive orders.
Further,
free trade has been a major benefit to the US and global economies. True, there are cheaters. I support measures to level the playing
field, but not starting a trade war.
That said, I have observed that Trump’s rhetoric may just be a
negotiating position---‘may’ being the operative word. But I worry about the enactment or imposition
of any measure that restrains free trade.
(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.
As you know,
this week the Fed released the minutes of its last FOMC meeting and took the
art of obfuscation to new heights. In
addition in those minutes, it cited the potential of a more aggressive fiscal
policy as a risk [to inflation] after having complained for the last five years
that it needed a more assertive fiscal policy to relieve the Fed of being the
sole agency of economic stimulation.
Fed uncertainty BINGO (medium):
Further, as I
noted on Thursday, the Fed continues to shrink the money supply which is a
monetary tightening move. True, it had
injected a lot of liquidity into the system which now it apparently is trying
to soak up---and this may just be neutralizing maneuver. However, focusing attention on interest rates
and failing to address money supply only adds the confusion and plays to the
notion that the Fed hasn’t a clue what it is doing.
Another
excoriating critique of global central banks addressing the above issue from
Jeffery Snider (must read):
Overseas, the
Chinese are having a hell of a time stabilizing the yuan. This has led to several dramatic policy steps
including severe restrictions on capital flows.
These measure amount to tightening monetary policy. So whether or not the Fed is drifting in that
direction, there is now more upward pressure on interest rates.
Aside from the
chronicling of Fed ineptness, the point here is that global central banks’ monetary
policy is starting to diverge with China and the US beginning to tighten and
Japan and the ECB remaining accommodative.
Sooner or later this will create trade issues for all and profit
problems for US companies.
(4) geopolitical
risks: ‘the Syrian conflict seems to be
winding down [the US again losing] and being replaced by [a] the US/China
sparring match, [b] the brouhaha over whether Russia interfered in the US elections
and [c] the Donald’s selection for Secretary of State. As I said last week, I feel less comfortable
about the geopolitical risks now than before Trump’s actions of the last two
weeks.’
(5)
economic difficulties in Europe and around the globe. This week:
[a] the
December EU final composite PMI and CPI were stronger than expected as was the
UK manufacturing and services PMI’s,
[b] the
December Chinese manufacturing, services and composite PMI’s were above
estimates,
[c] the
December Japanese Markit manufacturing PMI was above forecast.
Other
factors bearing on that state of the global economy include:
[a] the
potential difficulties with rescuing Italy’s third largest bank and the
consequences of whatever occurs,
[b] early
signs of cheating on the OPEC production cut agreement,
Rising
US rig count (short):
[c]
China continues to have difficulties stabilizing the yuan. This week it continued to fall in the face of
aggressive government countermeasures. A
declining yuan does not improve the outlook for the likely coming trade
negotiations with the US. In addition,
Mexico is now starting to have currency valuation problems. It is not helpful to either trade or the
securities markets for two major economies to be experiencing significant
currency volatility.
This
week’s data was very upbeat, keeping the streak of mixed or upbeat readings
intact. This has gone on long enough to
suggest that the global economy may be stabilizing. However, when coupled with
the potential economic/financial problems in Italy, Greece, China and the UK, I
am not persuaded to change my ‘muddle through’ scenario just yet; though to be
fair, six weeks ago I was afraid that I was going to have to revise it to a
more negative outlook.
Bottom
line: the US economic stats were quite
positive this week. That keeps alive the possibility that the US economy is
stabilizing, though after a month of disappointing stats not by much. Of course, this may all be irrelevant if the
Trump euphoria translates in to improved numbers and then he actually delivers
on all those promises. On the other hand, nothing has happened just yet; so it
might be wise to be a bit circumspect for the moment.
Foreign economic
data also improved significantly, though the record of improvement to date is
less dramatic than even our own.
Nonetheless, I will take good news from wherever I get it. I just need a lot more of the same before
considering any revisions to our ‘muddle through’ scenario.
A
counterproductive central bank monetary policy is the biggest economic risk to
our forecast. Plus, it is still unclear the
extent to which the US and global economies are or will improve.
This week’s
data:
(1)
housing: weekly mortgage and purchase applications fell,
(2)
consumer: month to date retail chain store sales grew more
than in the prior week; December light vehicle sales were higher than
anticipated; the December ADP private payroll report was disappointing as was
December nonfarm payrolls, although the November number was revised
significantly upward; weekly jobless claims fell more than projected,
(3)
industry: November factory orders were down less than
consensus; the December Markit manufacturing PMI was slightly above expectations
while the services PMI was below; the December ISM manufacturing and nonmanufacturing
indices were ahead of forecast; November construction spending was well ahead
of estimates,
(4)
macroeconomic: the November US trade deficit was
greater than anticipated.
The
Market-Disciplined Investing
Technical
Yesterday, the
indices (DJIA 19963, S&P 2276) reaccelerated. Volume was flat but is still high. Breadth was mixed again. The VIX (11.3) fell another 3 ¼ %, closing
below its 200 day moving average (now resistance), below its 100 day moving
average (now resistance), within a short term downtrend and moved closer to 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 {18392-20442}, [c] in an
intermediate term uptrend {11662-24512} and [d] in a long term uptrend
{5730-20318}.
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 {2149-2493},
[d] in an intermediate uptrend {2019-2621} and [e] in a long term uptrend
{881-2435}.
The long
Treasury declined and ended 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). However, it still has plenty of room to
rebound before it meets any of the multiple resistance levels or threatens to
break any major downtrends.
GLD continues to
mimic TLT, trading off yesterday and remaining 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). Also like TLT, it can recover significantly
before threatening to challenge major resistance/downtrends.
The dollar rose,
continuing its pattern of acting in reverse of GLD and TLT, finishing
considerably above multiple support levels---so it can fall a lot and not
challenge its 100 or 200 day moving averages (now support) or its short term
uptrend.
Bottom line: my
assumption continues to be that the indices will at least challenge the
20000/2300 levels; and if victorious, there is no resistance between those
levels and the upper boundaries of their long term uptrends. But as you know, I don’t believe any such
challenge (of the upper boundaries) will be successful.
Despite
yesterday’s minor counter trend moves, TLT, GLD and UUP still seem to be rebounding
from extreme positions. Part of this is
related to the turmoil in the Chinese and Mexican currency markets, part of it
seems to be function of waning optimism among the bond boys about the strength
of any impact of the Trump/GOP fiscal/regulatory reforms. Clearly the latter is in direct conflict with
the giddy attitude of stock investors. I
am not saying who is right; just that there appears to be some dissention in
the ranks.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (19963)
finished this week about 56.6% above Fair Value (12741) while the S&P (2276)
closed 44.5% overvalued (1575). ‘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 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 turned positive after a month long run of disappointments. Under normal circumstances, I would say that
the overall trend supports the notion of an economy continuing to struggle to
stay on the plus side of growth. But
these are not normal circumstance. As
you know, I believe that there is a reasonable likelihood that the vast
improvement in business and consumer sentiment will soon start being reflected
in the numbers; and I believe that this likelihood will increase dramatically if
the anticipated changes in fiscal/regulatory policies are implemented.
This week’s
international stats were very positive---a very unique occurrence over the past
two years. And they follow a brief
period in which negative weeks have been alternating with neutral to upbeat
weeks. This timeframe is still too short
to assume that the global economy has stabilized; but it is certainly a hopeful
sign.
Well, says you,
that must mean that you (I) are looking for higher equity valuations. Au contraire, monsieur. My less than positive outlook for stocks has
been much less contingent on economic/corporate profit improvement and more on
irresponsibly aggressive global central bank monetary policy which led to the
gross misallocation and mispricing of assets.
To be sure, a pickup in economic/profit growth will have a positive
impact on Fair Value in our Model. But
valuations are so distorted to the upside that this will likely prove small comfort
when the mean reversion process begins.
And that assumes
that we get the fiscal/regulatory measures over which investors have become so
infatuated---for which there are no guarantees.
Certainly, most of the Donald’s executive branch appointments lend
credence to the notion that great positive changes are afoot. On the other hand, I am dismayed by his
attacks on corporations which made perfectly legal decisions based on the best
interest of their shareholders. That is
not free enterprise and suggests that we could be trading one form of
regulation for another.
In addition,
Trump’s comments on trade suggest that free trade is not high on his economic
goals list. True, these may only be
initial negotiating positions; but they are nonetheless worrisome. Free trade has been part and parcel of the US
economies growth; and I dare say that in its absence the economic malaise of
the last decade would have been worse.
A lesson in
trade economics (medium and a must read---that means you Donald):
Further, the
push back has started. McConnell has
already said expanding the budget deficit (cutting taxes and increasing
spending) is a nonstarter. Ryan has
jumped in and said there will be no tariffs.
Plus, Trump has gone out of his way to piss off Chuck Schumer; and while
the GOP controls both houses in congress, the last thing we need is a fist
fight over every issue.
None of this
even addresses the 800 pound gorilla in the room---which is the need to unwind
years of the aforementioned irresponsible monetary policies, i.e. QE and ZIRP.
I have no idea whether or not we are witnessing the beginning of the end in the
form of the currency problems being experienced in China and Mexico. But I will suggest that those are the kind of
problems to expect when the unwinding process begins.
Of course, the
Market could apparently care less about anything negative at the moment. While I doubt that this willful disregard will
last, there is still the problem of quantifying the uncertainty surrounding
these elements of change---which is clearly a determinant of Fair Value. To be sure many of these shifts in policy
will have a positive impact. But
everything is not coming up roses. 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 economically.
‘That said, 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, aggravated by a
rising dollar and rising interest rates.
In addition, while I am positive 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.
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.
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 19963 2276
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 74hard way.
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