The Closing Bell
1/14/17
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 18479-20519
Intermediate Term Uptrend 11690-24540
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 2155-2498
Intermediate
Term Uptrend 2022-2623
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 an upward bias to equity valuations. This
week’s data was negative: above
estimates: weekly mortgage and purchase applications, weekly jobless claims, November
consumer credit, December small business optimism, December import and export
prices; below estimates: December retail sales, month to date retail chain
store sales, January consumer sentiment, December labor market conditions,
November wholesale and business inventories and sales, December PPI; in line
with estimates: none.
There was only
one primary indicator reported and it too was negative: December retail sales
(-). That makes the score: in the last 67
weeks, twenty-two were positive, forty-one negative and four neutral.
That said, this
week’s data, in and of itself, certainly wasn’t enough about which to get that
gloomy. However, for the last month I have
been watching for a pick up in the numbers as a result of the improved post-election
Market sentiment being translated into an increase in consumer spending and
capital expenditures. On that count,
this week was a disappointment. First,
because the euphoria on Wall Street did not make its way into the consumer sentiment
reading; and two, I would have thought that December retail spending would see
jump if consumers were feeling better.
To be sure, these
are just two datapoints, so it is too soon to assume that Wall Street’s
optimism won’t transfer to the economy. Upbeat
stats could still be on the way. But as
an early sign, it is not reassuring. Of
course, there remains the likelihood that while improved sentiment may not result
in a pickup in economic activity, the actual enactment of a new
fiscal/regulatory regime will do the trick.
But that lays further out on the timeline. In the meantime, the risk may be about to
increase that the economy remains stagnant, however enthused investors may
be.
Overseas, while the
data in total continued to recover, it was offset by really poor trade numbers
out of China. I continue to believe that
we should be considering that the global economy may be stabilizing, though
this week’s stats don’t really support that notion. Neither do the as yet unresolved problems
stemming from 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. Net, net I am not
altering our ‘muddling through’ forecast, but I leave open the probability that
this outlook could be changing.
In summary, this
week’s US economic stats swung back to negative. In addition, the initial post Trump election
Market euphoria data has yet to show signs of spreading to Main Street. That may change but, at this moment, the
economy is not demonstrating much progress over our pre-election forecast. On the other hand, the global dataflow improved
once again; and that could help keep the US economy sputtering along.
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]
and (3) the unknown [tax cuts and infrastructure spending] policies are not
being discussed.
The
negatives:
(1)
a vulnerable global banking system. This week, the FDIC accused Bank of America of
falsifying its books in order to diminish the required capital under new
rules. The banksters never seem to learn
and keep open the question of the risk that they are carrying on their balance
sheets.
(2) fiscal/regulatory
policy. I continue to be hopeful that
this potential negative goes away, given the Donald’s campaign promises. Some progress was made this week as his
cabinet nominees met little resistance in the approval process. Given the Schumer threats to disturb any and
all legislation/appointments that was a hopeful sign that the only thing the
GOP has to fear is itself.
And that is not
an idle comment. Trump continues to
insist on punitive trade measures. As I have
said before, this may only be an opening negotiating position but our trading
partners are starting to make retaliatory statements which could get any trade
talks off on the wrong foot.
Importantly, any import taxes or so called ‘border taxes’ along with the
expected reciprocal countermeasures will only hurt both global and US trade.
In addition, in
the Donald’s first press conference, among the many issues he didn’t discuss
was the budget. As I have noted
previously, he is getting push back from both the dems and his own party on
measures that would expand the budget deficit.
Making this
lack of a budget discussion more confusing is that the bill which is the first
step to repealing Obamacare is a budget resolution that adds $9 trillion to the
deficit over the next 10 years. Makes you
wonder what Mitch McConnell was talking about when he said that there would be
no additional deficit spending.
Regrettably, this sounds like the same bulls**t routine the GOP has been
handing the electorate since W was president---say that you are for fiscal
discipline and then spend like a drunken sailor.
Hence, the absence
of any comments during the press conference could be a telling sign that either
major disagreements exist between Trump and congress or that they all know that
the current level of US debt precludes the fulfillment of the tax and
infrastructure spending elements on his campaign promises. Whichever [and at this point it is only my idle
speculation], then the euphoria generated by the prospects of a new
expansionary fiscal policy may need to be reconsidered.
(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.
Thankfully, the
global central banks have been pushed off center stage---so we didn’t have to
endure another week of their enervating double talk. [although Yellen did say that the US economy
was ‘doing fine’] Regrettably, that doesn’t mean that their policies are any
less counterproductive. The Fed still
has to normalize monetary policy which includes unwinding of $4 trillion in
liquidity injections---no mean feat for even the most accomplished economists which
the Fed has consistently proven it has none.
Overseas, the
Chinese continue to battle to stabilize the yuan. It had been joined in the battle by the
central banks of Mexico and Turkey fighting their own currency valuation
problems. This kind of currency volatility
tends to reflect domestic problems that will likely be exacerbated by
retaliatory measures such as the Trump ‘border tax’. The point being economic turmoil among our major
trading partners is not a positive for the US economy.
(4) geopolitical
risks: the Syrian conflict took a turn for the worse this week as Israel began
bombing suspected Hezbollah positions around Damascus. This war is like a bad case of herpes---we
just can’t get rid of it and you never know when it is going to flare up
again. Unfortunately that is not the
only international problem as the US and China continue to spar over multiple
issues and the level of antagonism between Russia and the US grows. 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] November
German industrial production was below estimates, while 2016 GDP and exports
were ahead of forecasts; Italian unemployment rose again; November UK
industrial output was ahead of expectations,
[b] 2016
Chinese exports fell 7.7% while imports declined 5.5%; the December Chinese CPI
rose 2.1% while PPI was up 5.5%,
[c] the World
Bank raised its forecast for global economic growth.
Other
factors bearing on the state of the global economy include:
[a] the
Italian government injected E6.6 billion into Monte Paschi and said no EU bail
out would be needed. However, the bank
is still trying to raise over E10 billion from private sources, with no success
to date. In addition, any plan still has
to be approved by the EU. This problem
has not been solved,
[b] currency
instability has spread from China and now includes Mexico and Turkey. That means two of the US’s largest trading
partners are having currency translation problems which affect import and export
pricing. At a time when the Donald is
threatening border taxes, this will only contribute to the odds of some kind of
trade war.
[c] and
surprise, surprise, OPEC acknowledged that there would not be 100% compliance
with the production cut agreement, that at the moment it was about 80%, but
that 50% was acceptable---please.
This
week’s data was upbeat again. As I opined
last week, this has gone on long enough to suggest that the global economy may
be stabilizing---though not long enough to warrant a change in our ‘muddle
through’ forecast. Also holding me back are the potential economic/financial
problems in Italy, Greece, China, Mexico, Turkey and the UK.
Bottom
line: the US economic stats turned
negative again this week---which calls into question whether the economy is
currently stabilizing. And of course,
that doesn’t help my short term forecast that economic conditions will improve
as the result of rising optimism. That
said, this may all be irrelevant if Trump delivers on all those fiscal/regulatory
promises. Unfortunately, the only policy about which we have gotten any details
is trade and that appears to be a negative for the economy. So it might be wise to be a bit circumspect
for the moment.
Foreign economic
data also improved, though the record of progress 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.
This week’s
data:
(1)
housing: weekly mortgage and purchase applications rose,
(2)
consumer: month to date retail chain store sales grew
less than in the prior week; December retail sales were below consensus; the
December labor market conditions index was very poor; weekly jobless claims
rose less than forecast; November consumer credit was well above expectations;
January consumer sentiment was less than projected ,
(3)
industry: the December small business optimism rose
dramatically; both November wholesale and business inventories rose more than
expected but sales were less,
(4)
macroeconomic: December import and export prices rose more
than estimates; December PPI was bit lower than anticipated.
The
Market-Disciplined Investing
Technical
Following
another volatile day, the indices (DJIA 19885, S&P 2274) finished mixed
(Dow down, S&P up). Volume declined
but remained at a high level. Breadth was
negative. The VIX (11.2) was down 2 ½ %,
closing below its 200 day moving average (now resistance), below its 100 day
moving average (now resistance), within a short term downtrend and remains
close 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 {18479-20519}, [c] in an
intermediate term uptrend {11690-24540} 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 {2155-2498},
[d] in an intermediate uptrend {2022-2623} and [e] in a long term uptrend
{881-2435}.
The long
Treasury declined, ending 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 rose, but
remained 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). However, it can continue
to recover significantly before threatening to challenge major
resistance/downtrends.
The dollar fell,
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. The recent pin action appears to reflect continuing
investor faith in major positive changes coming in fiscal/regulatory
policies. Until that notion gets
disabused, stock prices are likely to go higher.
The GLD, TLT and UUP investors are
apparently a bit less sanguine about the ultimate implementation of those policies. As I said Tuesday, I don’t know how this gets
resolved; I am simply pointing out the disagreement among investor types.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (19885)
finished this week about 56.0% above Fair Value (12741) while the S&P (2274)
closed 44.3% 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 returned to its negative trend with the initial post Trump election
numbers showing no sign of the enthusiasm demonstrated by the equity
Market. To be sure, it was a small sample
and subsequent stats could reveal more optimistic consumers and businesses. Or they may just be waiting for the new
fiscal/regulatory policies to actually be implemented before opening their purse
strings. But at the moment, there is no
sign that Main Street is nearly as pumped as Wall Street.
Unfortunately,
what we do know about Trump’s policy changes is not that positive. As you know, I am dismayed by his attacks on
corporations and his anti-free trade rhetoric.
The remainder of his pledged fiscal policies are still very unclear and
remain so even after his first press conference. And as I noted above the push back on any
increase in deficit spending from the dems and his own party’s leadership along
with the seeming inconsistency in McConnell’s statement on deficit spending
make matters all the more confusing. My
only thought is that the current Market jubilation may be premature and overdone.
This week’s
international stats overall were upbeat but included some pretty rotten China
trade numbers. Still the recent trend of
negative weeks alternating with neutral to upbeat weeks continues. Unfortunately, the timeframe is still too
short to assume that the global economy has stabilized.
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. To be sure, a pickup in economic/profit
growth would 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.
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 will likely 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 for both our economic forecast and, 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, 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 19885 2274
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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