The Closing Bell
1/21/17
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 18517-20557
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 2162-2505
Intermediate
Term Uptrend 2026-2627
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 mixed: above estimates: weekly
mortgage applications, weekly jobless claims and the January Philadelphia Fed manufacturing
index; below estimates: weekly purchase applications, the January housing
market index, month to date retail chain store sales, the January NY Fed
manufacturing index; in line with estimates: December housing starts/building
permits, December/revised November industrial production and December CPI.
A little unusual---the
two primary indicators were also mixed: December housing starts/building permits
and the upbeat December industrial production number along with the dramatically
downward revised November reading.
Clearly, this has to be scored as a neutral week: in the last 68 weeks,
twenty-two were positive, forty-one negative and five neutral.
Two other bits
on information gave a more positive tilt: (1) the IMF raised its US GDP growth
forecast for 2017 and 2018---but that is likely because everyone else in the
universe are upgrading theirs based on the Trump growth euphoria and (2) the
latest Fed Beige Book showed the US economy growing modestly in most geographic
regions.
I noted last
week 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. While
this week was not a complete dud, it was clearly not supportive of that notion.
Of course, that
is really not relevant anymore, because it is show time. The Donald is installed; and talking no
longer cuts it. Now the issues are the
speed, magnitude and legislative cooperation with which new fiscal/regulatory
policies are implemented. Given Trump’s
prior actions and his blistering indictment of the Washington crowd in his inaugural
address, the assumption has be that we are in for rapid, significant proposal’s
for change, leaving legislative cooperation as the biggest unknown. And we know
that even under ideal circumstances, the legislative process is going to take
some time. On the other hand, the
executive orders on the regulatory element should be out of the blocks starting
Monday. Then the question becomes what
impact this will have on investor sentiment and more importantly the economy---which
in the meantime, it is going nowhere.
Overseas, the
data, especially out of the EU, continued to recover. As I noted last week, I am now starting to
consider that the global economy is stabilizing. However, a major reason for caution is 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 am getting closer.
In summary, this
week’s US economic stats were mixed which doesn’t support the notions that
either the economy is improving or is about to improve based on increasing investors
sentiment. However, with the
inauguration behind us 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. On the plus side, his cabinet nominees are
outstanding choices for implementing his stated agenda. Nevertheless, Schumer is
still threatening to disturb any and all legislation/appointments. On the other hand, indications are that he will
immediately begin undoing many of the business unfriendly Obama regulations
imposed by executive order---and that starts now.
However,
everything is not peaches and cream. Trump has made a lot of pronouncements
that are not pro-economic growth, including: [a] anti-free trade policies, [b] first
rejecting the Ryan sponsored border tax as too complicated, then later relenting,
[c] comments about the dollar being too high which is not only bad economics, but
encourages other countries to consider pushing their currencies down---another
form of trade war [d] attacking individual companies to impose his will and [e]
finally, the failure to address taxes and infrastructure spending---two of the
most important elements of any economic plan---which is disappointing, at the
least, and concerning.
All that said, the
curtain is rising. Now we will begin to
see how much of the rhetoric becomes action.
The next 100 days will be interesting, perhaps exciting, and will likely
alter this commentary on fiscal/regulatory policy.
Here is a look
at what could be coming (medium and a must read):
One other
positive development this week was a vote by the Senate to preserve the ban on
earmarks. Now if they and their House colleagues
can just come up with a responsible budget.
(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.
We were
entertained by multiple speeches from Yellen this week. In the first, she attempted to rationalize
the Fed monstrously unsuccessful monetary policy in the form of explaining its
goals. As I opined on Thursday, I
thought the presentation right out of the usual bag of Fed tricks; which is to
say, dazzle them with your footwork so that they continue to believe that you
know what you are doing but keep them guessing as to exactly what that is. In this case, the narrative tilted to the
hawkish side; but we know that in the end, this Fed has been, is and always will
be dovish. And not to put too fine a
point on this, less than twenty four hours later, she gave the second
speech---this one [drum roll, please]………dovish. All these comments really did
is confirm that she knows in retrospect how ineffective QE and ZIRP were and
that now she has no idea how to undo what has been done.
Overseas, the ECB
left rates unchanged and also kept its bond purchase program at current levels. At the subsequent Draghi new conference, I suddenly
thought of Seinfeld’s bizarro world [up is down, left is right, etc.]. Having just listened to Yellen sound hawkish because
the US economy is doing so well when the numbers indicate otherwise, now comes
Draghi sounding dovish, pissing and moaning about the EU economy just when the
data has started improving.
Confused? Yeh, me too. But it does reinforce the notion that these
guys are clueless and have no idea how to extract themselves from the QE, ZIRP,
NIRP world that they have created.
Meanwhile,
Trump is trying to talk down the dollar at the same time that the central banks
of China, Mexico and Turkey fighting their own currency valuation problems. The resulting currency volatility exacerbates
internal economic problems, encourages retaliatory measures from trading
partners and damages the collective growth of all participants.
(4) geopolitical
risks: this week, the center of attention became focused on
[a] another
step forward in a ‘hard’ Brexit. While
the press and pundits alike continue their doomsday predictions, the UK economy
just keeps on beating expectations.
Maybe the pessimists will ultimately prove correct; but so far, they are
not even close,
[b] Trump moved
his travelling show into the international sphere by attacking NATO, calling it
obsolete. Of course, the top EU leaders
puked all over his comments. But in my
opinion, he was correct. I commented on
this earlier so I just summarize: {i} only five EU countries pay their allotted
dues to NATO; so if they don’t think NATO that important, why should we? and {ii}
at the same time that they are ignoring external threats, they are aiding and
abetting the growth of an internal existential threat---a muslim population, unwilling
to assimilate, unwilling to follow the laws of the host countries and
supportive, either passively or actively, of jihadist. As I said, Trump may be right, but he has
started something that could ultimately cause a lot of heartburn.
(5)
economic difficulties in Europe and around the globe. This week:
[a] January
German investor confidence soared; UK inflation rose but retail sales fell; 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,
Other developments
in factors bearing on the state of the global economy include:
[a] currency
volatility continues in China, Mexico and Turkey. That is not helped by Trump’s dollar
comments. The risk here is internal
economic instability in two of the US’s largest trading partners and rising odds
of some kind of trade war.
[b] the
Saudi’s, God bless them, can’t get out of their own way. After acknowledging last week that there
would not be 100% compliance with the production cut agreement, this week they
suggested that the OPEC production cut would likely only last till mid-year {they
should be so lucky}. Not helping their cause,
Brazil declined to participate in the quota agreement.
This
week’s data was sparse but still 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. 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
lackluster---meaning that the data is not supporting the notion that 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.
Foreign economic
data also improved. I just need a lot
more of the same before considering any revisions to our ‘muddle through’
scenario.
This week’s
data:
(1)
housing: December housing starts were stronger than
anticipated but building permits were weaker; weekly mortgage applications rose
slightly while purchase applications fell;
the January housing market index was below consensus,
(2)
consumer: month to date retail chain store sales grew
less than in the prior week; weekly jobless claims declined versus projections
of an increase,
(3)
industry: December industrial production was 0.2%
better than forecast but the November number was revised down 0.3%; the January
NY Fed manufacturing index was below expectations while the Philadelphia Fed
index was above,
(4)
macroeconomic: December CPI was in line as was its
reading ex food and energy.
The
Market-Disciplined Investing
Technical
The
indices (DJIA 19827, S&P 2271) rallied on inauguration day, on higher
volume and stronger breadth. The VIX (11.5)
was down 9 ½ %, closing below the upper boundary of a very short term downtrend,
near its 100 and 200 day moving averages (now resistance) and moving back
toward 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 {18517-20557}, [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 {2162-2505},
[d] in an intermediate uptrend {2026-2627} and [e] in a long term uptrend
{881-2435}.
The long
Treasury fell on big volume, although most of the rest of the fixed income
complex was up. It remained 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) and is near challenging its recent uptrend.
GLD rose, ending
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)---but also finished in a very short term uptrend.
The dollar fell,
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. However, it is developing
a very short term downtrend.
Bottom line: the
Averages declined to ‘sell on the news’ (the inauguration), ending up and still
within the recent very tight trading range.
I think that suggests that investors are resting, allowing the recent
very overbought condition to work itself off.
My assumption that the indices will challenge the 20000/2300 level
remains intact.
The pin action
of the last three days is telling us that the GLD, TLT and UUP correlations have
broken apart.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (19827)
finished this week about 55.6% above Fair Value (12741) while the S&P (2271)
closed 44.1% 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 was uninspiring and continued to show little evidence that post Trump
election Market euphoria was translating into higher consumer spending or
business investment. That said, the main event is here. Trump has been inaugurated so any improvement
in the data will be less dependent on sentiment and more so on the actions of
the new administration.
Given all the
promises, that likely means that this narrative will have a lot to consider in
the coming months. Hopefully, the
Donald/GOP will deliver on many of those pledges. And indeed, I think that he will. Certainly, the economic philosophies of his
political appointees argue that. As does
the rumored list of budget cuts outlined in the above link from The Hill. On the other hand, Trump’s attacks on
individual corporations, his anti-free trade rhetoric as well as his comments
on the dollar are not, in my opinion, supportive of economic growth.
However, before
making any major revisions to our economic forecast, I want to ‘see the whites
of their eyes’. Of course, expectations
are that regulatory reforms are going to come fast and furiously; so we may not
have to wait that long for concrete actions and proposals.
In the end, the
fiscal/regulatory landscape is likely to change dramatically in this year; so
there will be much to analyze and digest.
The extent to which this alters the numbers and expectations is still a
question.
This week’s
international stats were scant but still upbeat, increasing the odds that I may
upgrade our ‘muddle through’ forecast.
However, this positive trend is still too short to assume that the
global economy has stabilized. Plus
there are some major problems (Brexit, currency problems, free trade issues) looming
out there that need to solved before I will view this improvement as anything
other than temporary.
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
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 more optimistic than 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 19827 2271
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.
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