2/25/17
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 18812-20870
Intermediate Term Uptrend 11782-24634
Long Term Uptrend 5751-23298
2016 Year End Fair Value
12600-12800
2017 Year End Fair Value
13100-13300
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Uptrend 2202-2536
Intermediate
Term Uptrend 2050-2654
Long Term Uptrend 881-2561
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 basically neutral: above
estimates: January existing home sales, month to date retail chain store sales,
February consumer sentiment and the February Kansas City Fed manufacturing
index; below estimates: January new home sales, weekly mortgage and purchase
applications, the February Markit flash manufacturing PMI and the January
Chicago national activity index; in line with estimates: weekly jobless claims.
Further, the primary indicators were also a
wash: January existing home sales (+) and January new home sales (-). The score: in the last 73 weeks, twenty-four
were positive, forty-two negative and seven neutral.
If you are an
optimist, then the interpretation of this week’s stats is that they are a weak
continuation of the prior two weeks’ upbeat dataflow which in turn is an
indication of a pickup in the numbers due to the improved post-election Market sentiment
being translated into a more rapidly growing economy. While I have put myself in that camp, it is
still a bit too short of a time span to declare victory.
On the political
side, Trump continued his deregulation agenda; and while it may deliver upbeat
economic results long term, to date, his measures have not been enough to move
the needle on our economic forecast. But
just to be clear, this phase of his presidency, in my opinion, is a positive,
economically speaking.
Trade is the other area that Trump has spent
a lot of time and capital on; and while he has unquestionably shaken up the
establishment by criticizing NAFTA/Mexico, Germany and the euro, nothing really
concrete has been done---and that is the good news. I am not going to repeat
the endless number of reasons why actually following through with his threats
would be a negative for both our trading partners and ourselves. My hope is that they are just negotiating
bluster and the final results will be much more free trade friendly. But if he is serious, this will be a major
economic negative.
Just as
important, it is becoming increasingly apparent that tax reform is going to
take some time. Much debate continues on
the efficacy of the border tax; and the Senate appears to be steadfast in
opposing anything that will increase the budget deficit. To be clear, (1) I have always doubted the
rapid passage of a tax cut and (2) increasing the budget deficit is not, in my
opinion, sound economic policy given the current level of federal debt. So I consider neither of these factors a
negative.
But if you have
noticed, the semantics of taxes has changed a bit. The discussion has gone from tax cuts to tax
cuts versus tax reform---the former being cuts without offsetting increases or
spending cuts, the latter a revenue neutral restructuring, the intent of which
is to make the tax code simpler and fairer.
Of course, tax
cuts are generally received with much enthusiasm for obvious reasons. And there
are times when they can be quite stimulative.
But this isn’t one of those times---at least if you accept the
Reinhart/Rogoff thesis (at a certain level [which the US has achieved], additional
government debt inhibits rather fuels economic growth). This is a major reason the Senate leaders
have opposed cuts with no offsets and have the power to enforce it.
Tax reform is also
generally applauded as a good thing; but it is quite different in its economic
impact than tax cuts. There is little doubt that a simpler and fairer tax
system will have a positive effect on the economy; but it likely won’t produce
the magnitude of growth in GDP and corporate earnings that the dreamweavers
have been prognosticating. Just to be
clear, I want to repeat that, assuming tax reform is anywhere close the model
that has been floated, reform will result in growth, just not to the extent
that I now see in Street forecasts of GDP and corporate profit growth. Particularly, if the reform includes the
border tax as a revenue offset.
Overseas, the
data this week returned to the plus side, supporting the notion that there is a
decent probability that the ‘muddle through’ scenario gets replaced by an
improving economy. But it is just too
soon to make that call. 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.
Bottom line: this
week’s US economic stats were neutral, neither helping nor damaging the notions
that either the economy is improving or is about to improve based on increasing
investor sentiment. More is needed
before I will feel confident with my revised tentative short term forecast. But I 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.
In the meantime,
my take is that we are in an economy (1) that is making only sluggish headway,
(2) in which the known Trump economic policy changes are not that encouraging
[‘border’ tax; currency valuation] and (3) the unknown [tax cuts and
infrastructure spending] policies have yet to be addressed in any meaningful
way, but which may be about to change.
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
US data this week was mixed. While it
could still be part of the improvement from the recent trend of lousy stats, it
is hardly a sign that the economic growth is something other than slow.
The
negatives:
(1)
a vulnerable global banking system. The good news is
that there was nothing in this arena this week occurring in the US. Overseas is another story. [a] the EU and the ECB are at odds over Monti
Dei Paschi rescue and [b] IMF told Greece that it must make further structural changes
before assistance can be provided.
A bankruptcy of either Monti Paschi or Greece would
not be a plus for the EU or global banking systems. That said, the EU ruling class has always
been able to cobble together measures that allowed them to muddle
through---and, indeed, that has been our forecast for years. But that doesn’t mean that there is not a
risk in assuming they will do it one more time.
(2) fiscal/regulatory
policy. I continue to hope that the
Donald’s new policies will prove beneficial to the economy and I can eliminate
this factor as a negative. Certainly, his
efforts at deregulation are a positive.
However,
Trump’s comments on trade demonstrate the seeming lack of understanding of what
free trade has meant to global prosperity and peace. Plus trying to talk down the dollar only
generates similar responses from our trading partners, which in the end
accomplishes nothing expect fostering ill will.
That
said, I remain open to the notion that many of Donald’s initial currency/trade
positions may just be for negotiating purposes.
So the ultimate outcome could be quite positive. However, until we know how this turns out,
there is cause for unease.
One of the most
important elements of Trump’s campaign pledges was tax cuts. Two weeks ago, he sent the Market into ecstasy
with his ‘phenomenal’ tax plan that he said would be out in two or three weeks. And here we are two weeks later and nada. Indeed, in a Thursday interview, Treasury
Secretary Mnuchin suggested that the timing would be much longer than implied
by the Donald. In addition, as in noted
above, the administration is now comparing and contrasting tax cuts [not
revenue neutral] and tax reform [revenue neutral]. Meaning it is unclear what tax cuts/reform
will look like.
In addition, rumors
now suggest that infrastructure spending, the second major element of Trump
fiscal plan will be put off until 2018 (medium):
To be fair the Washington
sausage making process always take longer than anyone expects; so I am not
going to hold a delay against Trump. But,
but, but, it seems clear that [a] the pushback on tax cuts from multiple
parties and [b] the implementation of a border tax as a revenue offset in a tax
reform package should give pause to those who are forecasting significant growth
[again, please note, ‘significant growth’; some pick up in ‘growth’ will almost
surely happen] in the economy and corporate profits.
Bottom line, it
seems like congress is faced with a Hobson’s choice on tax policy. Tax reform, assumes the border tax, which as you
know I think economically unsound. Tax
cuts run up the budget deficit, which longer term is even worse.
(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 minutes
from the last FOMC meeting were released this week. They depicted the same old Fed engaged in a
great discussion about the economy and the risks it faces but completely unable
to make a decision.
Of course, no
decision is a decision. The problem
being that the longer the Fed takes to initiate a normalization of monetary
policy, the more it harms the economy and diminishes its own credibility. I know that there are plenty of people out
there that believe that the Fed is doing a spectacular job. I suspect that most of that admiration is
derived from current equity [over] valuations.
But when Act III is over, I also suspect that same group will be excoriating
the Fed as villain not hero.
The Fed’s
credibility (medium and a must read):
(4) geopolitical
risks: I continue to worry about Trump’s
seeming willingness to throw diplomacy aside and treat the rest of the world
like they are the press. To be clear, I
don’t have an issue with most of the principles behind his offensive comments. And
I understand that he may just be trying to set up a negotiating position.
This article
supports that notion (medium):
My point here is that, in my opinion, duking
it out with foreign leaders in public increases the odds of a misstep that
could be costly in far more ways than just economically.
(5)
economic difficulties in Europe and around the globe. This week, the number from the rest of the
world were scarce as they were from the US; but they were all upbeat:
[a] the
February EU Markit composite, manufacturing and services PMI’s were above
projections; January EU inflation was less than anticipated; fourth quarter UK
GDP growth was revised higher; February German business was better than
expected;
On the
other hand, news reports indicated that the bankruptcy problems at Italy’s
Monti Paschi and the Greek bailout have not been resolved If history repeats itself the EU ruling class
will come up with band aid that will buy more time; but that won’t solve the
problems. Ultimately somebody has to
swallow some bitter medicine.
While sparse,
this week’s data gets the global economy back on its winning track, leaving a
change in our forecast on the table. We
are just not quite there yet. Part of my
hesitation is because of the continuing potential economic/financial problems
in Italy, Greece, China, Mexico, Turkey and the UK.
Bottom
line: the US economic stats were neutral---a
microscopic boost to those hoping that the economy is currently improving. In addition, the Donald continues his drive
for deregulation and that is a decided plus.
Finally, while there has been a lot of dialogue about taxes, spending,
Obamacare, trade, nothing is even in writing much less close to enactment. In other words, while I am hopeful that Trump
will be able to deliver on his promises, it is too soon to be building economic
models assuming some specific outcomes.
Net, net, at this moment, what has been accomplished to date may only
modestly alter long term secular growth rate of the economy.
Foreign economic
data this week improved, leaving open the possible revision to our ‘muddle
through’ scenario.
This week’s
data:
(1)
housing: January existing home sales were well ahead of
forecast while January new home sales were below; weekly mortgage and purchase
applications were down,
(2)
consumer: month to date retail chain store sales growth
improved from the prior week; weekly jobless claims rose slightly more than
projected; February consumer sentiment was better than the January reading,
(3)
industry: the February Markit flash manufacturing PMI came
in below estimates; the January Chicago Fed national activity index was considerably
worse than anticipated while the February Kansas City Fed manufacturing index
was very strong,
(4)
macroeconomic: na.
The
Market-Disciplined Investing
Technical
The indices
(DJIA 20821, S&P 2367) made a dramatic intraday comeback on Friday to close
in the plus column. Volume fell (for the
sixth day in a row), but remained at a high level; breadth was weaker despite
the positive finish. The VIX (11.5) was
down 2%, ending below its 100 and 200 day moving averages (now resistance) and
in a short term downtrend but is near the lower boundary of its intermediate
term trading range (10.3)---leaving complacency at a near record high level.
The Dow closed
[a] above its 100 day moving average, now support, [b] above its 200 day moving
average, now support, [c] in a short term uptrend {18812-20870}, [c] in an
intermediate term uptrend {11782-24634} and [d] in a long term uptrend {5751-23298}.
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 {2202-2536},
[d] in an intermediate uptrend {2050-2651} and [e] in a long term uptrend
{881-2561}.
The long
Treasury was up 1% on heavier than normal volume, breaking above the upper
boundary of that developing pennant---a sign that the bond guys may be having
second thoughts on the Trumpflation trade.
But it still has work to do to correct its negative chart since it remains
below its 100 and 200 day moving averages and in a very short term downtrend.
GLD advanced on elevated
volume, closing within a very short term uptrend and above its 100 day moving
average (now support). Plus it ended
near its 200 day moving average (now resistance) and within a short term
downtrend.
The dollar was
up, ending above its 100 day moving average (now support), its 200 day moving
averages (now support) and in a short term uptrend.
Bottom line: yesterday’s
pin action just provides more support that there is a strong bid below the
Market and that the Averages are headed for the upper boundaries of their long
term uptrends. However, the sharp rally
in bonds suggests that the hopes associated with Trump fiscal plan may be
fading in the bond pits. If the bond
guys are right, stocks are at risk.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (20821)
finished this week about 62.8% above Fair Value (12782) while the S&P (2367)
closed 49.8% overvalued (1580). ‘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 were a draw. Some may want to read
that as more evidence that a growth spurt is in the making. Certainly, the Market continues to interpret
all data/news in a very positive light---which currently is that a major
turnaround in the economy is occurring based on pro Market regulatory/fiscal
policies from the new administration. I
think more information is needed to draw that conclusion.
Politics
continues to dominate the headlines.
This week, Trump issued more executive orders to undo the regulatory
infrastructure. These cumulative
regulatory changes should have a positive economic impact on the economy.
In addition, the
reality of the legislative process and math seem to be working their way into
the discussions on tax cuts and infrastructure spending. But the Market seems to have not grasped that
same reality quite yet. To be clear, as
a result of fiscal and regulatory reforms, I may very well make upward revisions
in our forecast for GDP and corporate profit secular growth and that could in
turn positively impact stock valuations in our Model. On the
other hand, many on the Street have already made huge changes in their forecast
based on, what I believe, are extraordinary leaps of faith on what will be
enacted. As long as this remains their perspective, the gap between reality and
the numbers in their models will persist.
At the moment, their hopes are all that matters to the Market; but if I am
correct, then ultimately those models will change for the worse.
I remain
concerned about Trump’s push towards tariffs and manipulating the dollar
lower. Free trade is and always has been
an agent of economic progress and global political stability. His proposals would inhibit those
objectives. Although I have acknowledged
that his moves may be nothing more than initial negotiating positions from
which positives can be derived. Still the evidence to date keeps this factor
as a negative.
Finally, I don’t
believe that the Donald’s unnecessarily hostile rhetoric is conducive to
accomplishing his objectives. To be
clear, I have no disagreement with most of his goals. In just seems to me that they can be more
easily achieved without getting into a public pissing contest, especially with
foreign leaders. An unstable international environment tends not to be good for
stock prices---and that is what we are concerned with here.
This week’s
international stats were positive, increasing the likelihood of a change in
international segment of our economic forecast.
I still need more data. In the
meantime, I am worried about a number of major problems (Brexit, currency
problems, free trade issues) looming out there.
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.
As you know, my thesis all along has been that since the
economy was little helped by QE/ZIRP, then it could do just fine in the face of
a reversal of those policies. On the
other hand, since the Markets were the primary beneficiaries of Fed largesse,
it would be they who suffered when the Fed began to tighten.
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 the rate of 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.
Finally, whatever happens, stocks are at or near historical extremes in
valuation and there is no reason to assume that mean reversion no longer occurs.
Bottom line: the
assumptions in our Economic Model may very well improve as we learn about the
new fiscal/regulatory policies and their magnitude. However, unless they lead to explosive growth,
they do little to alter the assumptions in our Models. 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. In any
case, at least according to the math in our Valuation Model, equities are way
overpriced.
As a long term investor, with
equity valuations at historical highs, 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 2/28/17 12782
1580
Close this week 20821 2367
Over Valuation vs. 2/28 Close
5% overvalued 13421 1659
10%
overvalued 14060 1738
15%
overvalued 14699 1817
20%
overvalued 15338 1896
25%
overvalued 15977 1975
30%
overvalued 16616 2054
35%
overvalued 17255 2133
40%
overvalued 17894 2212
45%
overvalued 18533 2291
50%
overvalued 19173 2370
55%overvalued 19812 2449
60%overvalued 20451 2528
65%overvalued 21090 2607
Under Valuation vs. 2/28 Close
5%
undervalued 12142
1501
10%undervalued 11503 1422
15%undervalued 10864 1343
* 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.
