The Closing Bell
2/4/17
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 18655-20697
Intermediate Term Uptrend 11740-24592
Long Term Uptrend 5730-20736
2016 Year End Fair Value
12600-12800
2017 Year End Fair Value
13100-13300
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Uptrend 2182-2525
Intermediate
Term Uptrend 2038-2639
Long Term Uptrend 881-2500
2016 Year End Fair Value
1560-1580
2017
Year End Fair Value 1620-1640
Percentage
Cash in Our Portfolios
Dividend Growth
Portfolio 55%
High
Yield Portfolio 54%
Aggressive
Growth Portfolio 55%
Economics/Politics
The Trump
economy will likely provide an upward bias to equity valuations. However,
this week’s data was mixed: above
estimates: December pending home sales, the January ADP private payroll report,
January nonfarm payrolls, weekly jobless claims, the January Markit manufacturing
PMI, the January ISM manufacturing index, the January Markit services PMI,
December factory orders, fourth quarter nonfarm productivity and unit labor
costs; below estimates: weekly mortgage and purchase applications, December
personal income, month to date retail chain store sales, January retail chain
store sales, January light vehicle sales, January consumer confidence, the
January Dallas Fed manufacturing index, the January ISM nonmanufacturing index,
the January Chicago PMI, December construction spending; in line with estimates:
December personal spending, fourth quarter employment cost index.
The primary
indicators were also mixed: December personal income (-), December construction
spending (-), December personal spending (0), January nonfarm payrolls (+) and
December factory orders (+). The score:
in the last 70 weeks, twenty-two were positive, forty-two negative and six
neutral.
I noted previously
that we should start seeing a pick up in the numbers if the improved post-election
Market sentiment was going to be translated into an increase in consumer
spending and capital expenditures. In that light, some might want to interpret
the fact that this week’s stats were mixed versus negative as a positive. If they are a lead into a series of upbeat
datapoints, that would be true. Right
now, all we know is that they are a pause in an otherwise discouraging
trend. Time will tell.
Trump continues
to pound away on his immigration and deregulation agenda. While some of the measures could have some positive
short term marginal economic effect (Keystone pipeline, limiting contract
awards by agencies), most of his executive orders to date will simply change
the way immigration and regulation are administered. Although the latter may have larger positive
economic/social consequences longer term. Still 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 is
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.
The one, and by
far the most significant, economic policy pledge that the Donald made has
largely ignored to date: his promises on taxes and infrastructure spending. And again, I am not going to repeat the
numerous reasons why the math in implementing big tax cuts and major
infrastructure spending doesn’t work.
In short, Trump
is making changes that will alter important aspects of how the government works
and those policies will likely improve the way business in the US gets done. However, on the big economic issues of trade,
taxes and infrastructure spending, with what we know to date, I think it
unlikely that there will be much impact on the secular growth rate of our
economy. For the moment, the economy
continues to struggle and nothing has occurred that would alter that.
Overseas, the
data, especially out of the EU, continued to recover. I still believe that a couple more weeks of
this kind of performance and the ‘muddle through’ scenario gets replaced by an
improving economy. That said, there are
still problems out there: the Monte Paschi bailout, the Brexit, currency
turmoil in China, Mexico and Turkey, the potential impact of a Trump anti- free
trade agenda and Greece’s bailout difficulties.
Along those lines, this week, China reported that 2016 witnessed record
capital outflows.
In summary, this
week’s US economic stats were mixed which may or may not support the notions
that either the economy is improving or is about to improve based on increasing
investor sentiment.
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
US data this week was both plentiful and mixed.
While an improvement from the recent trend of lousy stats, it is hardly
a sign that the economy has turned the corner.
We must wait for more information before drawing that conclusion. In
the meantime, my take is that we are in an economy (1) that isn’t making much
headway, (2) in which the known Trump economic 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.
Update on bug
four economic indicators (medium):
The
negatives:
(1)
a vulnerable global banking system. This week:
[a] Deutschebank pleaded guilty to laundering Russian
money. These guys seem to know no bounds
to breaking the law,
[b] Secretary
of Treasury nominee Mnuchin said that he would not permit bank proprietary
trading. The US continues to lead the
rest of the world in eliminating practices that put the ‘too big to fail’ banks
at risk. However, progress in the rest
of the developed world has been slim to none, leaving the global banking system
vulnerable,
[c] and there
is this (short and a must read):
(2) fiscal/regulatory
policy. As you know, I have been hopeful
that the Donald would eliminate this as a potential negative. And, indeed, he has taken steps to reverse
the regulatory burden that has been loaded on the economy, including executive
orders barring the EPA from awarding any new contracts, freezing the
implementation of last minute regulations imposed by Obamacare, advancing the
construction of the Keystone and Dakota pipelines, authorizing the building of
the wall on our southern border, cutting funds to sanctuary cities, the enhanced
vetting of immigrants [potential terrorists] and the temporary travel ban. In addition, his nominee for the Supreme
Court will be a major plus for those of us who object to legislation from the
bench.
However, on
Friday Trump did produce one potential sour note in his deregulation campaign---which
was the roll back of some provisions of Dodd Frank. Just a point: Dodd Frank is law and he can’t
change it with an executive order. All
he can do [and is doing] is draft proposals for congressional
consideration. So nothing is going to
happen in this arena immediately. But he
has set the ball rolling. As I read his
proposals they will no doubt help the banks and their profitability; although
they also seem to lift the penalties for screwing the public. The administration is selling [and apparently
the Street is buying] its proposals not as a voiding of Dodd Frank, but rather
as an adjustment that corrects some of the more extreme provisions. And that could be true; we need just need more
detail before drawing any firm conclusions.
On the other hand, Trump fiscal actions have, in my
opinion, been negative: muscling company or industry officials to do his
bidding [just another form of regulation], talking the dollar down [currency
war], getting into a pissing contest with Mexico over ‘the wall’ and Germany
over the valuation of the euro and the continuing failure to address taxes and
infrastructure spending [the policies that could have the largest impact on the
economy].
Of
course, 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.
With
trade, there are no losers (medium and a must read):
The
potential impact of the border tax on the EU (medium):
With regard to
cutting taxes and instituting major infrastructure projects, I have suggested
that the math of these promises simply doesn’t work. The current level of both the federal debt
and the budget deficit are too high to make such proposals economically constructive. Sure, he can cut fat in the budget and can
reverse expensive regulations implemented by prior executive orders; and those
saving can be spent elsewhere. He can
rationalize the tax code, making it fairer.
But a net large tax cut and a net major increase in infrastructure
spending would do more to stymy economic growth than enhance it [reference the
Rogoff/Reinhart study which states that countries where debt in greater than
90% of GDP spend more resources servicing the debt than stimulating growth---see
link below]. And none of this takes into
consideration the congressional GOP leaders pledge to not add to the debt. In short, I am not sure of the extent to
which Trump can deliver on what were, economically speaking, his most important
campaign promises.
On a
potentially more positive note, on Thursday, there was an announcement
published by the Japanese government stating its intent on investing in US
infrastructure projects.
A
follow up to the Japanese proposal (medium):
Finally, I
think that there is an issue of style that is problematical. I know that many love the Donald’s
confrontational approach. I do too; at
least in respect to the press. However,
I am not sure name calling, personal insults and narcissistic self-praise advance
the odds of getting his proposals implemented, assist in winning the support of
those Americans in the middle of the political spectrum and enhance the stature
of the office.
(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 FOMC held a
meeting this week; and its subsequent statement was notable in what was
said---which was absolutely nothing. The
narrative and tone was almost exactly the same as the prior statement---with
one minor exception. The verb referring to rising inflation went from
‘expected’ to ‘will’. That hints at a
slightly more hawkish stance.
However, the
odds for a rate increase [as determined by spreads in the bond market] actually
declined, suggesting that the bond guys think nothing has changed. That likely also means that they see little
chance of large tax cuts and infrastructure spending, at least anytime soon,
since those measures would probably put upward pressure on inflation and that
would require a Fed response.
But that is
just speculation at this point. For the
moment we are in a struggling economy and I have serious doubts that we will
get the kind of massive tax and spending programs promised by Trump. In which case, the central banks can continue
their dovish approach to monetary policy, i.e. do nothing to correct to
residual problems [i.e. asset mispricing and misallocation] created by QE, ZIRP
and NIRP.
Counterpoint
(medium and a must read):
Dead dove
walking (medium):
Across the
pond, the Bank of England left key interest rates unchanged and upgraded its
economic outlook. While the latter seems
to be a continuing theme, I imagine that the BOE will be constrained by worries
over the potential impact of Brexit---which is moving along.
(4) geopolitical
risks: Trump continued to stick his finger in as many foreign eyes as
possible. The primary recipient this
week was the Germans, who a chief advisor accused of keeping the euro
undervalued in order to exploit the US and other EU countries. This on top of earlier comments on EU NATO
members not carrying their fair share of that organizations budget. To be sure, both are valid criticisms. So this may be another of those ‘hard ass’
initial negotiating positions whose intent is to achieve something more modest
but still accomplishes pro US objectives.
There also
rising tension between the US and Iran following the latter’s missile test that
the former claims violates the Iran nuclear deal. The administration ‘put Iran on notice’ and
then immediately acted on that notice, imposing new sanctions on Iran. Personally, I have no problem with expecting
Iran to live up to the terms of the nuclear deal and taking action when it
doesn’t. But the process of making this
point does increase the odds of a misstep.
And finally, it
appears terrorists are coming across the southern border (medium):
My conclusion
remains: I don’t think it an understatement to say that geopolitical risks are
increasing.
(5)
economic difficulties in Europe and around the globe. This week:
[a] January EU
industrial and economic confidence were above estimates while services
confidence was below; 2016 EU GDP growth was up, unemployment was down and
inflation up, all better than consensus; the January UK manufacturing PMI was
in line,
[b] January
Chinese manufacturing PMI was below estimates while the nonmanufacturing PMI
was above; 2016 Chinese capital outflows hit a record high,
[c] the Bank of
Japan raised its forecast for 2017 GDP growth and inflation.
[d] the Greek bailout problem is raising its head once again.
So this
week’s data was another positive one. The
stats continue to improve sufficiently to suggest that the global economy may
be stabilizing---enough so that another couple of weeks of better numbers will
warrant a change in our forecast. Holding me back are the potential
economic/financial problems in Italy, Greece, China, Mexico, Turkey and the UK.
A new
problem for Mexico (medium):
Bottom
line: the US economic stats turned mixed
this week---meaning that the data is still not supporting the notion that the
economy is currently improving. That of
course, doesn’t help my short term forecast that economic conditions will get
better as the result of rising optimism.
In the meantime, we have precious little on fiscal/regulatory policies
that could have a material long term positive impact on the economy.
Foreign economic
data improved. I just need a bit more of
the same before considering any revisions to our ‘muddle through’ scenario.
This week’s
data:
(1)
housing: December pending home sales were above
projections; weekly mortgage and purchase applications were down,
(2)
consumer: December personal income was below estimates
while personal spending was in line; the January ADP private payroll report was
well ahead of expectations as was January nonfarm payrolls; weekly jobless
claims were better than anticipated; month to date retail chain store sales
grew slower than in the prior week, while January sales were below consensus; January
light vehicle sales were less than forecast; the January consumer confidence
was slightly below projections,
The Market
seemed particularly enthralled with the January nonfarm payroll number. Here is Mohamed El Erian’s take (medium):
(3)
industry: the January Dallas Fed manufacturing index
was disappointing as was the January Chicago PMI; however, both the January Markit
manufacturing PMI and the January ISM manufacturing index were better than estimates
while the services PMI and ISM nonmanufacturing index was worse; December
construction spending was terrible; December factory orders were well ahead of
expectations,
(4)
macroeconomic: the fourth quarter employment cost index
was below forecast; fourth quarter nonfarm productivity and unit labor costs
were better than anticipated.
The
Market-Disciplined Investing
Technical
The indices
(DJIA 20071, S&P 2297) had a good day Friday with the Dow regaining 20000
but the S&P once again failing to mount 2300. Volume fell but remained at elevated levels;
breadth was positive. The VIX (11.0) dropped
8%, closing below its 100 and 200 day moving averages (now resistance) and in a
short term downtrend but is again nearing the lower boundary of its
intermediate term trading range (10.3) which is only slightly above the lower
boundary of its long term trading range (9.8). Thus it is very close to record complacency.
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 {18655-20695}, [c] in an
intermediate term uptrend {11740-24592} and [d] in a long term uptrend
{5730-20736}.
The S&P
finished [a] above its 100 day moving average, now support, [b] above its 200
day moving average, now support, [c] within a short term uptrend {2182-2525},
[d] in an intermediate uptrend {2038-2639} and [e] in a long term uptrend
{881-2500}.
The long
Treasury declined slightly, remaining in a very short term downtrend, near the
lower boundary of its short term trading range and below the 100 day moving
average (now resistance), falling further below its 200 day moving average (now
resistance).
GLD (116.1) was
up again and will reestablish a very short term uptrend if it finishes above
116.0 on Monday. It is also close to
challenging its 100 day moving average (now resistance). It remained below its 200 day moving average
(now resistance) and within a short term downtrend.
The dollar declined
slightly, but remains in a narrowing range bounded by the 100 day moving
average (now support) on the downside and the upper boundary of its very short
term downtrend on the upside. A break
above/below one of these levels will likely point to a directional move. It is still above 200 day moving averages
(now support) and in a short term uptrend.
Bottom line: investors
got jiggy Friday with the nonfarm payrolls number and Trump’s move to amend
Dodd Frank. While the Dow regained
20000, the S&P failed to move above 2300.
Until that occurs, I think the upside in stocks in general is
limited.
TLT,
UUP and GLD appear to be about to challenge the first resistance/support levels
that could lead to directional changes---although rising interest rates, rising
gold prices and a weak dollar are somewhat inconsistent suggesting something is
amiss. My interest is in GLD which I
think would be a trade if it reestablishes a very short term uptrend and
successfully challenges its 100 moving average.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (20071)
finished this week about 57.0% above Fair Value (12782) while the S&P (2297)
closed 45.3% 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 was mixed this week. Some may want
to read that as a positive. I think more
information is needed to draw that conclusion.
However, 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 new pro Market regulatory/fiscal policies from the new
administration.
To be sure, Trump
is moving at neck break speed issuing one executive order after another. But those are bringing both welcome and
unwelcome regulatory change to immigration, trade and the government
bureaucracy. While construction of the
Keystone pipeline and the suspension of agency awarded contracts will have a
positive economic impact, most of these orders will more heavily influence
social/political policy.
On the other
hand, Trump’s economic actions to date have been less than positive: muscling
corporations, talking down the dollar and threats of tariff. Although, not to be repetitious, much of the
dollar/tariff talk may just be initial negotiating positions on issues from
which positives can be derived. Still
what we have today is negative.
In addition, all
we have now is talk with respect to the major economic pillars of his campaign
pledges: tax cuts and infrastructure spending.
And as I have opined throughout this narrative, he may have real
problems implementing any such policies that would significantly enhance
economic expansion.
That said, the
stunning announcement by the Japanese that they would invest in US
infrastructure could be a God spend for Trump; though I need to remind all that
the only way foreigners have dollars to invest in the US is if we run a trade
deficit with them. We can’t have it both
ways.
Finally, Trump
seems intent of antagonizing as many foreign leaders as possible. The actions toward Mexico, Germany, Japan and
China may again just be initial negotiating positions that could lead to
changes that will favor the US. However,
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 upbeat, increasing the odds that I will upgrade our
‘muddle through’ forecast. However, I am
still worried about a number major problems (Brexit, currency problems, free
trade issues) looming out there.
Net, net, in
general, my expectations for some improvement in the economic outlook remain
high (‘some’ being the operative word).
However, I am not sure how much it will impact the assumptions in our
Models. Remember, those assumptions are
calculated more on long term trend basis and less on what is likely to happen
the coming 12 months. Currently, they
show a higher economic growth rate than now exists; so a modest pickup in
growth will not alter the assumptions.
Trump/GOP will need to up their game to have any impact on the
Models. The point being, current euphoria
notwithstanding, nothing has happened yet to change our Fair Value
estimates. I would love to see policies
that would.
All that being
said, you know that my negative outlook for stocks has little to do with the
progress or lack thereof for the economy/corporate profits and is directly
related to the irresponsibly aggressive global central bank monetary policy
which has led to the gross misallocation and mispricing of assets. The Fed has $4 trillion on its balance sheet
which it has no clue how to get rid of.
And Draghi just said that EU QE isn’t going away anytime soon.
The investment
problem here is that while a big pickup in economic/profit growth could have a
positive impact on Fair Value in our Model, it would also push the Fed toward
unwinding the bloated balance sheet and raising interest rates. You will recall that 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 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.
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 20071 2297
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
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.
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