The Closing Bell
2/11/17
I have family business to attend to next Monday and Tuesday and it
could run into Wednesday. I don’t know
which; but I will be back.
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 18742-20784
Intermediate Term Uptrend 11758-24613
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 2188-2531
Intermediate
Term Uptrend 2042-2643
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. While this
week’s data was comprised entirely of secondary indicators, it was, nonetheless,
overwhelming positive: above estimates: weekly
mortgage and purchase applications, month to date retail chain store sales, weekly
jobless claims, December consumer credit, December wholesale inventories/sales
and the December trade deficit; below estimates: February consumer sentiment; in
line with estimates: January import/export prices (note: I am listing this as a
neutral because it depends on your perspective whether this is good or bad news.)
The score: in the last 71 weeks, twenty-three
were positive, forty-two negative and six neutral.
If you are an
optimist, you would consider the last two weeks’ dataflow as a sign of a pick
up in the numbers due to the improved post-election Market sentiment being translated
into an increase in consumer spending and capital expenditures. I think it a
bit too short of a time span to conclude that but it must be regarded as a
possibility.
On the political
side, Trump continues to dazzle us with his footwork. By and large, his deregulation agenda is
right on track and while it may deliver upbeat economic results long term, to
date, his measures short term will not be 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 is just negotiating
bluster and the final results will be much more free trade friendly---and
this week’s meeting with Abe, who comes bearing gifts, may be a signal that is
the case.
But if he is serious, this will be a major economic negative.
Most important,
this week the Donald finally addressed one of the most significant, economic
policy pledges of his campaign: taxes.
However, all he really did was address it---saying simply to expect a
‘phenomenal’ plan in the next two to three weeks. However, given the rumors from two well
connected sources, there seems little doubt that he will present a ‘phenomenal’
plan. But when he does so, he needs to
tackle (1) its math as regards the budget deficit and federal debt and (2)
congressional concerns about the same.
As you know, I don’t see how it can be done and not exacerbate the already
huge deficit/debt problem---which has been shown to have a substantial negative
impact on economic growth. In other
words, a larger deficit doesn’t solve the growth problem. I await the plan breathlessly.
Overseas, the
data this week turned sour; though this is just one week in what has been a
hopeful trend of more positive numbers.
If this proves to be an aberration, then there remains a decent
probability that 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.
In summary, this
week’s US economic stats were quite positive, providing minor support to the
notions that either the economy is improving or is about to improve based on
increasing investor sentiment. More is
needed before I consider changing our forecast.
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 very upbeat. 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] 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.
The latest from
Van Hoisington (medium and a must read):
The
negatives:
(1)
a vulnerable global banking system. In what may be the best news that I have seen
on this issue in some time, this week the DOJ launched a probe of individuals
involved in Deutschebank’s mortgage security fraud. I have always believed that one of the best
ways of curbing corruption was hold the people involved accountable, i.e. jail
time.
Here is another must read piece from Jeffrey Snider on
the failures of the banking system (medium):
(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,
the efforts to curb the power of regulatory agencies is an economic plus. In addition, advancing the construction of
the Dakota and Keystone pipelines and reforming the aviation industry’s
infrastructure could be helpful; although as I noted in a link this week, it
appears that the Keystone pipeline is not economically viable at current
prices. Enforcing the immigration laws
could be advantageous if handled properly.
So there is lots of good news.
However,
Trump’s comments on trade, which can be far more impactful than any of the
above, demonstrate the seeming lack of understanding of what free trade has
meant to global prosperity and peace. And
trying to talk down the dollar only generates similar responses from our
trading partners, which in the end accomplishes nothing expect fostering ill
will.
To be
fair, 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. The recent meetings between Tillerson and his
Canadian and Mexica counterparts is a hopeful sign as was Trump’s friendly
overture to China and the Japanese apparent intent on investing in US infrastructure
projects. However, until we know how
this turns out, there is cause for unease.
Further, while
we have no idea of what firm reforms could come out amending Dodd Frank, the
provisions that were targeted in Trump’s comments are ones that may improve the
banksters’ profitability, provide less consumer protection and increase the
odds of another 2009 too-big-to-fail bailout.
That said, legislative reform seems to have disappeared into the
Washington quicksand.
The fiduciary
rule rollback (medium and a must read):
Finally, this
week Trump addressed at least one of his key campaign pledges: tax cuts. As I noted above, his comments were woefully
short of details; but at least we know that something will be on the table in the
next couple of weeks. To be fair, the
link to John Mauldin’s last post suggested that tax reform is definitely in the
works and would be all encompassing.
Providing some
details of the plan is Grover Norquist, head of Americans for Tax Reform (must
read):
If Grover’s
summary as anywhere close to the truth then (1) making the tax code simpler and
fairer will be a plus in any time frame and (2) it will also likely provide an
initial spur to growth [the good news]
and inflation [the bad news]. However,
if that occurs, it the Fed will almost assuredly become more aggressive in
raising interests.
In addition, I
stand by my earlier comments that ‘the
math of huge tax cuts and major infrastructure spending 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.
Here is the aforementioned math
(medium and an absolute must read):
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.
Blessed
silence.
(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.
The problem, at
least as I see it, is that by publicly insulting a country/foreign leader, he
puts them in a position of losing face if they knuckle under. Sure the US is the 900 pound gorilla in the
room but why use that power to try to browbeat a country/leader into submission
in front of the rest of the world? It
makes the US look like a bully. More
importantly, you never know when are going to need their help on an even more
important issue. Finally, it runs the
risk of the other party being willing to accept the pain out of shear
stubbornness and then nobody wins. Life
would be so much easier if he simply delivered the message privately, held a
meeting/conference and came up with a ‘new’ agreement that both side
supported.
That said, to
give credit where it is due, I am sure the Japanese didn’t decide to invest in
US infrastructure projects out of the goodness in their hearts. It is likely the first counter move to
assuage Trump in his campaign against the currency devaluations by our trading
partners. Further, he did manage to have
a friendly conversation with the Chinese president in which he vowed to honor
the ‘one China’ policy.
My principal
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:
[a] December
German factory orders were strong but industrial output fell; French economic
uncertainty rose; fourth quarter UK industrial output was better than
anticipated,
[b] January Chinese
services and composite PMI’s, car sales were below estimates and foreign
exchange reserves declined substantially; but January imports and exports were
stronger than projected, though there was likely some seasonal influence,
[c] January
Japanese retail sales were below expectations,
[d] Greece and
its creditors remain unable to reach an agreement on the current phase of its
bail out.
This
week’s data took a decidedly negative turn in the midst of what has been an
upbeat trend. I don’t think this takes
the odds of an improved global economy off the table; but it clearly delays a
call to that effect. Hanging in the
background are the continuing potential economic/financial problems in Italy,
Greece, China, Mexico, Turkey and the UK.
Bottom
line: the US economic stats were quite
upbeat this week---a tiny 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, he addressed the tax cut issue, though it was more of a pep
talk than a plan; and he certainly didn’t speak to the major problems
associated with a big tax cut: the math and congress. 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 the week was disappointing but doesn’t take the possible revision to our
‘muddle through’ scenario off the table.
This week’s
data:
(1)
housing: weekly mortgage and purchase applications were
up,
(2)
consumer: month to date retail chain store sales grew more
rapidly than in the prior week; December consumer credit rose less projected;
weekly jobless claims fell versus an anticipated increase; February consumer
sentiment was well below estimates,
(3)
industry: December wholesale inventories were flat, but
sales soared,
(4)
macroeconomic: the December trade deficit was slightly
less than forecast; January import prices were much higher than consensus,
while export prices were line.
The
Market-Disciplined Investing
Technical
The indices
(DJIA 20269, S&P 2316) had another good day as investors remain overjoyed
by the promise of a coming tax proposal.
Volume declined, but remained at a high level; breadth was strong. The VIX (10.8) slipped further, finishing
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 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 {18742-20784}, [c] in an
intermediate term uptrend {11758-24613} 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 {2188-2531},
[d] in an intermediate uptrend {2042-2643} and [e] in a long term uptrend
{881-2500}.
The long
Treasury declined slightly, continuing to give back much of Wednesday’s gain
and hampering its attempt to reestablish the recent two week recovery. It remained 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 gained,
closing within a very short term uptrend and above its 100 day moving average
(now support). It finished below its
200 day moving average (now resistance) and within a short term downtrend.
The dollar rose,
ending above its 100 day moving average (now support), its 200 day moving
averages (now support) and in a short term uptrend.
Bottom line: the
S&P remained above the 2300 level.
If it closes above that level on Monday, it will set up a challenge of the
upper boundaries of the Averages’ long term uptrends---made easier by the lack
of any technical resistance above 20000/2300.
While I remain skeptical that they can be successfully penetrated, it,
nonetheless, means another possible 6-8% increase on the upside.
The
dollar and GLD continue to push against resistance levels. But the sharp setback in TLT raises the
question as whether it can keep up.
Certainly, if the Trumpflation trade reasserts itself as a result of the
tax cut promise, one would expect higher interest rates, a stronger dollar and
possibly higher gold prices---though that is less clear.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (20269)
finished this week about 58.5% above Fair Value (12782) while the S&P (2316)
closed 46.5% 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 quite upbeat. Some may want to
read that as the beginning of a growth spurt.
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 the highlights were on the
ongoing battle over the Trump’s travel ban, the consent process on his
executive appointees and the promise of a ‘phenomenal’ tax plan. The latter
could potentially impact the economy, though the arithmetic points at it being
more negative than positive. But as we
know, the Market loves it; and at the moment, that is all that matters.
As you know, I
have objected to a number of the Donald’s early moves that do have an
impact. I don’t like his muscling corporations
on the thesis that this just another form of regulation. Nonetheless, to date, companies seem to be
going along with his ‘build in America’ push---the latest example being a major
project announced by Intel. However, it
remains to be seen if their actions will maximize the economic benefits to the
country. On the other hand, we all can
only applaud his efforts to cut government contract costs (see Boeing and
United Technologies).
I also have a
major problem with 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. Supporting that notion is
the recent proposals by the Japanese to invest a substantial amount in US
infrastructure projects. Still the
evidence to date keeps this factor as a negative.
Of course, the
standout item of the week was the Donald’s promise of a ‘phenomenal’ new tax
plan. While that is all he had to say,
there were indications from several good sources that this plan truly is one of
import. One of its goals appears to be
making the tax code simpler and fairer.
That is a plus for all of us, period.
The other objective (a large net tax cut) is a bit more dicey. For one, congressional leaders have raised
concerns about increasing the deficit.
And number two is the molasses like pace of the legislative process. He
may present the greatest tax reform program ever known to man and it could
still take forever to get enacted, and maybe not even then.
The larger issue
in all this is one that I have repeated probably too many times; and that is
that the math of a net large tax increase doesn’t work absent a decline in
spending---which would be in direct contradiction to Trump’s other main
economic goal---increased infrastructure spending. The US budget deficit and level of government
debt are simply too massive to allow tax cuts and infrastructure spending of
the magnitude Trump has suggested to have a positive impact on growth---in the
absence of the aforementioned offsetting spending reductions.
Of course, that
doesn’t mean that the tax cuts and spending won’t happen anyway. But (1) studies have shown that when deficits
and debt reach a certain level, more debt and deficits inhibit not simulate
growth and (2) if the Fed has an ounce of integrity left, it will almost
certainly get more aggressive in its rate hikes. And that (raising the rate at which earnings
are discounted) is the most likely trigger for unwinding of asset mispricing
and misallocation. Neither of the above
are particularly Market friendly.
Finally, I don’t
believe that the Donald’s unnecessarily hostile rhetoric when addressing
foreign leaders 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 putting these leaders in a spot from
which they either have to lose face by knuckling under to a perceived bully or
stand and fight a battle that both they and the US could be losers. An unstable international environment tends
not to be good for stock prices---and that is what we are concerned with here.
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. Certainly, the construction of the Keystone
pipeline, the suspension of agency awarded contracts and reform of the aviation
infrastructure will have a positive economic impact---but not on the scale of
obstructing free trade and the enactment of a budget busting tax cut and
infrastructure spending plan.
This week’s
international stats were negative but that doesn’t necessarily mean the end of
the trend towards a more upbeat global economy.
On the other hand, it might. We
just need more data. In the meantime, I
am still worried about a number major problems (Brexit, currency problems, free
trade issues) looming out there.
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 if that an major increase in deficit spending will likely push the
Fed toward higher interest rates and a tighter money supply. And 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. 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 20269 2316
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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