3/25/17
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 19148-21431
Intermediate Term Uptrend 11884-24736
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 2234-2568
Intermediate
Term Uptrend 2072-2678
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 57%
High
Yield Portfolio 54%
Aggressive
Growth Portfolio 55%
Economics/Politics
The Trump
economy is providing an upward bias to equity valuations. This
week’s data was neutral: above
estimates: February new home sales; the Chicago Fed national activity index,
fourth quarter current account deficit; below estimates: February existing home
sales, weekly mortgage and purchase applications, month to date retail chain
store sales, weekly jobless claims and the March Markit flash composite PMI; in
line with estimates: February durable goods orders.
The primary indicators were also neutral: February
new home sales (+), February existing home sales (-) and February durable goods
orders (0). Other factors to consider are
the anecdotal evidence we are getting from the used car, student loan, oil and
retail sales sectors, all of which are doing poorly. The question is, are these stats false flags
or precursors to lousy data in the macro indicators? Time will tell us. As you might expect, I am scoring this week
as a neutral: in the last 77 weeks, twenty-five were positive, forty-three
negative and nine neutral.
Net, net, the
recent trend in the data has been mildly upbeat. It is not as good as much of
the narrative on Street would have you believe; but it, at least, seems to be
stabilizing if not improving. So perhaps
the thesis that economic growth would start to mend post-election due to a pickup
in sentiment is being played out. While
I have bought into that notion, I still feel a bit uncomfortable with it,
especially in light of this week’s anecdotal numbers.
On the political
side, it was all about passage of the healthcare bill---which didn’t happen. As
you know, Trump issued an ultimatum to either pass the bill on Friday or he was
moving on. Then the GOP pulled the
bill. Probably a good move, though one
of the benefits of reforming healthcare was that it would reduce costs that
could be used to offset tax cuts. Given
the senate’s strong opposition to increasing the budget deficit, that is going
to make any tax reform that is not revenue neutral all the more difficult.
Not that a revenue
neutral tax reform wouldn’t be a plus if it simplified and was more fair. It just wouldn’t have the supposed
stimulative effect that a cut is thought to have. That last sentence was obviously a hedged one
because as I have repeatedly opined, an increase in the budget deficit from
current levels has been shown to be a negative to economic growth. So a revenue neutral tax reform is likely the
good news scenario; though I suspect that dreamweavers will be disappointed.
In addition, the
State Department approved the Keystone pipeline. This adds emphasis to the point I made last
week that Trump’s effort downsizing and rationalization of the bureaucracy will
likely have a bigger impact on the economy than I originally forecast. Indeed, I am adding 25 to 50 basis points to our
long term economic secular growth rate assumption. That, of course, sounds a good deal more
precise than I want to be; but you have to start somewhere. So just be aware that this number could
easily go higher or lower.
Oil prices continued
their decline this week. As you know, I am
not surprised by this given my skepticism about OPEC’s ability to follow
through with proposed production cuts. Of
course, it is doing all it can to salvage the production cut agreement. In fact, it is meeting this weekend to
‘assess the effectiveness of the production cuts’. I could save them the time and expense by
pointing to the obvious. Nonetheless, I
would expect another bulls**t statement from this group aimed at papering over
its lack of success. My point in
including this discussion is that the last round of oil price declines was not
good for the economy. I don’t expect
this time will be any different.
While trade policy
has played second fiddle to the healthcare bill of late, it is still an ‘….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.
Overseas, the
data this week was again almost nonexistent; but what we got was positive. That leaves our ‘muddle through’ scenario in
place but also leaves open the possibility that our forecast could be upgraded. That said, there are still problems out there
that could stop a recovery in its tracks: 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 was neutral, neither helping or hindering the thesis
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. On the other hand, based on the likely
positive impact of Trump’s deregulation efforts, I am upgrading our long term
secular growth rate by 25 to 50 basis points.
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 spending
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.’
The
negatives:
(1)
a vulnerable global banking system. Nothing new this
week.
(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.
Holding
center stage this week was the healthcare drama---which in the end played out
as a tragedy. From the standpoint of the
healthcare plan itself, I am not sure it is all the bad because [a] given the
opposition in the senate, it wasn’t clear at all that it would ultimately pass
anyway and [b] as I understand the issues that were preventing agreement among
the GOP, the plan as presented had enough liabilities that it could very well
have ended up ultimately as a negative.
So I am not that upset that a bad bill wasn’t replaced by a somewhat
less bad bill. Further, from a political
point of view, Obamacare is still owned by the dems.
To be sure,
a lack of reform of Obamacare is a negative.
The fact that the republicans couldn’t manage the repeal and replace
process hurts (1) the Market’s image of Trump the dealmaker, (2) lays bare the
popular assumption that healthcare and tax reform along with increased
infrastructure spending were somehow a slam dunk---the everything is awesome
scenario. But I never believed that line
anyway and (3) it impacts tax reform because the large tax savings from
Obamacare was planned to be used for tax cuts.
As I noted above the Keystone pipeline received State
Department approval this week. This is
another positive in the Donald’s deregulation effort which I believe will have
a positive impact on the US economy; so much so, that as I also noted above, I
am raising our assumption on the long term secular growth rate of the
economy. It is not going to put back in
the historical range; but it is a move in the right direction.
The
bottom line here is that (1) deregulation is lifting our economy’s long term
growth prospects, (2) the Trump/GOP election victory was not the magic elixir
that many seemed to believe, (3) however, I believe that they will still
achieve some form of tax reform and infrastructure spending legislation which
will also prove beneficial to the economy’s long term growth but (4) the
restraint on accomplishing aggressive tax and spending programs is not GOP
harmony but math. In my opinion, they
simply won’t get done and if they do, it will be more harmful than beneficial.
As a
final note, some of the above is political speculation on my part---something
that is above my pay grade. So take it
for what it is worth; which is very little.
(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.
Not much to
discuss this week. The news on monetary
policy came from overseas as [a] the Bank of Japan said that there was little reason
to tighten and [b] the ECB’s latest round of bond purchases was more aggressive
than had been expected. So it looks like
these guys are at odds with Yellen & Co---they having raised rates last
week.
But I don’t
think the spread is that great. As I
opined last week, I believe the only reason the Fed raised rates was because
the bond market forced it. I think that
the Fed would be perfectly happy to not hike rates again; and given that the
bond market continued its turnaround [rally] this week, I think that takes the
pressure off the Fed for further rate hikes.
As you know my thesis has always been that what the Fed really fears is
that rising rates will derail the Markets because its QE/ZIRP policies were one
of the main drivers of this grossly overvalued Market. So any excuse to delay lifting rates is a God
send.
Of course, the
other part of my thesis is that I believe that the Fed is way behind schedule
in raising rates. But I don’t believe
that a tightening Fed will side track the economy because its easy money policy
[except QE1] did little to help it.
My bottom line
remains that when the unwinding of the global QE/ZIRP/NIRP begins in earnest, I
believe that it will have only a modest effect on the economy but a noticeable
one on the Markets.
(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.
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.
(1)
economic difficulties in Europe and around the globe. Another slow week for the release of global
economic numbers: February UK inflation was higher than expected; and the March
EU flash composite PMI rose, hitting a six year high.
In other
news, the UK triggered the Brexit process; Greece said it would likely fail to
achieve results necessary to receive the next round of bailout money; and most
concerning the G20 failed to renew a pledge to resist all forms of protectionism.
In sum,
this week’s data was parse but what there was, was upbeat. Still not enough to add to or detract from
any judgement about the trend. So there
is little incentive to alter our ‘muddle through’ forecast.
Bottom
line: the US economic stats appear to be
stabilizing. More importantly, the
Donald’s drive for deregulation and improved bureaucratic efficiency is a
decided plus. On the other hand, the
turmoil over the healthcare bill is a good illustration that the Donald’s
fiscal program has a rocky road ahead of it however great it may sound on
paper. I continue to believe that
something positive will come from changes in fiscal policy; and they will
likely be enough to alter our long term secular economic growth rate assumption
in our Models. However, I also believe
that they will take longer and have less impact than seems to be Street
consensus at this time.
This week’s
data:
(1)
housing: February existing home sales were
disappointing while new home sales were off the charts; weekly mortgage and
purchase applications were down,
(2)
consumer: month to date retail chain store sales growth
slowed from the prior week; weekly jobless claims rose considerably more than
estimates,
(3)
industry: February durable goods orders were above
forecast but ex transportation they were below; the February Chicago Fed
national activity index was much better than consensus; the Kansas City Fed
manufacturing index was above projections; the March Markit flash composite PMI
was below expectations,
(4)
macroeconomic: the fourth quarter current account
deficit was less than anticipated.
The
Market-Disciplined Investing
Technical
The indices
(DJIA 20596, S&P 2343) ended slightly lower following the pulling of house
Trumpcare bill. Volume rose; breadth was
weak. The VIX (13.1) was up, ending
above the lower boundary of its very short term uptrend, above its 100 day
moving average for the third day (it now reverts to support), below its 200 day
moving average (now resistance) and in a short term downtrend. It appears that the thesis that the period of
complacency could be ending remains in place.
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 {19148-21431}, [c] in an
intermediate term uptrend {11884-24736} 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 {2236-2570},
[d] in an intermediate uptrend {2072-2676} and [e] in a long term uptrend
{881-2561}.
The long
Treasury was up fractionally, but remained above its 100 day moving average for
the third day (it now reverts to support), below its 200 day moving average
(now resistance) and in a very short term downtrend.
GLD rose
slightly, but finished above its 100 day moving average (now support), below
its 200 day moving average (now resistance) and within a short term
downtrend.
The dollar
inched higher, but ended below its 100 day moving average (now resistance),
above its 200 day moving averages (now support) and in a short term uptrend.
Bottom line: all
of our indices have broken short term support/resistance levels. Whether that is just noise, reflects consolidation
or the start of a directional change, I don’t know. But we need to be alert in case it is the
latter.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (20596)
finished this week about 60.6% above Fair Value (12823) while the S&P (2343)
closed 47.7% overvalued (1585). ‘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 though the anecdotal reports were something a good deal less. Still the recent trend in the numbers suggest
that the economy has less downside than I had feared, though I am not sure of
the magnitude of any upside. Yes, I am
raising the long term secular economic growth rate in our Models based on
Trump’s good work at deregulation. And
yes, I will likely raise it even more once we know the magnitude and timing of
any new fiscal policies. But (1) increasing
the secular long term growth rate potential of the economy does nothing for the
forecast for the next 12 months and (2) as I have continually pointed out, the
math of substantial tax cuts and/or major infrastructure spending just doesn’t
work. As a result, I think that if our improved
short term and long term growth assumptions for the economy are anywhere near
correct, they will likely still be a disappointment to many on the Street.
Further, while talk
of trade and currency has been out of the headlines of late, 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. However,
the initial responses to his efforts by both Mexico and the G20 belie that
notion, leaving me concerned that this factor could prove to be a negative.
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.
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 changes already made in regulatory
policy and the potential improvements coming in fiscal policy, I caution
investors not to get too jiggy about the rate of any accompanying acceleration
in economic growth and corporate profitability.
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 are beginning to improve as we learn about
the new fiscal/regulatory policies and their magnitude. However, I think the timing and magnitude of
the end results will less than the current Street narrative suggests---which
means Street models will ultimately will have to lower their consensus of the Fair
Value for equities.
Our Valuation
Model are also changing as I raise our long term secular growth rate
assumption. This will, in turn, lift the
‘E’ component of Valuations; but there is a decent 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, even
with the improvement in our growth assumption the math in our Valuation Model
still shows that 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.
If only I knew when (medium):
DJIA S&P
Current 2017 Year End Fair Value*
13200 1630
Fair Value as of 3/31/17 12823
1585
Close this week 20596 2343
Over Valuation vs. 3/31 Close
5% overvalued 13464 1664
10%
overvalued 14105 1743
15%
overvalued 14746 1822
20%
overvalued 15387 1902
25%
overvalued 16028 1981
30%
overvalued 16669 2060
35%
overvalued 17311 2139
40%
overvalued 17952 2219
45%
overvalued 18593 2298
50%
overvalued 19234 2377
55%overvalued 19875 2456
60%overvalued 20516 2536
65%overvalued 21157 2615
70%overvalued 21799 2694
Under Valuation vs. 3/31 Close
5%
undervalued 12181
1505
10%undervalued 11540 1426
15%undervalued 10899 1347
* 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.
