The Closing Bell
3/4/17
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 18881-21182
Intermediate Term Uptrend 11815-24667
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 2211-2545
Intermediate
Term Uptrend 2057-2661
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 will likely provide an upward bias to equity valuations. This
week’s data was weighed to the plus side: above estimates: weekly mortgage and purchase
applications, the December Case Shiller home price index, month to date retail
chain store sales, February consumer confidence, weekly jobless claims, January
personal income, the Dallas and Richmond Fed manufacturing indices and the
February ISM manufacturing and nonmanufacturing indices; below estimates: January
personal spending, February retail chain store sales, the February Markit
manufacturing and services PMI’s, January durable goods orders, January
construction spending, revised fourth quarter GDP and the January trade deficit;
in line with estimates: none.
On the other hand, the primary indicators were
almost all negative: January personal income (+), January personal spending
(-), January durable goods orders (-) January construction spending (-) and revised
fourth quarter GDP (-).
Adding a little
flavor to our weekly assessment was (1) the Fed released its latest Beige Book
which read pretty much as expected---the economy modestly improving, (2) the
Atlanta Fed lowered their first quarter GDP growth estimate to 1.9% and (3) the
latest update to the big four economic indicators which for the first time in
over a year were negative.
I am going to
score this as a neutral; though I am bending over backwards for the optimists:
in the last 74 weeks, twenty-four were positive, forty-two negative and eight
neutral.
Speaking of
optimists, they have to be very uneasy trying to sell this week’s stats as a
weak continuation of the prior two weeks’ upbeat dataflow which in turn is supposed
to be 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, I
recognize the fragility of that case.
On the political
side, Trump delivered his state of the union address. While it generated much enthusiasm (as an
aside, I thought the absence of vindictiveness and self-aggrandizement was the
most important takeaway), few details on repealing and replacing Obamacare, tax
reform and infrastructure spending were forthcoming. He did announce an increase in defense
spending to be offset by cuts in other government agencies but the order of
magnitude of these measures was more symbolic than economically
significant.
In short, all we
have on the issues of taxes and spending is rhetoric and included in that
rhetoric is nothing about the current budget deficit or the level of federal
debt. And we know that because of this absence,
there is dissention in the GOP ranks on all these issues---meaning it will likely
be a tough slough getting from rhetoric to enactment
. Finally, if the studies of Reinhart and
Rogoff are to be believed, tax cuts and infrastructure spending unaccompanied
by offsets will be counterproductive in stimulating economic growth. The point here is that the magnitude and
timing of fiscal change may be less than many hope for. I, for one, am not altering our longer term
secular forecast until we see the whites of their eyes.
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.
Overseas, the
data this week was again very upbeat, supporting the notion that there is a
decent probability that the ‘muddle through’ scenario gets replaced by an
improving economy. While it still a bit
too soon to make that call, another couple of weeks of solid positive stats
would likely push me to do so. 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 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 [Obamacare reform 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.’
The
negatives:
(1)
a vulnerable global banking system. The Greek bail out,
or lack thereof, continues to hang around like a bad case of herpes. The euros seem unable to resolve this problem;
and while the fallout from a Grexit and redenomination of Greek government debt
may by itself have only a marginal impact, the Markets now starting to get
squirrelly about Spanish, Italian and French debt, meaning such an occurrence
could have a domino effect.
However, as I have said before, the EU ruling class
has always been masterful in pulling a rabbit out of the hat at the eleventh
hour that allowed all to muddle through---and, indeed, that has been our
forecast for years. Still there is 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, to
date we have almost no parameters for healthcare reform or infrastructure
spending, other than broad promises. The
details on tax reform are more well developed; though there appears to be
opposition on the border tax element of this legislation as well as its
potential impact on the budget deficit.
Please
understand, I don’t think Trump is blowing smoke up our skirt about his
intentions to follow through with all of the above. But the key to getting any of these measures
enacted is, as it always has been, to achieve compromise. And compromise means getting less than you
hoped for.
In addition,
there is still almost no discussion about the debt ceiling freeze coming on
March 15th. And the point
here is that not only does Trump/GOP need to pass all the aforementioned
legislation, compromised or not, but also if any of it will lead to a violation
of the debt ceiling, then additional legislation will be need to raise that
limit. In essence, the bills will have
to be passed twice. So while I believe
that some action on Obamacare, taxes and spending will occur, trying to create
an economic forecast based on the as yet unknown particulars is probably an
exercise in futility.
Finally, 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. Certainly, Friday’s comments from Wilbur Ross
provides some hope of that. However,
until we know how this turns out, there is cause for unease.
This is
a great discussion on possible changes in NAFTA, the implications of the border
tax and how this would all play in the global trade arena. It is a bit long but worth the time.
(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.
Update on auto
loans (short):
This week Fed
members were out in force, trumpeting the case that an improved economy calls for
higher rates---quite a change from the Casper Milquetoast tone of last week’s
FOMC minutes. Yellen added her two cents
worth on Friday, saying that a March rate hike would be appropriate [on the one
hand] assuming [on the other hand] next week’s nonfarm payroll number is a
positive.
Of course, what
the Fed says and what it does have very seldom been correlated. And while I
have embraced the notion of a modestly improving economy driven by better
sentiment, the numbers still aren’t that great---witness this week’s primary
economic indicators and the downward revision of first quarter GDP by the
Atlanta Fed. Meaning one wonders what is
driving the Fed’s enthusiasm for a rate hike.
(hint: Dow 21000)
So all other
things being equal, I could easily see the Fed chickening out at the eleventh
hour. But all things are never equal;
this time it is the pin action in the bond pits which has driven the odds of a March
rate hike to over 70%. While I take Fed
rhetoric with a grain of salt, when the bond markets speaks, I listen. So I think it a reasonable probability that a
second Fed funds rate hike is on the way, soon.
In addition to
the Fed, the ECB also meets next week.
As I have been chronicling, the EU economy has been making a major
turnaround over the past couple of months.
So the pressure is also increasing on Draghi to begin normalizing EU
monetary policy.
Clearly, that
moves forward my scenario that a tightening Fed will do little to impact the
economy but will have a significant effect on asset pricing and allocation.
(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.
(5)
economic difficulties in Europe and around the globe. This week, the global economic numbers
continued the recent trend towards improvement:
[a] the February
EU Markit composite, manufacturing and services PMI’s were above projections as
was economic sentiment, while the UK manufacturing and services PMI were below;
February EU CPI was over 2% {ECB’s goal} while PPI came in at 3.5%; fourth
quarter UK GDP growth was revised higher; February German business was better
than expected; the French fourth quarter GDP was up more than anticipated,
[b] the
February Chinese manufacturing PMI rose from the prior month while the services
PMI declined
[c] January Japanese CPI rose for the
first time in over a year.
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 a band aid that will buy more time; but that won’t solve the
problems. Ultimately somebody has to
swallow some bitter medicine.
In sum,
this week’s data keeps the global economy 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---little
help to those hoping that the economy is currently improving. On the other hand, 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: weekly mortgage and purchase applications were
up; January pending home sales were worse than forecast; the December Case
Shiller home price index rose more than anticipated,
(2)
consumer: January personal income was above projections
but personal spending was below; month to date retail chain store sales growth
improved from the prior week while February sales were weaker than in January;
February consumer confidence smoked consensus; weekly jobless claims were quite
positive,
(3)
industry: January durable goods orders were in line,
but the December reading was marked down big and the ex transportation number
was lousy; January construction spending was really bad; the February Dallas
and Richmond Fed manufacturing indices were much better than expected; the
February Chicago PMI was above estimates; somewhat confusingly the February ISM
manufacturing and nonmanufacturing indices came above projections while both the
February Markit manufacturing and services PMI’s were below,
(4)
macroeconomic: fourth quarter GDP fell short of forecasts;
the January US trade deficit was greater than anticipated.
The
Market-Disciplined Investing
Technical
The indices
(DJIA 21182, S&P 2383) continued to consolidate after Wednesday’s strong
performance. Volume fell, but remained
at a high level; breadth was mixed. The
VIX (10.9) was down 7 ¼%, ending 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)---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 {18881-21182}, [c] in an
intermediate term uptrend {11815-24667} 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 {2211-2545}, [d] in an
intermediate uptrend {2057-2661} and [e] in a long term uptrend {881-2561}.
The long Treasury
was up, ending right on the lower boundary of that developing pennant---which
it had violated on Thursday. It remains
below its 100 and 200 day moving averages and in a very short term downtrend.
GLD voided its
very short term uptrend but still closed above its 100 day moving average (now
support). Nevertheless, it ended below 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), in a short term uptrend and seems to have set a new
very short term uptrend.
Bottom line: the
Averages continued their relentless move to the upside. The assumption has to be that they are headed
for the upper boundaries of their long term uptrends. Bonds, the dollar and gold are all pointing
at an improving economy and a tightening Fed.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (21182)
finished this week about 65.2% above Fair Value (12823) while the S&P (2383)
closed 50.3% 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 were a draw. Some may want to read
that as more evidence that a growth spurt is in the making; but the primary
indicators, the Atlanta Fed’s revisions in its first quarter GDP forecast and
the latest update on the big four economic indicators suggest otherwise. 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 highlight was Trump’s state of the union which sounded
great but was woefully short of specifics. Last week, I opined that ‘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; at least judging by its response to the
Donald’s speech which was about all things but math.
Not that tax
reforms and infrastructure spending won’t happen. Indeed, 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. But ‘may’ is the operative word because, at
this moment, we are woefully short of details. 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. And the risk is that those
forecasts won’t materialize. That said,
at the moment, hope is all that matters to the Market; but if I am correct,
then ultimately those models will change for the worse.
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. Still the
evidence to date keeps this factor as a negative.
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. If the bond Markets are correct in their
assessments that the Fed is about to get more aggressive in monetary
tightening, that could start the process.
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 3/31/17 12823
1585
Close this week 21182 2383
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.
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