The Closing Bell
4/29/17
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 19460-21635
Intermediate Term Uptrend 12015-24864
Long Term Uptrend 5751-23390
2016 Year End Fair Value
12600-12800
2017 Year End Fair Value
13100-13300
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Uptrend 2279-2612
Intermediate
Term Uptrend 2098-2702
Long Term Uptrend 905-2591
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. There
was little economically redeeming about this week’s data: above estimates: March
new home sales, weekly mortgage applications, the April Chicago PMI, the April
Dallas and Richmond Fed manufacturing indices; below estimates: weekly purchase
applications, the February Case Shiller home price index, March pending home
sales, month to date retail chain store sales, April consumer confidence and
consumer sentiment, weekly jobless claims, March durable goods orders, the March
Chicago Fed national activity index, the Kansas City Fed manufacturing index, first
quarter GDP and its accompanying cost indices, the March trade deficit; in line
with estimates: none.
In addition, the primary indicators were negative:
March new home sales (+), March durable goods orders (-) and first quarter GDP
(-). This week wasn’t a close call: in
the last 82 weeks, twenty-six were positive, forty-five negative and eleven
neutral.
As you know, I raised our short term economic
growth outlook based on the post-election-euphoria-stimulated-economy thesis. Unfortunately
after a brief improvement in economic activity, the numbers have stagnated of
late which includes this week’s dataflow. As a result, I am seriously considering
reversing that growth forecast and this week is yet another brick in the wall. Just not quite yet.
On the political
side, the Donald made a big splash this week with the introduction of his tax
plan. While it sounded good, there was
little detail, no scoring on the budget effect and we don’t yet know how
congress will react. In short, it is a
long trip from the cup to the lip.
In addition, the
house made a second stab at repeal and replace legislation which failed. There are two problems with this lack of
success (1) it leaves a lousy law in place and (2) it doesn’t yield the saving
which can be applied to the tax plan---making that legislation less
likely.
My conclusion: I
am sticking with my initial position that these fiscal reforms will take longer
and be less invigorating to the economy than many hope. But that is the good news because a dramatic
increase in the deficit/debt, in my opinion, will be more inhibitive to growth
than the policies are stimulative.
The troubles
with Syria and North Korea continued in the headlines this week. However, as frightening as the headlines may
be, I can’t imagine either situation leading to anything more serious than
threatening headlines. Still, we have to
be open to the chance of either or both of these situations going beyond a war
of words.
Overseas, the major
new item was the results of the French election; the bottom line of which is
that worries about economic disruptions stemming from the fear of or the actual
withdrawal of France from the EU have been calmed. While I remain concerned about the worsening liquidity
in Italian banking system, the odds of me revising our ‘muddle through’
scenario to something more positive continue to grow.
Bottom line: this
week’s US economic stats again turned to the negative side, supporting the
notion of a fading momentum from the Trump bliss. Nevertheless, I have held off revising our
forecast back down until I knew whether or not any actual progress on the
Trump/GOP fiscal program could reignite that enthusiasm. Regrettably, given events to date, it appears
these measures will probably take longer and be of a lesser magnitude than the
dreamweavers had hoped. Failing a turnaround in the numbers, another week or
two of ruling class’s business as usual will prompt me to return to our
original short term economic forecast.
On the other
hand, based on Trump’s deregulation efforts and his more reasoned approach to
trade, I remain confident in my recent upgrading our long term secular growth
rate by 25 to 50 basis points. Clearly, if Trump/GOP manages to effect all
that they have promised, then that forecast will get even better.
Our (new and
improved) forecast:
An undetermined
but positive pick up in the long term secular economic growth rate based on
less government regulation. This
increase in growth could be further augmented by pro-growth fiscal policies
including repeal of Obamacare, tax reform and infrastructure spending. On the other hand, it could prove detrimental
if the result is a dramatic increase in the federal budget deficit. However, it is far too soon to speculate on
any outcome.
Short term, the economy may be losing momentum
as the post-election Trump buzz wears off.
If that is the case, then our former recession/stagnation forecast would
likely reappear brought on by the current expansion dying of old age and/or the
unwinding of the mispricing and misallocation of assets wrought by another
instance of failed Fed monetary policy. Clearly that would all change if Trump/GOP
were to achieve their promised fiscal program without running up the federal
debt.
It is important
to note that this forecast is made with a good deal less confidence than normal;
so it carries the caveat that it will almost surely be revised.
The
negatives:
(1)
a vulnerable global banking system. Nothing new.
(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 regulatory element is unfolding as well
if not better than anyone could have imagined.
Trump kept it going this week by signing an executive order to study
federal overreach in our education system,
[I don’t know about you; but I think our rotten education system is one of
the biggest social/economic problems this country has.]
In addition, the Donald’s actions with respect to
trade have been much less negative than I had feared. Although many may wonder about this point,
given his imposition of tariffs on Canadian lumber. I discussed this in Wednesday’s Morning Call,
but my bottom line was that [a] the tariffs were less than anticipated and [b]
it was likely the opening negotiating salvo in a more encompassing discussion
regarding trade with Canada.
Supporting
that notion was the quick turnaround Trump did on NAFTA. As you know, he said that he would end it,
then reversed himself, largely as the result [he said] of calls from Mexico and
Canada asking to renegotiate. This
appears to be yet another example of his barking loud to get someone’s
attention, then biting softly. I
recognize that many object to his belligerent behavior. Indeed, I have expressed misgivings. But you can’t argue with results.
Counterpoint:
On the
other hand, Trump introduced his new, awesome tax plan this week---which was
something of a dud in that it (1) was short on detail and (2) provided nothing
with respect to its impact on the budget deficit. My thinking is that it was just for show,
designed to be announced within the first 100 days. I continue to assume that the end result,
while likely a plus for the economy, will take longer and provide less in the way
of net tax cuts than many of the dreamweavers hope.
Further, the GOP congressional leadership failed a
second time to present a bill to repeal and replacement of Obamacare. Again, this indicates that any reform of
fiscal policy will be a long, hard road.
The bottom line here is that (1)
deregulation is lifting our economy’s long term growth prospects, (2) announced
trade positions are not the negative that I had feared, (3) but 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 secular growth but (4) the restraint on accomplishing
aggressive tax and spending programs is not GOP harmony but math.
(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.
Ah,
silence---at least here.
Not so
overseas. This week, the Bank of Japan
raised its economic growth forecast for 2017, lowered its inflation outlook and
said that QE would continue until inflation reached its 2% objective. Remaining accommodative is not
surprising. Predicting better growth is
a bit of a stretch, considering the dismal economic performance of the Japanese
economy for the last decade. And indeed
many economists have attributed the lousy results to the BOJ aggressive
monetary policy.
Meanwhile, the
ECB left rates unchanged; but the tone of the accompanying policy statement was
slightly more dovish than previous ones---which is a little more difficult to
understand since the European economy has been doing much better of late. Whether Draghi is just trying to give himself
a little wiggle room, is concerned about the French elections or suffers from
the universal disease of central bankers [fear of tightening], I have no idea.
The bottom line
is that we are setting up for a potential clash of monetary policies [if the
Fed continues to tighten] which could lead to trade problems [currency
valuation] and asset price volatility.
(4) geopolitical
risks: the troubles over Syria and North Korea were again in focus this week. The saber rattling continued in North Korea
[a] it fired off another missile [b] as the US has three carrier groups
steaming toward the Korean peninsula and is moving anti-missile defense
equipment into South Korea. China
continues to help. But when you are
dealing with at least one nut case, the risk of some untoward event occurring
is higher than normal.
Japan warns
citizens about a potential North Korean attack (medium):
In Syria,
things weren’t much better. Most of the
verbiage this week continued to center on the accuracy of the facts in Syrian
government’s alleged gas attacks on civilians---with the French saying that
they had proof that the Syrian government was indeed responsible. Not helping, Israel bombed an Iranian arms
depot near Damascus and the US moved troops to the Iraq/Turkey border in a move
to support the Kurds. In the meantime, the risk of a faceoff with Russia
remains.
(5)
economic difficulties in Europe and around the globe. This week, the global data flow was almost
nonexistent: the April German business climate index came in above expectations,
first quarter UK and French GDP were below projections while April EU inflation
rose to 1.9%---a short hair away from the ECB’s 2% goal.
That is not say that there was no impactful news. The first round of the French elections took
place and the results were pretty much as forecast by the polling
agencies. While the anti-EU candidate
made it to the second round, her opponent is a middle of the road type who
quickly won the backing of the other two parties and at this time is assumed to
be a shoo in as a victor. As a result, fear of further disruptions to the EU
have subsided and that should mean a return to business as usual---which in
this case is an improving EU economy.
In sum, while
there were few global economic stats this week, the results of the French
elections appears to have relieved anxieties which in turn should leave the EU
on an improving growth path. A few more
weeks of upbeat global data and I will likely alter our ‘muddle through’
scenario.
Growth in the
developing world (medium):
A happier global
economy (medium):
Bottom
line: the post-election sentiment
inspired economic improvement seems to be fading. As a result, a return to our prior short term
economic forecast is a definite possibility.
Though, if Trump/GOP were to pull off healthcare reform, tax reform and
infrastructure spending on a reasonable timely basis, I would suspect that
sentiment driven increases in business and consumer spending would be
positively affected; and more importantly, our long term secular economic
growth rate assumption would almost certainly rise---with the caveat that it
doesn’t result in a big increase in the national debt.
For the long
term, the Donald’s drive for deregulation and improved bureaucratic efficiency
is a decided plus; and as a result, I inched up my estimate of the long term
secular growth rate of the economy. In
addition, a more reasoned approach to trade appears to be emerging which would remove
a potential negative.
This week’s
data:
(1)
housing: March new home sales soared; weekly mortgage applications
were up but purchase applications were down; the February Case Shiller home price
index was up less than expected: March pending home sales were worse than
consensus,
(2)
consumer: month to date retail chain store sales growth
slowed from the prior week; April consumer confidence and sentiment were below
forecast; weekly jobless claims were more than anticipated,
(3)
industry: both the headline and ex transportation March
durable goods orders were below projections; the March Chicago Fed national
activity index was well below estimates while the April Chicago PMI was above;
the April Dallas and Richmond Fed manufacturing indices were above consensus
while the Kansas City Fed’s was below,
(4)
macroeconomic: first quarter GDP was less than expected
while the price index and employment cost index were more; the March trade
deficit fell but due to a decline in both exports and imports.
The
Market-Disciplined Investing
Technical
The indices
(DJIA 20940, S&P 2384) were lower on Friday but not dramatically so. Volume rose; breadth weakened. The VIX (10.8) was up 4 ¼ %, but closed below
its 100 day moving average (now resistance), below its 200 day moving average (now
resistance). However, it did bounce off
of the lower boundaries of its short and intermediate term trading ranges.
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 {19460-21635}, [c] in an
intermediate term uptrend {12015-24864} and [d] in a long term uptrend
{5751-23390}.
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 {2279-2612},
[d] in an intermediate uptrend {2098-2702} and [e] in a long term uptrend
{905-2591}.
The long
Treasury rose, ending above its 100 day moving average (now support), below its
200 day moving average (now resistance), in a very short term downtrend and in
a short term trading range. It seems to
have found support right on the upper boundary of the former trading range that
dated back to November 2016. Fear of
Trumpflation seems to have subsided, at least for the moment.
GLD was up, closing
above its 100 day moving average (now support), above its 200 day moving
average (now support), in a very short term uptrend and in a short term
downtrend. Gold has held in very well in
the face of expectations for a stronger economy and higher interest rates.
The dollar fell,
ending back below its 200 day moving average (now support; if it remains there through
the close on Wednesday, it will revert to resistance), below its 100 day moving
averages (now resistance), below the upper boundary of its very short term
downtrend and in a short term uptrend.
Bottom line: the indices continued to rest after the
strong Monday/Tuesday performance, which is normal and suggests nothing
directionally. Their upside is now being
marked by their former highs [21228/2402] and the upper boundaries of their
long term uptrends while support on the downside exists at their 100 and 200
day moving averages and the lower boundaries of their short term uptrends.
While I would expect a challenge of the old
highs, the big question in my mind is, will those gap openings which I have
mentioned get closed as part of a near term correction (which would clearly be
the more positive alternative) or will the Averages continue to rise and it
occur on the way down following a Market top?
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (20940)
finished this week about 63.3% above Fair Value (12823) while the S&P (2384)
closed 50.4% 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 a clear negative and returns to the trend prior to last week. Consequently, I am questioning my decision to
raise our short term growth forecast based on the thesis that the rise in post-election
sentiment would eventually be reflected in the hard data---which it did
initially but is now fading. Meaning a reversal in our outlook is on the
table---which would suggest a possible near term disappointment for the
dreamweavers.
Of course, we just
got a new round of fiscal promises this week with regards to healthcare reform,
tax reform and dealing with current federal debt limit; and that accounted for
at least two days’ worth of positive pin action. Unfortunately, the tax reform was received
with skepticism, the repeal and replace legislation failed (again) but at least
they were able to keep the government open for another week. This all is likely somewhat deflationary to
the dreamweavers’ euphoria balloon as the burden of proof starts to shift in their
direction. That said, if Trump/GOP can
just produce some solid progress, then they not only would almost surely
revive/keep alive the positive post-election Market sentiment but also have a
constructive impact on the economy.
On a long term
basis, I feel like I am on firmer ground modestly raising the secular economic
growth rate in our Models based on Trump’s good work at deregulation and the move
toward a more free trade posture. In
addition, if Trump/GOP can successfully enact a fiscal program, I will likely
raise the secular growth rate assumption again.
But I again
emphasize that given the magnitude of the federal debt, the GOP has have very
little room for a net tax cut---with the caveat that they can do a big net tax
cut but it will likely be more of a negative than a plus for the economy. My point is that while a revenue neutral
fiscal reform will be a positive for the long term secular growth rate of the
economy, it will not be nearly as big as the optimists are suggesting.
And I have made
it clear that the effect that any new programs, at least as calculated by our
Valuation Model, have on the secular growth trends, won’t erase the current
overvaluation of equity prices---just make it a bit less so.
Finally, this
earnings season is coming in better than expected, following the pattern of the
last couple of years---GDP coming in below estimates, but earning above. Part of this can be explained by strenuous
cost cutting by management, part by massive stock buybacks and part by
accounting tomfoolery. However, at some
point, (1) all the cost cuts than can be made will be made, (2) given the
rising debt load of corporations, they are running out of room on their balance
sheets to borrow money to buy back stock and (3) investors ignoring the
accounting tricks may give way to a more realistic assessment of real earnings
power. When that happens, I haven’t a
clue. But the math is working against a
continuation of the current trend.
In short,
current valuations/expectations are not supported by the numbers or the
prospect that they will improve sufficiently to justify those valuations/expectations.
Of course, 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 also 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 (again, just for clarity’s sake, the economy
can slow down due to old age and that would have nothing to do with unwinding
QE. The point being that the ending of
QE wouldn’t make the slowdown any worse). On the other hand, since the Markets were the
primary beneficiaries of Fed largesse, it would be they who suffered when the
Fed begins 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 as well as a more rational approach to trade, I am cautious that this
second round of fiscal reform promises are any more likely to be enacted than
the first. And if they fail to
materialize or, more likely, are revenue neutral, it will probably have
detrimental effect on Street economic, corporate profits and Market
expectations. Finally, whatever happens, stocks are at or near historical
extremes in valuation, even if the full Trump agenda is enacted; 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 regulatory policies and their magnitude. However, as this week’s developments indicate,
fiscal policies remain an unknown as well as their timing and magnitude. I continue to believe that end results will be
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 assumptions are also changing as I raise our long term secular growth
rate estimate. This will, in turn, lift
the ‘E’ component of Valuations; but there is a decent probability that short
term this could be at least partially offset by 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.
DJIA S&P
Current 2017 Year End Fair Value*
13200 1630
Fair Value as of 4/30/17 12864
1590
Close this week 20940 2384
Over Valuation vs. 4/30 Close
5% overvalued 13507 1669
10%
overvalued 14150 1749
15%
overvalued 14793 1828
20%
overvalued 15436 1908
25%
overvalued 16080 1987
30%
overvalued 16723 2067
35%
overvalued 17366 2146
40%
overvalued 18009 2226
45%
overvalued 18652 2305
50%
overvalued 19296 2385
55%overvalued 19939 2464
60%overvalued 20582 2544
65%overvalued 21225 2623
Under Valuation vs. 4/30 Close
5%
undervalued 12220
1510
10%undervalued 11577 1431
15%undervalued 10934 1351
* 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.
