The Closing Bell
4/15/17
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 19305-21635
Intermediate Term Uptrend 11936-24785
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 2261-2594
Intermediate
Term Uptrend 2087-2691
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. This
week’s data, what there was of it, was positive in aggregate: above estimates: weekly
mortgage and purchase applications, month to date retail chain store sales, weekly
jobless claims, revised March consumer sentiment, March export prices, March
PPI and CPI; below estimates: March retail sales, the March small business
optimism index; in line with estimates: March import prices.
However, the one primary indicator was negative:
March retail sales (-). I also want to note that I categorized the
weak PPI and CPI numbers as a positive because, in general, falling PPI/CPI is
good news on the inflation front.
However, into today’s environment in which (1) the Market consensus has
congealed around the Trumpflation trade and (2) the Fed is talking up rate
hikes and balance sheet shrinkage, these stats could be read as deflationary,
creating cognitive dissonance at the least.
All that being
said, I am going to score this week as a neutral with an asterisk denoting it
could have just as easily been scored as a negative: in the last 80 weeks,
twenty-five were positive, forty-four negative and eleven neutral.
As you know, I have been much less impressed
with the supposed strength in the economy than many others---even though I bought
into the post-election-euphoria-stimulated-economy thesis. And this week’s numbers don’t really help that
conviction. Indeed, this makes the
fourth week in a row of flattish to negative numbers; and that may be suggesting
that the economy may be reverting back toward our prior recession/stagnation
scenario---which would in turn make those aforementioned inflation numbers bad
news. I am not making that call yet; but
it is under serious consideration.
One final point:
the April 28th vote to fund government operations or risk a shutdown
is not getting near enough attention. I
am not suggesting the latter; but if history is any guide there will at least
be a lot of wrangling before the vote that could cause some heartburn.
On the political
side, congress was on vacation and the Donald spent most of his time on
international affairs this week but did manage to keep the media’s hair on fire
with major policy reversals: (1) he now likes a weak dollar, (2) he likes the
Import/Export Bank, (3) China is no longer a currency manipulator, (4) he hasn’t
decided what to do with Yellen, and (5) NATO is not obsolete.
I applaud Trump’s
backing down on Chinese currency manipulation.
That whole thesis was a straw man anyway; and it is another plus for
free trade. Ditto, backing off on
beating up NATO. However, I believe that
he is wrong on the dollar (all he has to do is look at the historical relationship
of the value of the dollar and the rate of economic growth); and I could care
less about Yellen.
The troubles
with Syria and North Korea got a lot of attention this week. I expand on this below. But my conclusion is that 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
data this week was much better than the prior week. That resumes the somewhat erratic improvement
in the global economy and leaves open the possibility of an upgrading of our ‘muddle
through’ scenario. Nevertheless, I remain
concerned about the Greek bailout, the worsening liquidity in Italian banking
system and the growing odds of an anti-EU president being elected in France.
Bottom line: this
week’s US economic stats were mixed.
Whether this is a continuation of a temporary loss of momentum from the
Trump bliss or another sign of the end of it, we will just have to await
further evidence. If it is the latter,
then short term that could mean that I have to reverse the recent slight
increase in our 2017 economic growth forecast.
As I noted above, more is needed to make that call.
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.
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 its 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 latest from
Bill Gross (medium):
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. Plus, his actions with respect to trade have
been much less negative than I had feared.
On the
other hand, Trump/GOP’s fiscal program is a mess. Despite repeated assurances
than repeal and replace would be accomplished in reasonably short order, so far
all we have is that narrative with little else to back it up. Further, many had hoped that with the seeming
demise of repeal and replace, the Donald/GOP would turn their attention to tax
reform. However, this week, Trump
acknowledged that meaningful tax reform was impossible without the savings generated
by repeal and replace because the math of a big tax cut simply doesn’t work
without it.
Nevertheless,
I do believe that Trump and the GOP congress will ultimately deliver healthcare
reform, tax reform and some infrastructure spending legislation in some form;
and that it will be a net positive for the long term secular growth rate of the
economy. But it (1) is not apt to have nearly as big an
impact as many of the dreamweavers would hope and (2) could get lost in the
short term if the current economic expansion dies of old age/or is put to death
by the Fed.
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.
Thankfully, the
Fed was on its own break this week.
Yellen did give a speech on Monday but added little to the narrative
generated last week by the release of
the latest FOMC meeting’s minutes [it is giving serious consideration to begin
shrinking its balance sheet].
Which leaves us
with the question, will it start reducing its balance sheet if in fact, the
economy is starting to weaken, as the latest data may be suggesting? The answer, of course, is why wouldn’t
it? It has screwed up every single
tightening process in its history. Why
ruin a perfect record?
That said, you
know that my concern is not the damage ending QE might do to the economy---QE
did little to help it, so I don’t imagine that its reversal will be that
disruptive. But it does fit my thesis of
asset price mean reversion. Once
investors realize that the Fed has again stimulated too much and deferred
tightening for too long, the Markets which were the prime beneficiaries of QE
will become the victims of its reversal.
The illusion of
liquidity (medium):
The latest on
the Chinese monetary policy (medium):
(4) geopolitical
risks: the troubles over Syria and North Korea were center stage this
week. Things went a bit better for the
US in the latter situation. Following
Trump’s meeting with president Xi last weekend, the Chinese made some fairly
aggressive verbal attacks on the North Koreans.
That makes sense because the Chinese have a lot to lose---possible major
deployment of both offense and defensive weapons in Japan and South Korea. And not being labelled a currency manipulator
didn’t hurt.
Unfortunately,
a resolution to the Syrian problem appears a long way off. Russia and the US spent most of the week in a
war of words over whether there actually was a chemical weapons attack and if
there was, who was responsible. That is
not that difficult to understand, since the Russians have everything to gain
[construction of a major gas pipeline through Syria that would supply western
Europe] defending the Assad regime.
Secretary Tillerson, Foreign Minister Lavrov and Putin did meet on
Wednesday. The rhetoric in the following news conference got a bit testy; but
it was refreshing to hear a Secretary of State do something other than pander.
On the gas
attack; presented with no comment (medium):
In addition,
for those morally offended by the civilian casualties from the gas attack, look
at these numbers (medium):
http://www.zerohedge.com/news/2017-04-13/third-straight-month-us-killed-more-syrian-civilians-russia
All that said,
barring a nuclear holocaust, history suggests that a breakout of hostilities is
not that bad for either the economy or the Markets.
(medium and a must read):
(5)
economic difficulties in Europe and around the globe. This week, the global data flow improved:
[a] February
EU industrial production disappointed; March UK inflation came in over the
BOE’s target; March German economic conditions index and investor sentiment
both rose.
[b] March
Chinese auto sales were better than expected; March Chinese PPI and CPI were
reported below estimates while March Chinese imports and exports were stronger
than anticipated.
In sum, the
eurozone economy continues to improve while the stats out of Asia were a bit more
promising this week. After some mixed stats
last week, this keeps alive the chances that I could alter our ‘muddle through’
forecast.
Bottom
line: the recent trend toward economic improvement
seems to have stalled in the last four weeks.
I have no idea if this is a pause that refreshes or it marks the end of
the economic effects of the post-election boost in sentiment. Time will tell us.
More importantly
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.
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 further 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: weekly mortgage and purchase applications were
up,
(2)
consumer: March retail sales and sales ex autos were below
consensus; month to date retail chain store sales growth improved from the
prior week; weekly jobless claims were better than anticipated; revised March
consumer sentiment improved more than forecast,
(3)
industry: the March small business optimism index was
slightly below expectations,
(4)
macroeconomic: March import prices were in line while
export prices were higher than projections; March PPI and PPI, ex food and
energy were weaker than estimates; March CPI and CPI, ex food and energy were
below consensus..
The
Market-Disciplined Investing
Technical
The indices
(DJIA 20453, S&P 2328) continued to sink on Thursday, probably helped by
the fact that after such an event filled week, traders wanted to reduce their
risk over a long weekend. Both again ended below the upper boundaries of
their very short term downtrends. Volume declined; breadth deteriorated further. The VIX (15.9) rose 1 ½ %, ending above the
lower boundary of its very short term uptrend, above its 100 day moving average
(now support), above its 200 day moving average for a fourth day (reverting to
support) and in a short term trading range.
Complacency appears to have left the room.
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 {19350-21635}, [c] in an
intermediate term uptrend {11936-24785} 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 {2263-2596},
[d] in an intermediate uptrend {2089-2693} and [e] in a long term uptrend
{905-2591}.
The long
Treasury rose on volume, remaining 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.
GLD was up,
closing above its 100 day moving average (now support), above its 200 day
moving average (now resistance; if it stays there through the close on Monday,
it will revert to support) and right on the upper boundary of its short term
downtrend.
The dollar increased,
ending above its 100 day moving average (now support), below its 200 day moving
averages (now resistance), below the upper boundary of its very short term
downtrend and in a short term uptrend.
Bottom line: stocks
moved steadily lower for a second day; although as I noted above, at least part
of this decline was probably because traders wanted to reduce their risk in
front of a long weekend. Nevertheless,
the Averages remain in a fairly tight three week trading range which has been
characterized by intraday volatility that didn’t follow through to the close---reflecting,
I think, a standoff between the bulls and bears. Right now the weight of evidence (moving
averages and major trends) is that it gets resolved in favor of the bulls.
Unlike stocks, the
VIX, gold, TLT and the dollar continue to challenge resistance/support levels,
suggesting those investors are less positive on the economy/corporate profits
than the stock guys.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (20591)
finished this week about 60.5% above Fair Value (12823) while the S&P (2344)
closed 47.8% 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 (but with a negative caveat).
As you know, I recently raised our short term growth forecast based on
the thesis that the rise in post-election sentiment would eventually be
reflected in the hard data. That is
starting to look a bit iffy. Given the
difficulties that the Donald/GOP have had implementing its fiscal program, it
wouldn’t be a surprise that companies/consumers may be retreating from earlier
more ambitious spending programs. Nevertheless, I am not reverting to our former
outlook just yet.
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---this week backing down from ‘currency
manipulator’ charges aimed at China. Assuming a continuing pro free trade tilt
in policy, a major negative for economic growth will be eliminated.
In addition, if Trump/GOP
can successfully enact a fiscal program, I will likely raise the secular growth
rate assumption again; although I have no thought on the order of
magnitude. However, I have made it clear
that based on the budget math, I seriously doubt that the final product will be
anywhere near as positive as many on the Street believe.
Not to be
repetitious, but I want to be clear.
First, the improvement in the long term secular growth rate of the
economy effects the potential for growth.
It increases my assumption about long term growth which impacts our
Models.
However, it has much less to do with the
growth estimates for this year or next. That
forecast is more heavily impacted by cyclical forces. For example, if the post-election pickup in economic
activity is fading and I have to return to our prior forecast of
recession/stagnation, the long term growth potential of the economy doesn’t
change but it also does little to help.
The important factor at that point is that the excesses that occurred
during what has been a record (in length) expansion are being reversed as the
expansion dies of old age. The point
being that I can have a more optimistic outlook for economic growth longer term and at the same
time recognize that cyclical forces are working to slow the economy down short
term.
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 (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 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 as well as a more rational approach to trade, I caution investors not to
get too jiggy about the potential improvements coming in fiscal policy and the
rate of any accompanying acceleration in economic growth and corporate
profitability. If that fails to
materialize it will likely have detrimental effect on Street economic,
corporate profits and Market expectations. 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.
The latest from
Doug Kass (medium):
Bottom line: the
assumptions in our Economic Model are beginning to improve as we learn about
the new regulatory policies and their magnitude. However, 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 20591 2344
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
70%overvalued 21868 2703
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.
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