The Closing Bell
5/6/17
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 19625-22623
Intermediate Term Uptrend 17992-25800
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 2292-2625
Intermediate
Term Uptrend 2118-2722
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. The
data flow this week was pretty evenly divided: above estimates: weekly purchase
applications, April and month to date retail chain store sales, weekly jobless
claims, the April ADP private payroll report, April nonfarm payrolls, the April
Markit services PMI and the April ISM nonmanufacturing index, the March trade
deficit; below estimates: weekly mortgage applications, March personal income,
March personal spending, March PCE price index, April auto sales, March
construction spending, March factory orders, the April ISM manufacturing index,
first quarter nonfarm productivity and unit labor costs; in line with estimates:
April Markit manufacturing PMI.
However, the primary indicators were overwhelmingly
negative: March personal income (-), March personal spending (-), March
construction spending (-), first quarter nonfarm productivity (-), March
factory orders (-) and April nonfarm payrolls (+). Based on this tally, I score the week a
negative: in the last 83 weeks, twenty-six were positive, forty-six negative
and eleven neutral.
I would also note
that the recent collapse in commodity prices adds to the negative case. While individually reasons can be sited as to
why the price of each commodity has been down, but it seems like too much of a
coincidence that they are all down in unison.
Clearly, declining commodity prices point to an economic
slowdown/recession.
I said last week
that a couple more weeks of soft numbers and I would likely reverse my recent
short term economic growth forecast.
That is getting closer.
Update on big
four economic indicators (medium):
On the political
side, a spending/debt ceiling bill was enacted. That is a plus in that it eliminates any
potential negative economic fallout that would come from a government
shutdown. In addition, the house passed
a repeal and replace Obamacare bill. I
discussed it in Friday’s Morning Call and further pursue the subject below. But my bottom line is that (1) if this
legislation even passes, it will be much different than the current bill and
take a long time, but (2) the success of Trump/Ryan producing a coalition on
such a divisive issue bodes well for tax reform and infrastructure spending.
My conclusion: I
am sticking with my initial position that 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
numbers keep improving in Europe. So
much so that I am near taking it out of the ‘muddle through’ forecast for
global growth---with the caveat that a major financial crisis in Italy could
end that progress abruptly.
Bottom line: this
week’s US economic stats were again 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 know
whether or not any actual progress on the Trump/GOP fiscal program could
reignite that enthusiasm. This week’s house
passage of repeal and replace keeps that hope alive. But failing a near term turnaround
in the numbers, I will likely return to our original short term economic
forecast.
Longer term I
continue to believe that ultimately the Trump/GOP fiscal agenda will probably
take more time and be of a lesser magnitude than the dreamweavers had originally
hoped. 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 the house’s passage on repeal and
replace postpones that revision day until we can determine if any potentially improved
sentiment impacts consumer and business spending plans.
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. Canada’s largest nonbank mortgage lender
reported serious liquidity problems which led to huge depositor
withdrawals. In sympathy, other nonbank
mortgage lenders also experienced the same.
While the banking system has remained relatively unscathed to date, this
is a situation that needs to be watched.
Further, Puerto Rico has filed for what basically is
bankruptcy. At the moment, there are
more questions than answers as to exactly what this will mean. The major issue I will be watching is how
much of its debt is owned by the banks.
To be clear, the answer could be zero; so I mention this more as an item
to pay attention to than to worry about.
(2)
fiscal/regulatory policy. Several meaningful developments this
week. First is congressional agreement
on a spending/debt ceiling bill that would keep the government operational
through September. While there was much
useless posturing over which political party cut the best deal, the good news
is that it prevents any negative collateral impact on the economy from a
government shutdown.
Second, the
house passed repeal and replace. Of
course the dems hair is on fired, senate approval is needed and the CBO has not
scored it. But credit where credit is
due---Trump/Ryan were able to corral a conflict ridden republican caucus to
pass a bill dealing with one of the most controversial programs ever. I have no expectations that we ever get
repeal and replace. But the concerted
efforts by the GOP leadership to achieve consensus surely bodes well for the odds
of getting tax reform and infrastructure spending---with the caveat that they
don’t shoot the moon and bust the budget.
(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.
The FOMC met
this week and produced another head scratcher narrative. Specifically, the [data dependent] Fed chose
to basically ignore the steady stream of poor economic data, characterizing
them as transitory. When in fact the
brief period of upbeat data following the elections was the transitory
phenomena. In any case, the tone of the
statement following the meeting indicated that it remains on schedule to raise
rates at least once more this year.
‘The risk here is that the Fed continues to
tighten just as the economy rolls over in what would be a normal correction
after eight years of expansion, albeit subpar.
As you know, I am not particularly concerned that about the economic
consequences of the unwinding of a disastrous monetary experiment. But such a move would likely (1) destroy the
blind faith in the Fed by at least a portion of yet another new generation of
investors and (2) reaffirm the stupidity of trusting the Fed to all the
subsequent generations of investors that have already been f**ked enumerable
times---my thesis that triggers the unwind of the massive mispricing and
misallocation of assets.’
Overseas, the
Chinese central bank has been in the process of tightening in the face of
speculation in real estate and commodities that equals our own. Like our Fed it has plenty of economic/political
reasons for not wanting the process to get out of control. However, the threat here is that it does and
begins to impact foreign markets. That
is not a prediction; just a warning that this situation needs to be watched
carefully.
(4) geopolitical
risks: the troubles over Syria and North Korea were again in focus this week. The saber rattling continued in North Korea as
threats sailed back and forth between it and the US. China remains very much in the mixed; but it
is obviously not pleased with the anti-missile defense equipment that the US is
placing in South Korea. On the other
hand, it continues to try to help defuse the situation which has earned it the
ire of the North Koreans. The danger is
that, when you are dealing with at least one nut case, the risk of some
untoward event occurring is higher than normal.
In Syria,
things may be improving with Trump and Putin speaking this week and agreeing
[so says the official narrative] to work to defuse the situation. Who knows what that really means? The risk of a faceoff with Russia
remains.
(5)
economic difficulties around the globe. The European economic stats continue to
improve to point that I will remove the continent from the ‘muddle through’
scenario if the French don’t throw us a curve ball this weekend. Not that there are not risks; specifically
from Italy, where the danger of a financial crisis remains.
[a] the April EU manufacturing PMI rose to a six year
high; the April UK construction PMI improved while its services PMI hit a four
month high; April German unemployment fell,
[b] April Chinese new orders for manufacturing and
services declined to a six month low.
The latter is where the biggest international risk
exists. The economy is slowing and the
central bank is tightening in order to curb excess speculation {sound
familiar?]. This maybe the test case for
my US economic thesis, so clearly I will be watching with interest.
One more item
to mention is the apparent unraveling of the OPEC oil production cut agreement. This,
of course, is not a problem but a plus for the world’s economies, ex oil
producers, of which the US is one.
Remember the impact of the last ‘unmitigated positive’ decline in oil
prices.
On the
other hand, there could be another explanation for the decline in oil prices
(medium):
In sum, the
European economy has progressed to the extent that it is a candidate for
removal from the ‘muddle through’ thesis.
On the other hand, China’s economic problems appear to be worsening; and
while there was no news out of Japan this week, there is little reason to assume
that its QEInfinity policy will have any better effect today than it has for
the last decade.
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.
On the other
hand:
This week’s
data:
(1)
housing: weekly mortgage applications fell while
purchase applications rose,
(2)
consumer: March personal income and spending as well as
the accompanying PCE price index were short of expectations; April auto sales
were disappointing; month to date and April retail chain store sales growth increased
from their prior readings; the April ADP private payroll report and April
nonfarm payrolls report were better than forecast as was weekly jobless claims,
(3)
industry: the April Markit PMI manufacturing index was
in line while the services PMI was above consensus; the April ISM manufacturing
index was below estimates while the nonmanufacturing index was above; March
construction spending and factory orders were below projections,
(4)
macroeconomic: the March trade deficit was lower than
expected; first quarter nonfarm productivity was lower than forecast while unit
labor costs were higher.
The
Market-Disciplined Investing
Technical
The indices
(DJIA 21006, S&P 2399) had a decent day on Friday, though volume was down and
breadth mixed. Both remain above their 100 and 200 day moving
averages and the lower boundaries of uptrends across all major time frames---all
of which act as support. Of more immediate
importance, they are a short hair away from challenging their former highs
(21228/2402). My assumption is that
they will probably make that challenge successful and set their sights on the
upper boundaries of their long term uptrend (23500/2620)---which I continue to
believe that they will not surpass.
The VIX (10.6) was
up, but remained below its 100 and 200 day moving averages. However, it continues to hold above the lower
boundaries of its intermediate and long term trading ranges and will almost
surely close the huge gap overhead.
The pin action
of the long Treasury and the dollar continue to defy the seeming equity thesis
of an improving economy and rising rates.
On the other hand, gold broke below the lower boundary of its short term
uptrend---indicating that either GLD investors are worrying about higher rates
or that it is caught up in current decline in commodity prices. However, its chart since November (the
election) belies the former; so I will be watching to see if this is a leading
indicator for TLT/UUP or a false flag.
Bottom line: investors
were apparently heartened by the jobs report on Friday, as they pushed the
Averages to very near their former highs. Still volume shrank and breadth was
mixed. In addition, bonds and dollar
gave no sign of being impressed by the jobs number. While I still believe that the indices will
make new highs, they are struggling and may need the Energizer Bunny to reach
the upper boundaries of their long term uptrends.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (21006)
finished this week about 62.7% above Fair Value (12906) while the S&P (2399)
closed 50.4% overvalued (1595). ‘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. Given the
dataflow of the last 2 months, 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.
In the political
arena, this week saw a reversal of much of what occurred last week. Last
week, there was no agreement on legislation to keep the government open. Now there is.
Last week, repeal and replace had failed twice. Now we have a house version. True, it has a torturous road ahead and many
are skeptical of any passage. But a thousand
mile journey begins with a single step.
Not that I think there will ever be a final repeal and replace. But the fact the Ryan/Trump were able to
cobble together a fractious GOP house caucus suggests that less controversial
issues (i.e. tax reform and infrastructure spending) have more visibility.
Accordingly, I think
that the odds of legislation on those issues are more likely and hence, the
odds that I will ultimately be able to raise our assumption on the long term
secular growth rate of the economy---which in turn will positively impact our
Models. That, of course, is a long term
judgment; so for the moment, nothing changes.
.
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.
More evidence of
the more-debt-equals-slower-growth thesis (medium and a must read):
Short term, I
thought that the repeal and replace would have hyped up investors. It didn’t; but the more important issue is
whether it will re-energize consumers and businesses to open their pocketbooks
and turn around the current deterioration in the data.
Absent that, current
valuations/expectations are not supported by the numbers or the prospect that
they will improve sufficiently to justify those valuations/expectations.
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. But 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.
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 (1) the changes already made in
regulatory policy as well as a more rational approach to trade, that is not
enough to alter the gross mispricing of assets and (2) what the house passage
of repeal and replace could mean for tax reform and infrastructure spending,
these measures need to be basically revenue neutral or else their impact is apt
to a detriment to long term growth. 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.
Exuberance,
expectations and gravity (medium):
A look at first
quarter earnings (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, 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.
Anatomy of a Market top
(medium):
DJIA S&P
Current 2017 Year End Fair Value*
13200 1630
Fair Value as of 5/31/17 12906
1595
Close this week 21006 2399
Over Valuation vs. 5/31 Close
5% overvalued 13551 1674
10%
overvalued 14196 1754
15%
overvalued 14841 1834
20%
overvalued 15487 1914
25%
overvalued 16132 1993
30%
overvalued 16777 2073
35%
overvalued 17423 2153
40%
overvalued 18068 2233
45%
overvalued 18713 2312
50%
overvalued 19359 2392
55%overvalued 20004 2472
60%overvalued 20649 2552
65%overvalued 21294 2631
Under Valuation vs. 5/31 Close
5%
undervalued 12260
1515
10%undervalued 11615 1435
15%undervalued 10970 1355
* 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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