The Closing Bell
5/20/17
We are headed for the beach. Be
back 5/30. As always I will have my
computer with me and will stay abreast of Market action. Any changes will be done via Subscriber
Alerts.
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 19783-22726
Intermediate Term Uptrend 18071-25785
Long Term Uptrend 5751-23836
2016 Year End Fair Value
12600-12800
2017 Year End Fair Value
13100-13300
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Uptrend 2311-2591
Intermediate
Term Uptrend 2134-2738
Long Term Uptrend 905-2741
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. While
sparse, the data flow this week was tilted to the positive side: above
estimates: the May housing market index, month to date retail chain store
sales, weekly jobless claims, April industrial production and the May Philly
Fed manufacturing index; below estimates: April housing starts, weekly mortgage
and purchase applications, the May NY Fed manufacturing index; in line with
estimates: April leading economic indicators.
However, the primary indicators were mixed: April industrial production (+), May housing
starts (-) and April leading economic indicators (0). Given the overall positive weighting, I score
the week a plus: in the last 85 weeks, twenty-eight were positive, forty-six negative
and eleven neutral.
On the political
side, the last two weeks have been all about the Donald’s problems, many of
which are self-imposed. I am not going
to speculate on his guilt or innocence.
For our purposes, the important factor is how these distractions impact
the Trump/GOP fiscal program. My
conclusion is that the best case is that any policy changes will be delayed,
likely into 2018. However, if he is
found guilty/complicit, the odds of any changes from here seem quite low.
On the other
hand, if all these issues are manufactured, this whole mess could be over
quicker than many may think. The
question at that point would be, can Trump curb is mouth and attack style long
enough not to bring another round of accusations.
The troubles with
Syria and North Korea slid from the headlines.
Although clearly, they have not gone away. My bottom line remains that while I can’t
imagine either situation leading to anything more serious than threatening
headlines, 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 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 positive this week, though this has been the
exception rather than the rule of late. I
continue to believe that the better economic momentum from the post-election Trump
bliss is fading; and I suspect that his political troubles will only exacerbate
this waning impulse. Another week or so
of poor numbers, I will likely return to our original short term economic
forecast.
Longer term, I
remain confident in my recent upgrading our long term secular growth rate by 25
to 50 basis points based on Trump’s deregulation efforts as well as his more
reasoned approach to trade. However, any
further increase in that long term secular economic growth rate assumption
stemming from enactment of his/GOP fiscal policy is now on hold.
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; though
the odds of that have certainly slipped.
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 either 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.
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. Bank derivative portfolios remain at the
center of this concern. This week we
received a report [which I linked to in Wednesday’s Morning Call] detailing the
derivative holdings of the ‘too big to fail’ banks---$222 trillion. To be fair, much of this exposure is hedged;
we just don’t know how much. We also
don’t know the strength of the counterparties---meaning if one of the parties
defaults, it can start a chain reaction.
Again, we have no idea where that could lead. But that is the point, nobody, including the
bank regulators know. And that is a
problem.
Meanwhile, another fraud and corruption suit is being
brought against Deutschebank (medium):
And the Bank of China’s crackdown on speculators is
having the expected effect---a likely surge in defaults (medium):
(2)
fiscal/regulatory policy. Regrettably, in the last two weeks, the swamp
has been all about presumed Trump infractions.
Whether or not he is innocent of all charges, the accompanying hysteria
has brought Washington’s real job to a halt.
Meaning until the accusations are adequately addressed, the work on the
Trump/GOP fiscal program is likely to go nowhere.
On the downside, this means that reforms are not
likely to be achieved in 2017; and the odds of them being accomplished in 2018
is probably tied to any finding of guilt or complicity of Trump in any of the
multitude of charges.
On the
upside, if there is no substance to the accusations, this crisis could be over
sooner than many think. That, in turn,
could mean an increased likelihood of passage of the +Trump/GOP reform
legislation.
Friday afternoon development (short):
Until we have a better idea of how much time is going to be
consumed by these going on’s, this also means any additional potential
improvement in our long term secular economic growth rate assumption in our
Models is on indefinite hold. However,
it in no way alters the recent changes made as a result of Trump’s actions on
the regulatory front. Further, the
upcoming overseas trip is rumored to include a number of economic deals that
would benefit the economy.
Finally, while
I am not trying to make chicken salad out of chicken sh*t, you will recall that
one of my concerns about the Trump fiscal agenda has been that it would add
substantially to the deficit and debt.
If indeed that is [was?] going to occur, then gridlock is [was?] a
positive alternative. In other words,
while a revenue neutral fiscal policy would be a plus, a major increase in the
deficit/debt would be a negative. We may
never know what the actual policies would have ultimately looked like; but
should they lead to more profligate spending, slowing down/reducing the
size/eliminating this program could be a blessing in disguise.
Goldman on the likely timing and shape of
fiscal policy (medium):
The latest from Nassim Taleb (medium):
(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.
It was another
quiet week for the Fed [thankfully]; though the lousy data from the last
quarter notwithstanding, there is no indication that a June rate hike is any
less likely.
Ooops, news
flash, Bullard says Fed should retain option for more QE.
You know my
thoughts:
‘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.’
This threat is
made all the worse by the [a] the recent crackdown on speculation by the Bank
of China and [b] the odds of an ECB tightening as a result of the much improved
outlook for the EU economy.
Meanwhile, the
Bank of Japan keeps doing what it does best---buy everything in sight (medium):
What happens
next? (short):
(4) geopolitical
risks: the troubles over Syria and North Korea haven’t gone away despite them
being demoted to second page news. The
risks remain [a] in North Korea, when you are dealing with at least one nut
case, the risk of some untoward event occurring is higher than normal and [b]
in Syria, the risk of a faceoff with Russia.
(5)
economic difficulties around the globe. The European economic stats continue to
improve to point that I am removing the continent from the ‘muddle through’
scenario. Not that there are not risks;
specifically from Italy, where the danger of a financial crisis remains.
[a] April UK CPI and PPI were higher than projected,
while EU inflation rose in line {as I suggested above, the importance of this
is the rising probabilities a monetary tightening by their respective central
banks]; UK retail sales were up more than anticipated,
[b] first quarter Japanese GDP was up and better than
forecast.
One more item
to mention is the struggle within OPEC to hold together and extend its as yet unsuccessful 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.
In sum, the
European economy continues to improve and has reached the point where I will
take it off the negative factors list and out of the ‘muddle through’
thesis. In addition, Japan is finally
showing some signs of life; though it has a long way to go to convince me that
it is no longer a negative. Finally,
there was no news on the Chinese economy this week. Although the Bank of China continues its
efforts to reduce speculation there which likely means a declining rate of
economic growth.
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.
However, 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.
Of course that
notion is now on hold until it becomes clearer how much substance is contained
in the multiple allegations against the Donald.
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: April housing starts were below consensus; weekly
mortgage and purchase applications fell; the May housing market index was above
expectations,
(2)
consumer: month to date retail chain store sales growth
increased from its prior reading; weekly jobless claims fell versus projections
of an increase,
(3)
industry: April industrial production was above
forecast; the May NY Fed manufacturing index was very disappointing while the
Philadelphia Fed index blew estimates away,
(4)
macroeconomic: April’s leading economic indicators were
up, in line.
The
Market-Disciplined Investing
Technical
The indices
(DJIA 20804, S&P 2381) had a good day, finishing above their 100 and 200
day moving averages and the lower boundaries of uptrends across all major time
frames---in other words, in solid uptrends.
And they still remained below those big Wednesday down gap openings
which gives extra gravitational pull to the upside. Volume fell; but breadth improved.
The VIX (12.0) declined
another 18%. It ended below its 100 day
moving average, voiding Wednesday’s break and leaving it as resistance. However, it still closed above its 200 day
moving average for a third day (if it remains there through the close next
Monday, it will revert to support) and Wednesday’s huge gap opening.
The long
Treasury and gold were up while the dollar was down, all pointing to a weaker
economy/lower rates.
TLT closed
between narrowing distances its 100 and 200 day moving averages and the upper
boundary of its short term downtrend and the lower boundary of its long term
uptrend.
The dollar
finished below its 100 and 200 day moving averages, within a very short term
downtrend and a short term trading range.
GLD remained
above its 100 and 200 day moving averages and within a short term trading
range.
Bottom
line: it looks like the indices are
about to close those Wednesday opening gaps down. After that technical task has been satisfied,
the question will then be, will they challenge their all-time highs. At the moment, the answer seems to be yes;
though I do think the burden is on the Market to prove that it can. In the meantime, we have to assume that there
is little danger of a trend reversal.
This
week in charts (medium):
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (20804)
finished this week about 61.1% above Fair Value (12906) while the S&P (2381)
closed 49.2% overvalued (1595). ‘Fair
Value’ will likely be changing based on a new set of regulatory policies which has
led to improvement in the historically low long term secular growth rate of the
economy (though its extent could change as the affects become more obvious); but
it still reflects the elements of a botched Fed transition from easy to tight
money and a ‘muddle through’ scenario in Japan and China.
This week’s US economic
stats, while few in number, were positive.
However, given the dataflow of the last two 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 has been fading. Meaning a reversal in our outlook is on the
table.
On the other
hand, Europe’s economy has been improving sufficiently to discard the label of
‘muddle through’ and expect that it will have a positive impact on the US
economy. Unfortunately, the Chinese government/central bank is making a
meaningful effort to reduce speculation and that is having a dampening effect
on liquidity in the financial system and economic growth. That has the potential of also pushing China out
of the ‘muddle through’ category, but to the negative side. So at the moment, I am not altering the
assumption on international economic growth in our Model.
In the political
arena, the last two weeks have seen nothing related to the Trump/GOP fiscal
program. Indeed, the accusations mounting
against the Donald will probably delay any implementation of their plan. Plus, there may be more to come. Further, if there is actually some fire in
the midst of all the smoke, it may be impossible to get any reform legislation
done ahead of the 2018 elections. Three
points:
(1) if
you believe that the post-election rally was in anticipation of a new
fiscal/regulatory regime, then sooner or later, it seems logical that the lack
thereof should lead to a downward adjustment in investor expectations,
(2) as
I noted above, if the Trump fiscal program was going to lead to a dramatic
increase in the deficit/debt, then its non-passage is a net plus,
(3) finally,
not that I think that the odds are high; but if the current political turmoil
degenerates into a Watergate atmosphere, the current investor euphoria is apt
to disappear quickly. On the other hand,
if the charges against Trump prove to be bulls**t, progress towards fiscal
reform could get back on track faster than many now think.
Net, net, I
think that the odds of fiscal legislation being delayed or destroyed have
grown. That means that I have put any
thoughts of upgrading the assumptions in our Models on hold.
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.
Another must
read article by Jeffrey Snider (medium):
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. While
I am encouraged about 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. Plus any increase
in valuations stemming from enactment of the Trump/GOP fiscal agenda is now, at
least temporarily on hold. 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.
DJIA S&P
Current 2017 Year End Fair Value*
13200 1630
Fair Value as of 5/31/17 12906 1595
Close this week 20804 2381
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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