The Closing Bell
6/3/17
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
(revised)
Real
Growth in Gross Domestic Product -1.25-+0.5%
Inflation +.0.5-1.5%
Corporate
Profits -15-0%
Current Market Forecast
Dow
Jones Industrial Average
Current Trend (revised):
Short
Term Uptrend 19934-224966
Intermediate Term Uptrend 18212-25461
Long Term Uptrend 5751-24198
2016 Year End Fair Value
12600-12800
2017 Year End Fair Value
13100-13300
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Uptrend 2330-2632
Intermediate
Term Uptrend 2153-2926
Long Term Uptrend 905-2763
2016 Year End Fair Value
1560-1580
2017
Year End Fair Value 1620-1640
Percentage
Cash in Our Portfolios
Dividend Growth
Portfolio 58%
High
Yield Portfolio 55%
Aggressive
Growth Portfolio 55%
Economics/Politics
The Trump
economy is providing an upward bias to equity valuations. The
data flow this week was negative, again: above estimates: the May ADP private
payroll report, the May Dallas Fed manufacturing index, the May Chicago PMI and
the May ISM manufacturing index; below estimates: April pending home sales,
weekly mortgage and purchase applications, the March Case Shiller home price
index, May consumer confidence, May and month to date retail chain store sales,
May light vehicle sales, weekly jobless claims, May nonfarm payrolls, the May
Markit PMI, April construction spending and the April trade deficit; in line
with estimates: April personal income and spending.
In addition, the primary indicators were negative:
April construction spending (-), May nonfarm
payrolls (-) and April personal income and spending (0), making this week an
easy call--a minus: in the last 87 weeks, twenty-eight were positive, forty-eight
negative and eleven neutral.
As a result, I am
resetting our short term economic forecast back to my prior estimates (see
above). This, however, has no impact on
the improvement in the longer term secular economic growth rate potential
stemming from Trump’s regulatory reform.
Overseas, the
numbers keep improving in Europe (recall that it is no longer part of the
‘muddle through’ forecast for global growth).
On the other hand, the other
major world economies continue to struggle. The net effect should be a plus for the short
term growth rate, though I would like to have more clarity on the Chinese
economy before I make any additional changes in our forecast
Bottom line: this
week’s US economic stats were negative again this week, prompting a reset in
our forecast back to our prior stagnate growth outlook. Longer term, I remain confident in my recent
upgrading our long term secular growth rate assumption 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 has seemingly lost its
post-election Trump momentum meaning that our former recession/stagnation
forecast is back as the current expansion seems to be dying of old age.
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.
Update on big
four economic indicators (medium):
The
negatives:
(1)
a vulnerable global banking system. Good news and bad news this week. [a] the auto and student loan markets in the
US continue to deteriorate while [b] the
Italian bank [Monte Paschi] at the center of the troubled Italian financial
system appears to have reached an agreement on a bailout.
We hear little about bank fraud in China; but read
this (medium):
(2)
fiscal/regulatory policy. There was little progress on the Trump/GOP
fiscal reforms this week. Regrettably, that
is likely to remain so as the dems and the media continue to focus on the
Donald’s alleged infractions and he only makes matters worse by his chronic
foot in the mouth disease. In short, the
work on the Trump/GOP fiscal program is likely to go nowhere anytime soon.
Until we have a better idea of how much time is going to be
consumed by these going’s on, this also means any additional potential
improvement in our long term secular economic growth rate assumption in our
Models is on indefinite hold.
However, all is
not bad news. Trump’s demands that the NATO
countries share the costs of their defense and the withdrawal from the Paris
accord are, economically speaking, positives.
To be clear, this opinion has nothing to do with science or
political/social policy. It is an observation
that the less money the US has to spend on defending NATO and funding climate
change projects in the third world, the more money there is to spend on our own
problems and/or cut spending altogether.
As you know, I believe
that the US has reached the point in which the debt and deficit are acting as
drags on our economic growth. This
country does not have an endless supply of funds to finance all the worthy
projects in the world. We simply have to
take care of ourselves first; then worry about others. In our current state of financial affairs, giving
money to third world countries to affect their own climate change efforts is
like you or I going to the bank and borrowing money to contribute to the United
Way. It might be a worthy cause but it
is, in my opinion, senseless to donate ourselves into poverty.
And speaking of
deficit spending, based on the same notion about deficit/debt impact on
economic growth, if any new GOP tax or spending measures would lead to further
increases in the deficit/federal debt, then I would not score them as a plus
for growth; and depending on their magnitude could very well lower our long
term secular growth rate assumption. In
that case, gridlock would be a positive alternative scenario.
Adding to this problem
is a decline in tax receipts [raising the obvious question, how can consumer incomes
and corporate profitability be rising and tax receipts falling?]
(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
released its latest Beige Book this week [I mistakenly referred to it as FOMC minutes
in Thursday’s Morning Call]. However,
the narrative was still as I described: the economy is doing fine; except that
there are problems; but no sweat, we are raising interest rates anyway.
Jeffrey Snider
on the Beige Book (medium and a must read):
BOJ and ECB
balance sheets now bigger than the Fed’s (short and a must read):
‘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.’
(4) geopolitical
risks: the troubles with Syria and North Korea haven’t gone away. This week North Korea and the US engaged in a
missile firing contest. And in addition to
the normal daily violence in the Middle East, there were lethal bombings in the
UK and Afghanistan. While I believe that
the risks of open warfare with North Korea or a confrontation with Russia in
the Middle East are small, the consequences of either are significant.
(5)
economic difficulties around the globe. The European economic stats continue to
improve which will almost surely be a plus for the US economic growth. However, Japan and China remain a problem as
economic weakness in both countries persists.
[a] April EU inflation was slightly less than anticipated;
May UK and EU manufacturing PMI’s were better than expected,
[b] May Chinese manufacturing PMI was flat while the
nonmanufacturing PMI was better than estimates.
Oil continues
to be a factor in global economic health---lower prices having proven to be a
negative for growth, at least in the US.
OPEC is still struggling to maintain discipline in its production cut
agreement, which is not working out too well.
There are signs of cheating within OPEC and increases in production
among nonmembers. Remember the impact of
the last ‘unmitigated positive’ decline in oil prices.
In sum, the
European economy showed further improvement, Japan may be showing signs of life
though there was no data to that effect this week and the Bank of China
continues its efforts to reduce speculation amidst signs of a declining rate of
economic growth. Overall, the better
numbers out of Europe makes this factor less negative.
Bottom
line: the post-election sentiment
inspired economic improvement seems to have faded into the mist. As a result, our near term forecast returns
to our prior weaker outlook.
However, if
Trump/GOP were to pull off a (near) revenue neutral 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
return; and more importantly, our long term secular economic growth rate assumption
would almost certainly rise.
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 and foreign charity should support
that revision.
The
Market-Disciplined Investing
Technical
The indices
(DJIA 21206, S&P 2439) continued their upward moves with the Dow closing in
on its former high (21228)---this pin action on a day with a very poor nonfarm
payroll number. That suggests to me that
bad news is still good news, which strengthens the case that the Dow will most
likely successfully challenge its former high.
If that occurs, there is little resistance between current price levels
and the upper boundaries of the Averages’ long term uptrends---now circa
24198/2753. Volume rose; while breadth improved.
The VIX (9.8) slipped
again, ending below the lower boundary of its intermediate term trading range
for the second day (if it remains there through the close next Tuesday, it will
reset to a downtrend) and also below the lower boundary of its long term
trading range (if it remains there through the close Thursday, it will reset to
a downtrend).
The long
Treasury was up 1 1/8 %, reflecting that lousy employment report (weak economy,
low rates). It ended above its 200 day
moving average (if it remains there through the close next Wednesday, it will
revert to support) and is closing in on the upper boundary of its short term downtrend. If that barrier is successfully breached, it
should lead to a sizeable move to the upside.
The dollar fell
0.5%, mirroring TLT’s move but indicating that the dollar traders also agree
with the weak economy/low interest rate scenario.
GLD rose 0.75%,
closing above its 100 and 200 day moving averages, in a very short term uptrend
and is nearing the upper boundary of its short term trading range.
Bottom
line: TLT, UUP, GLD investors all seem
to concur that the weak jobs number is pointing to slower growth/lower
rates. I am not sure what stock
investors believe other than that every day is Christmas. The indices are close to a harmonious break
above their former highs, opening the door to a move to the upper boundaries of
their long term uptrends.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (21206)
finished this week about 63.7% above Fair Value (12948) while the S&P (2439)
closed 52.4% overvalued (1600). ‘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.
The US economic stats
have lost their post-election high. In addition, while the EU economy is
improving, the Japanese and Chinese economies continue to flounder. At the momentum, I am unsure of the overall net
effect of the global economy on our own.
As a result, I am returning our economic forecast to our prior less positive
economic outlook. If I am correct that
means Street forecasts will begin declining.
The question is when; and more important from a Market standpoint, given
investor proclivity for interpreting bad news as good news, whether they will even
care. I can’t answer that latter issue
except to say that someday, bad news will be bad news; and mean reversion will
likely occur.
In the political
arena, the Donald continues to do what is in his power to bring reform,
specifically his deregulation efforts as well as pulling the US back from being
a bottomless purse for the rest of the world’s problems. While the effects of these moves are of a longer
term nature, they do impact the secular growth rate potential.
Also of a long term
character, it seems likely that the accusations mounting against the Donald
will probably delay any implementation of his/GOP fiscal reforms---irrespective
of whether he is guilty or not. However,
if indeed 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.
That
said, I just want to reemphasize that if a taxing/spending program were to be
enacted that was not near revenue neutral, I think that the outcome for the
economy long term would be negative. So
gridlock may not be as negative as many may 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.
The point of all
this being that I believe Street enthusiasm for a significant improvement in
the long term growth prospects of the US economy is certainly premature and
most likely wrong. This will probably
result in the eventual lowering of Market expectations for growth as well as
the discount factor it places on that growth.
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. While
I am encouraged about the changes already made in regulatory policy as well as
a more rational approach to trade and our global commitments 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.
Bottom line: the
assumptions on long term secular growth in our Economic Model are beginning to
improve as we learn about the new regulatory policies and their magnitude. On the other hand, 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 potential ‘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 want to own cash in my Portfolio
and 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 6/30/17 12948 1600
Close this week 21206 2439
Over Valuation vs. 6/30 Close
5% overvalued 13595 1680
10%
overvalued 14242 1760
15%
overvalued 14890 1840
20%
overvalued 15637 1920
25%
overvalued 16185 2000
30%
overvalued 16874 2080
35%
overvalued 17479 2160
40%
overvalued 18127 2240
45%
overvalued 18774 2320
50%
overvalued 19422 2400
55%overvalued 20069 2480
60%overvalued 20716 2560
65%overvalued 21364 2640
Under Valuation vs. 6/30 Close
5%
undervalued 12289
1520
10%undervalued 11653 1440
15%undervalued 11005 1360
* 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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