The Closing Bell
6/10/17
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 20039-22549
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 2340-2642
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 thin and mixed: above estimates: weekly mortgage and
purchase applications, month to date retail chain store sales, the April JOLTS
report, weekly jobless claims and revised first quarter nonfarm productivity;
below estimates: the May Markit services PMI, the May ISM nonmanufacturing
index, April factory orders, April wholesale inventories and sales and April
consumer credit; in line with estimates: none.
The primary indicators were also neutral: revised first quarter nonfarm productivity
(+), April factory orders (-). I score
this week a neutral: in the last 88 weeks, twenty-eight were positive, forty-eight
negative and twelve neutral.
Overseas, the
numbers out of Europe were directionless, the Japanese stats remain terrible
and Chinese data continues to improve (but remember, these guys lie a lot; plus
the government bond yield curve is flattening, usually a sign of an impending
recession). There is nothing here to warrant a change in our forecast of an
improving economy in Europe and a ‘muddle through’ scenario for the rest of the
world. As I noted last week, the better
outlook in Europe should have a positive impact on our short term US economic
growth assumption, though I have held off making a formal change to date.
The main
political event this week was the Comey testimony which while entertaining to
watch and providing enough material to get panties in a wad for both parties,
in the end provided little evidence of an impeachable offense. The question is, how long can the dems
delay/prevent the enactment of the Trump/GOP fiscal plan pursuing their ‘impeachable
offense’ narrative? I don’t know the
answer to that; but it is likely to be longer than envisioned in the original
game plan. That said, the house passage
of Dodd Frank reform this week is a hopeful sign at least some progress will be
made.
Bottom line: this
week’s US economic stats were mixed this week, neither supporting nor
countering our 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.
That conviction was bolstered this week by actions in the EU on defense
and negotiations with Mexico on the sugar trade. Nonetheless, any further increase in that
long term secular economic growth rate assumption stemming from enactment of the
Trump/GOP fiscal policy is still 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 are uncertain.
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.
The
negatives:
(1)
a vulnerable global banking system. One piece of good news this week: it was
reported that a Spanish bank was on the verge of bankruptcy; but almost
immediately a larger Spanish bank bought it.
That it happened so quickly is especially positive.
(2)
fiscal/regulatory policy. There was some progress on the Trump/GOP
fiscal/regulatory reforms this week.
[a] the
house passed a Dodd Frank reform package.
While undoubtedly a step forward {i} it still has a long journey ahead. The senate has to pass its version, then the
bills have to be reconciled and {ii} of all the needed reforms, this was last on
my list of things to do. As you know, I believe
that the big banks deserve all the regulation they get.
Though this is still a plus (medium and a must read):
[b] the NATO countries released a statement that they
need to take more responsibility for their own defense. Plus Mexico and the US reached an ‘agreement
in principle’ to alter the way sugar is traded as a precursor to a larger
review of NAFTA. While the narratives in
both were vague, it, nonetheless, suggests that Trump’s drive to remove the US
as patron of last resort for the world’s security and happiness is having an
effect and that is good news for US taxpayers {hopefully}.
On the other hand, internal GOP decent and the dems efforts
to block all Trump/GOP fiscal reforms will hamper enactment and chew up
time. The latter is made all the worse
by the constant stream of alleged infractions by the Donald and his incessant
combative and factually inaccurate tweets.
And let’s not forget, there is still a special prosecutor out there and
who knows what he will turn up.
In short, I am unsure about the speed with which the
Trump/GOP fiscal program can progress. Until
we have a better idea of how much time is going to be consumed by the
aforementioned goings on, any additional potential improvement in the long term
secular economic growth rate assumption in our Models based on fiscal progress is
on hold.
Finally, I
believe that the US has reached the point in which the debt and deficit are
acting as drags on our economic growth. A
corollary to that is that any tax reform or infrastructure programs have to be,
at least, near revenue neutral in order for them not cause more economic damage
than they are intended to cure. The point being that, in my opinion, while
revenue neutral reform maybe a plus for the economy, it would not be a magic
elixir that will return the secular economic growth rate to prior highs.
(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.
As Christine
Jorgensen once said, ‘it won’t be long now’.
In this case, I am referring to next week’s FOMC meeting. Odds still favor a rate increase, the numbers
be damned.
Credit markets
are screaming stagnation (medium):
‘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.’
In other markets,
[a] at its meeting this week, the ECB followed the Fed’s
oft used Alfred Hitchcock strategy---talk up the economy {it raised its growth
rate forecast for EU GDP for 2017, 2018 and 2019, cut its inflation outlook for
the same period} and then leave QE unchanged.
In short, the ECB and BOJ continue to supply lots of liquidity to the
markets in an attempt to postpone the inevitable,
[b] despite some encouraging numbers from the Chinese
economy, their bond yield curve is starting to invert---a sign of tightening
monetary policy and a precursor to recession.
(4) geopolitical
risks: the troubles with Syria and North Korea haven’t gone away. But they had to share the stage with other
global developments this week including[a]
a schism in the Gulf OPEC nations; with Qatar being called out for its
support of ISIS and other terrorist groups, [b] a terrorist attack in Iran of
all places and [c] yet another attack in England.
While I don’t
want to minimize the significance of the latter, I do think the prior two are
even more so. Remember that an integral
component of the Middle East violence is the long conflict between the Sunni
and Shi’a sects of Islam. They have
hated each other for centuries and it has often erupted in to warfare. This sectarian strife is a big part of the
problem achieving real peace in Iraq. It
is also part of the motivation of the Saudi’s and others [Sunni] in attempting
to punish Qatar [Shi’a] whom they have often accused of fomenting trouble
within their Shi’a minorities. And it
appears that the Iranian [Shi’a] attacker was a member of ISIS [Sunni]. http://www.zerohedge.com/news/2017-06-07/iran-blames-saudi-arabia-terrorist-attack-vows-revenge
The whole point
of this is that if the Sunni/Shi’a conflict breaks out into open warfare in the
Middle East, it will make the Syrian conflict look like an extended session of
laser tag. And we then won’t be talking
about what an ‘unmitigated’ positive lower oil prices are.
Meanwhile, back
at the ranch,
[a] here is the
latest from Syria (medium):
[b] the new
president of South Korea declined to accept the US offer of an anti-ballistic
missile system while North Korea set off a fireworks display of missile
launches.
(5)
economic difficulties around the globe. The European economic stats were mixed this
week [though I continue to view the EU as a source of strength for the US and
global economies], China improved [it said] and Japanese continues to bring up
the rear.
[a] the May EU Markit composite PMI was unchanged; the
May UK services PMI was worse than anticipated,
[b] May Chinese services PMI was better than expected; the
May Chinese trade numbers were very strong; May Chinese CPI was in line while
PPI was below forecasts; however, it is worrisome that the yield curve is
flattening---a phenomena that generally proceeds recession; first quarter
Japanese GDP grew less than expected.
[c] the World Bank forecast 2017 global growth of 2.7% and for 2018 2.9%
Oil continues
to be a factor in global economic health.
It is being torn directionally speaking, by the aforementioned dust up
in the Gulf States, on the one hand, and by rising inventories [meaning either
cheating by OPEC members or rising production from non-OPEC countries or
declining demand or all of the above] on the other. At the moment, higher inventories [lower
prices] is trumping fears of war in the Gulf States [higher prices]. Since energy is a major component of production,
its price usually has a significant impact on economic growth; and lower prices
have proven not to be an ‘unmitigated positive’.
And, the
Street continues to slash its price expectations.
In sum, the
European economy is out of the woods.
China and Japan remain in the ‘muddle through’ scenario.
Bottom
line: our near term forecast has returned
to the 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. Unfortunately its fate is uncertain given the
antics of our political class.
For the long
term, the Donald’s drive for deregulation and improved bureaucratic efficiency
is a decided plus. As you know, 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 21271, S&P 2431) turned in a very conflicting and confusing pin
action on Friday. The Dow closed above
its former high. It needs to remain
there for two more days to confirm the break but it clearly is setting up to
reverse its recent divergence in trend with the S&P. That suggests momentum to the upside could be
starting to assert itself.
On the other
hand, the S&P experienced a much more volatile day. Indeed, it created an outside down day (its
Friday high was higher than Thursday’s high, its Friday low was lower than
Thursday’s low and it ended the day below Thursday’s close). In technical terms that points to a change in
upside momentum and move to the downside.
So the bottom
line is we have traded one technical issue (divergent trends) for another (an
outside day for the S&P). I still
think that the move up is not over but the technical outlook is just as
uncertain today as it was yesterday.
Volume was up and breadth was positive.
The VIX (10.7) also
had an outside day but to the upside, voiding Thursday’s break of the lower
boundary of its intermediate term trading range and remaining above the lower boundary
of its long term trading range. However, it is still below its 100 and 200 day
moving averages and in a short term downtrend.
The long
Treasury was down slightly, closing out a down week and leaving it below its 200
day moving average but above its 100 day moving average and in a very short
term uptrend. The gap between the upper
boundary of its short term downtrend and lower boundary of its long term
uptrend continues to narrow.
The dollar rallied,
ending an up week but nothing disturbed its overall negative chart---ending in
a very short term downtrend and below its 100 and 200 day moving averages.
After failing to
break above the upper boundary of its short term trading range on Wednesday, GLD
fell further, closing below the lower boundary of its very short term uptrend for
a second day, negating that trend. It
finished above its 100 and 200 day moving averages and the 100 day moving
average is about to cross above its 200 day moving average which is usually a positive
technical signal. However, this chart is
getting a bit ugly.
Bottom line: next
week should be interesting given the indices’ unusual pin action on Friday. As I noted above, I think the assumption has
to be that the momentum remains to the upside.
However, the outside day of the S&P coupled with the fact that investors
in bonds, gold and the dollar seemed unimpressed with the better economy
scenario, keeps open the possibility that we could be looking at a change of
direction in equity prices. As always,
follow through is key.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (21271)
finished this week about 64.2% above Fair Value (12948) while the S&P (2431)
closed 51.9% 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; and I have returned our short term economic
forecast to its less positive predecessor. While the better numbers out of
Europe should add something to that growth rate, I am going to wait to see if
the rest of the world follows suit before making any additional changes.
If I am correct about the economy slowing short
term 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 (except to shut up) 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 the latter moves are of
a longer term nature, they did start to show some results this week as the EU
acknowledged that it had to take more responsibility for its own defense and
Mexico ‘agreed in principle’ to the start of a process to renegotiate portions
of NAFTA. In addition, the house passage
of Dodd Frank reform is the first concrete step in fiscal reform though it
remains a long way from becoming law.
On the other
hand, the dems are doing everything in their power including generating a barrage
of (as yet undocumented) accusations against the Donald to delay any implementation
of his/GOP fiscal reforms. I am unsure
of how successful they will be.
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 reform legislation being delayed are high; and that
means that I have put any additional of upgrading the long term secular growth
rate assumption 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.
Muddling in
economic darkness (medium and a must read):
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 remains in question. 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.
What to do now
(short):
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 21271 2431
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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