The Closing Bell
6/17/17
Statistical
Summary
Current Economic Forecast
2016 actual
Real
Growth in Gross Domestic Product 1.6%
Inflation
(revised) 1.6%
Corporate Profits (revised) 4.2%
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 20092-22603
Intermediate Term Uptrend 18296-25545
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 2349-2651
Intermediate
Term Uptrend 2167-2940
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 59%
High
Yield Portfolio 55%
Aggressive
Growth Portfolio 55%
Economics/Politics
The Trump
economy is providing an upward bias to equity valuations. By
volume, the data flow this week was slightly negative: above estimates: weekly
mortgage applications, weekly jobless claims, the June Philly and NY Fed
manufacturing indices, the May small business optimism index, May PPI, May CPI
and May import/export prices; below estimates: weekly purchase applications, June
housing index, May housing starts and building permits, May retail sales, month
to date retail chain store sales, June (preliminary) consumer sentiment, May
industrial production, April business inventories, the May federal deficit, May
PPI, ex food and energy; in line with estimates: none.
However, the primary
indicators were all negative: May retail sales (-), May industrial production
(-) and May housing starts (-). This
week was clearly a negative: in the last 89 weeks, twenty-eight were positive,
forty-nine negative and twelve neutral.
I
want to note that I listed the May PPI, CPI and import export prices as pluses
because I think lower prices are better than higher prices. However, under current economic circumstances
where a stagnant economy/recession, in my opinion, is a greater probability
than an improving economy/higher inflation, these numbers could easier be
construed as negatives, i.e. evidence that we are already in a stagnant
economy/recession.
NY
Fed slashes its second quarter GDP growth estimate (short):
Overseas, the
numbers were sparse and basically mixed; so not really enough data to support
or contradict our current outlook---EU improving, the rest of the world
‘muddling through’ or worse. I continue
to believe that 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.
Even though
Trump/GOP are giving their reform agenda the old college try (1) this week’s
primary effort was the administration’s new program to reverse many of the
provisions of Dodd Frank. As you know, I
am not certain that these efforts are a plus for the overall US economy, and
(2) the dems strategy to detract and delay all reform efforts via the demand
for hearings and law suits is working. I
have no idea how long their effort will remain successful.
Bottom line: this
week’s US economic stats were negative, supporting 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. However, 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:
A 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. Nothing this week.
(2)
fiscal/regulatory policy. This week:
[a] the administration
threw its hat in the ring on reforming Dodd Frank. To follow on my comments on last week’s house
reform package---I would prefer the Trump/GOP reform efforts focused on other
areas in which there is a much greater economic need for action. Not that there aren’t parts of Dodd Frank
that need to be tweaked or rolled back.
But this recovery started with the taxpayers bailing out the banksters
who were a primary cause of the financial meltdown in the first place. In addition, thanks to QEInfinity, Wall
Street has been one of the primary beneficiaries of the gross mispricing and
misallocation of assets.
Now the
banksters are whining because the regulatory efforts to prevent another
occurrence are starting to squeeze their shoes.
I am sorry but I am much more concerned about the Americans that can’t get
decent healthcare coverage and the middle class who need a tax break than I am
about the financial community.
[b] the dems and media are in full attack mode on the
Donald. Russia, Comey, travel
restrictions, his business dealings. You
name it. If they can find a basis for
demanding a hearing or filing a law suit, they are on it. To be sure, some questions have been raised
that deserve answers. However, whether
deserved or not, the result is still the same---slowing down or inhibiting the
Trump/GOP effort to alter the inefficient economic model this country has been
operated on for the past fifteen years.
Of course, Trump is not blameless in this situation. He has deliberately antagonized the dems and
media and made that even worse with his oft factually challenged tweets.
Whether or not one agrees with the social/political
aspects of the Trump/GOP program, its economic effects would likely improve the
growth prospects of the country and the livelihood of small business and the
middle class. So in that sense, delaying
or preventing the enactment of reform is an economic negative.
However, as you know, I qualify this lament about
reform with the caveat that if the tax and spending reforms would meaningfully
increase the federal deficit/debt, then I would be satisfied with just the
regulatory/trade reforms. ‘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.’
In short, I am unsure about the speed with which the
Trump/GOP fiscal program can progress and I am concerned that if it is enacted,
it may not be as positive as many think.
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.
But the Donald keeps trucking on
regulatory reform (short):
(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. It raised the Fed Funds rate
by 0.25% [expected], forecast four additional increases in the next two and a
half years [roughly in line with estimates], provided detail on the unwinding
of its balance sheet [much more than had been anticipated]; and its narrative was
somewhat more hawkish than expected---that in spite of the continuing flow of
lousy economic stats. In other words, it
once again ignored the data as well as its own staff’s economic analysis and
forecast a more positive outlook in order to justify the normalization of
monetary policy.
Another
embarrassing day for the Fed (medium):
Also of note is
that Chinese monetary policy is also tightening, meaning that the central banks
of the world’s two largest economies are now off the QE band wagon. To be sure the ECB [though it is promising
that it will end its bond buying program….sometime] and BOJ are still
easing. Indeed, the BOJ reiterated its
commitment to QEInfinity on Friday. How
this divergence in policy impacts global liquidity, particularly as it relates
to the securities’ markets, is clearly the big question at the moment.
‘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.’ Must read:
(4) geopolitical
risks: the temperature in the global hotspots cooled this week. Not that the risks in the Middle East and
North Korea have gone away. But the
efforts being made by Qatar and the Gulf States to resolve their issue and the
North Korean release of the US citizen are hopeful signs that some tensions
could be easing.
(5)
economic difficulties around the globe. The stats were scarce and mixed this week,
providing nothing that would affect our forecast.
[a] the May German investor confidence declined; the
May UK CPI was hotter than anticipated,
[b] May Chinese retail sales came in as expected, fixed
investment was lower than estimates while industrial production was higher.
Oil continues
to be a factor in global economic health and its price continued its roller
coaster ride this week, most of it brought on by rising inventories---meaning
either cheating by OPEC members or rising production from non-OPEC countries or
declining demand or all of the above.
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’.
Libya
ramps up production (medium):
In sum, our
outlook remains that the European economy is out of the woods. China and Japan remain in the ‘muddle
through’ scenario.
Bottom
line: our near term forecast is that the
US economy is stagnating despite an improved regulatory outlook and a now
growing EU economy. Both should have a positive impact on US growth though
there is no evidence of it to date. However, if Trump/GOP were to pull off a
(near) revenue neutral healthcare reform, tax reform and infrastructure
spending on a reasonably 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 21384, S&P 2433) drifted lazily through a quad witching. They retain their upward momentum as defined
by their 100 and 200 day moving averages and uptrends across all
timeframes. At the moment, I see
nothing, technically speaking, to inhibit the Averages’ challenge of the upper
boundaries of their long term uptrends---now circa 24198/2763. Volume rose (as is usual on option
expiration) and breadth was mixed but is still positive.
The VIX (10.4) declined
4 3/4 %; and remains stuck between its 100 and 200 day moving averages on the
upside and the lower boundaries of its intermediate and long term trading
ranges on the downside.
The long
Treasury rebounded, finishing above its 200 day moving average for the third
day (if it remains there through the close on Monday, it will revert to
support) and the upper boundary of its short term downtrend (if it remains
there through the close on Monday, it will reset to a trading range; if it
successfully challenges that boundary, it will also break out of the developing
pennant formation---a positive, technically speaking). What stronger economy?
The dollar was
down again after a one day rebound, ending in a very short term downtrend and
below its 100 and 200 day moving averages.
What stronger economy?
GLD was up,
ending below the upper boundary of its short term trading range but above its
100 and 200 day moving averages with the 100 day moving average now above its 200 day moving average (usually a positive
technical signal).
Bottom line: investors
either think that a tightening Fed and a slowing economy is a goldilocks
scenario or they aren’t thinking.
Investors either think that the third world political circus in
Washington will have no impact on fiscal reform or that fiscal reform is
irrelevant or they aren’t thinking. You
decide because I have no clue.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (21384)
finished this week about 65.1% above Fair Value (12948) while the S&P (2433)
closed 52.0% 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
are pointing to a weak economy. While the better numbers out of Europe should provide
needed support, I am going to wait to see if the rest of the world follows suit
before making any additional changes in our 2017/2018 outlook.
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. Since the effects of these moves are of a
longer term nature, they are likely to have little near term impact. What would
help short term is concrete moves on the major elements of Trump/GOP fiscal
agenda---not that we would see any near term improvement in the numbers. But psychologically, it would probably lift
consumer and business optimism and that would likely be seen in the data.
Unfortunately, the
dems are doing everything possible including generating a barrage of (as yet
undocumented) accusations against the Donald to delay any implementation of his/GOP
fiscal reforms. So far with some
effect. How long this strategy will
remain successful is the big question for both the near term psychology and
long term reform of a ham strung economy.
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 adverse. 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.
Stockman on
Trump’s budget (medium):
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.
And last but
certainly not least, the Fed took another step towards monetary tightening this
week despite the continuing deterioration in the economic stats. Plus, the Bank of China continued its own
efforts at curbing speculation and loose lending practices. A tightening effort by the world’s two largest
central banks should have a noticeable effect on liquidity conditions on their
own and this rest of the globe’s securities markets
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.
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 21384 2433
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
70%overvalued 22011 2720
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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