7/29/17
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 20558-23069
Intermediate Term Uptrend 18537-25786
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 2400-2702
Intermediate
Term Uptrend 2201-2975
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 weighed to the positive: above estimates: the May Case Shiller home price index, month
to date retail chain store sales, July consumer confidence and sentiment, the July
Richmond Fed manufacturing index, the July Markit composite, manufacturing and services
PMI’s; below estimates: weekly mortgage and purchase applications, June new and
existing home sales, weekly jobless claims and the Kansas City Fed
manufacturing index; in line with estimates: June durable goods orders, the
June trade deficit, the June Chicago national activity index and second quarter
GDP.
Note on ‘in line
with estimates’ numbers: the June trade deficit and the June Chicago national activity
index were positive but their prior month’s readings were revised down enough
to completely offset that improvement. As
a result, I rated those a neutral---with no qualms. The June durable goods orders was
different. Its headline number looked
very good but when the highly erratic transportation data was removed, it was a
big disappointment. I think that rates
as a negative; but in the interest of being sure our score is does not reflect
my prejudice, I rated it a neutral.
Still, the
primary indicators were negative: July new home sales (-), July existing home
sales (-), June durable goods orders (0) and second quarter GDP (0). I
score this week a minus: in the last 94 weeks, twenty-nine were positive, fifty-two
negative and thirteen neutral.
One final stat: the
IMF lowered its 2017 US economic growth estimate.
Overseas, the
numbers were upbeat with more good news out of Europe. That has been a good news story of late.
With respect to fiscal policy reform the news was
mixed. The senate failed in its attempt
to reform healthcare. Disappointing.
More important, I am not sure what that means for odds of passage of tax
reform and infrastructure spending.
On the other
hand, the house ditched the border adjustment tax, a measure that I believe
would have done more harm than good---score one for gridlock. The problem is that it was to be a source of
revenue to pay for lowering the corporate tax rate. So the question becomes will the GOP (1) find
a new source of revenue, (2) cut back on tax cuts to make reform revenue neutral,
(3) proceed with the original tax cuts and blow a hole in the budget? You know
my choice and the reason why.
Finally, the
FOMC met this week and the results were as expected: the economy is awesome but
not we are still afraid to do much of anything for fear of wrecking the
Markets. Good luck with that strategy,
Janet dear.
Bottom line: this
week’s US economic stats turned back negative, confirming the pattern for the
last 18 months---the economy struggling to keep its head above water. 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 as they struggle to get anything done.
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.
Wells is at it again (medium):
(2)
fiscal/regulatory policy. This week:
[a] while
the Russian connection/Comey firing problems hearing/hysteria continues, it had
a lower profile this week. As I noted previously,…while it is not at all clear how much substance there is to the multiple
accusations, in the best case where all are innocent, the opposition is still going
to hang on to the prospect of delaying the Trump/GOP fiscal agenda like a dog
to a soup bone. In politics, one never
knows what the next turn will bring; but at the moment its advantage dems which
means lower odds of success of the Trump/GOP effort to alter the inefficient
economic model this country has been operated on for the past sixteen years,
[b] the senate failed in its attempt to pass a bare
bones healthcare reform bill. I don’t
know if this spells the end to any attempt at reform; but it is clear from the
narrative in the press that the GOP disappointment was palpable. You know most of the time I value gridlock as
a major plus since in inhibits further government intrusion on the electorate
and the economy. But in this case in
which the legislation is to remove that intrusion, I make an exception. Plus I am concerned about what this failure
means for the likelihood of passage of tax reform and infrastructure spending.
[c] GOP leadership ditched the border adjustment tax
which was very controversial in the first place. There were apparently too many unknown
unknowns to take that step. Probably, it
was a smart thing to do and undoubtedly takes a negative off the table with
respect of trade. On the other hand, the
Donald was relying on the proceeds generated by the tax to pay for his
corporate tax cut. As I have noted, how
that impacts tax reform is important, to wit, tax reform that increases the
budget deficit and federal debt will be an additional burden for the economy,
inhibiting its ability to grow.
[d] the administration continues to move forward in
its deregulation effort. In Wednesday’s
Morning Call, I linked to some stats on cost savings to date as well as studies
on improving corporate management sentiment.
No one is talking about the impact that this factor is having on US
economic activity; indeed as you know, I had lost confidence that deregulation
was having any effect on business attitude or investment. If this study is valid, then my pessimism was
premature. That said, there is little evidence to
date that it is having an impact on the numbers.
(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 performed its usual routine, i.e. talked up the economy and then mewed
gutlessly about doing something in the future, depending on the data. I will save you my usual rant; but not the
conclusion: the Fed and other central banks have done little to improve their
respective economies but have created enormous distortions in asset pricing and
allocation. In my opinion when those
excesses are corrected it will have little impact on their respective economies
but will cause the securities markets pain.
Draghi’s
failure (medium):
(4) geopolitical
risks: the rhetoric ramped up again between North Korea and the US. Unfortunately, the US keeps making its
foreign policy more complicated/dangerous.
Trump turned his tweet machine on Iran this week, issuing a series of
public threats.
Plus congress,
in its infinite wisdom, decide to impose sanctions on Russia for interfering in
the 2016 elections---probably one of the most holier than thou, hypocritical
actions on record. I have usually end
this segment with the disclaimer that…nothing
may come of any of these problems; but they all pose a risk which we must
remain aware of. However Friday
morning, Russia gave its initial response, ordering the US to cut its
diplomatic staff and taking control of three US properties. I doubt this will be the only reprisal.
(5)
economic difficulties around the globe. The stats continued upbeat out of Europe this
week.
[a] the July EU Markit PMI hit a six month low, but German
business sentiment hit a new high and second quarter UK and German GDP’s were
above estimates, while French and Spanish GDP’s were in line,
[b] second quarter Japanese CPI was in line.
Oil remains a
factor in global economic health and its price continued its roller coaster
ride---this week to the upside. The main
factors playing on price being inventories, rig counts and the inability of
OPEC to make production cuts stick---this week, Saudi Arabia, Kuwait and the
UAE promised {again} that they would stick with their quotas under the recent
production cut agreement {yeah, right}; Indonesia said it will consider
rejoining OPEC but only if it is not subject to production quotas. On the other hand, adding more uncertainty to
the supply picture, Trump imposed sanctions on Venezuela which could, in turn, impact
its oil industry. The point here is that
[a] since energy is a major component of production, its price usually has a
significant impact on economic growth, [b] this week’s oil price move to the upside
notwithstanding, I don’t think that the future for oil prices is all that clear
and [c] lower prices have proven not to be an ‘unmitigated positive’.
In sum, our
outlook remains that the European economy is out of the woods. My belief is that it will eventually
positively impact the US economy.
Bottom
line: our near term forecast is that the
US economy is stagnating despite, an improved regulatory outlook and a now
growing EU economy. These two factors should have a positive impact on US
growth though there is scant 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 because of
it. In addition, a more reasoned
approach to trade and foreign charity should support that revision.
The
Market-Disciplined Investing
Technical
The indices
(DJIA 21830, S&P 2472) had another mixed week (Dow up, S&P flat). Volume fell; breadth improved. The upward momentum as defined by their 100
and 200 day moving averages and uptrends across all timeframes remains intact. At the moment, technically speaking, I see little,
except for the VIX, to inhibit the Averages’ challenge of the upper boundaries
of their long term uptrends---now circa 24198/2763.
The VIX (10.3) was
up another 1 ½ % on Friday. It finished above
the former lower boundaries of both the intermediate and long term trading
ranges for the second day. To be sure,
enough time has lapsed to confirm the break of both trends to the
downside. That said, given that we are talking
about the VIX hitting an all-time low, there is the question of whether the
last week’s decline was some kind of blow off bottom. Follow through.
The long
Treasury rose, but remained below the lower boundary of its very short term
uptrend. However, it is still above its
100 and 200 day moving averages, the lower boundaries of its short term trading
range and its long term uptrend. That is
a lot of support. If TLT starts breaking
those support levels, it would probably be a sign that the underlying
psychology of bond investors is changing.
The dollar plunged
below the lower boundary of its short term trading range for a second time; if
it remains there through the close next Tuesday, it will reset to a
downtrend. This is an ugly chart.
GLD continues to rise, ending above its 100 and
200 day moving averages and the lower boundary of a new developing very short
term uptrend.
Bottom line: this
week’s overall pin action was pretty confusing: with the Dow, S&P and
NASDAQ were out of sync on a daily trading basis. In addition, the pin action in TLT, UUP and
GLD was also a bit unclear as their investors seemed unable to decide whether
they believe in a weak economy/lower rates or the reverse. I don’t pretend to know what that means, if
anything. But we do know that the
Averages remain firmly in uptrends.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (21830)
finished this week about 68.0% above Fair Value (12990) while the S&P (2472)
closed 54.0% overvalued (1605). ‘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 effects 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
continue to point to a weak economy. If
I am correct about the economy slowing/stagnating, 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.
The political
class failed it first big test---healthcare reform. Clearly that provides no reason for revising
either our Economic or Valuation Models.
Plus it raises the concern as to the enactment of tax reform or
infrastructure spending. This is made
all the worse given the removal of the border adjustment tax from budget
considerations. The issue is, can these
clowns produce a revenue neutral tax reform---if not, it would negatively affect
both Models.
Unfortunately, a portion of the Trump/GOP
inability to get things done are a result of their own unforced errors (1) the
Donald’s insistence in wallowing in the mud with his opponents and making it
worse by his factually challenged tweets, (2) the inability to escape the
Russian tar baby because of the apparent absence of political savvy, and (3)
the GOP congress’ lack of preparation for assuming the reins of power. They had eight years to construct a viable
alternative to Obamacare and tax reform; and yet here they are arguing over
issues that should have been resolved long ago.
Finally, the FMOC’s
action and narrative remains in line with other the central banks who continue
to confuse, obfuscate and pursue a policy that has destroyed price discovery---and
it is being done not to have some potential positive effect on the economy, but
to avoid a Market hissy fit. Not
something that I believe is in the best long term interests of the economy or
the Markets. As you know, I have long time believed that the
loss of faith in or the dismantling of QE will result in correcting the
mispricing and misallocation of assets; and that most assuredly will not be a
plus for equity prices.
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, a more
rational approach to trade and our global commitments, fiscal policy remains a
mess. 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.
Just when you
think things can’t get more absurd, they do (short):
Counterpoint
(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. Plus, there is a tiny ray of hope that fiscal
policy could make progress though its timing and magnitude are unknown. I continue to believe that the 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 7/31/17 12990
1605
Close this week 21830 2472
Over Valuation vs. 7/31
55%overvalued 20069 2480
60%overvalued 20716 2560
65%overvalued 21364
2640
70%overvalued 22011 2720
* 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.
