The Closing Bell
7/15/17
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 20386-22897
Intermediate Term Uptrend 18467-25716
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 2383-2685
Intermediate
Term Uptrend 2167-2961
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 heavily weighed to the negative: above
estimates: May consumer credit, weekly jobless claims, June industrial
production, June PPI and June CPI, ex food and energy; below estimates: weekly
mortgage and purchase applications, June retail sales, month to date retail
chain store sales, July consumer sentiment, May wholesale and business inventories/sales, the June small
business optimism index, June PPI, ex food and energy, June CPI and the June
budget deficit; in line with estimates: none.
However, the
primary indicators were mixed: June retail sales (-) and June industrial
production (+). I score this a negative
week: in the last 92 weeks, twenty-eight were positive, fifty-one negative and
thirteen neutral.
Overseas, the
numbers was almost nonexistent. Just two
datapoints out of China: June inflation was in line while the trade numbers
were quite strong.
With respect to fiscal policy reform, this
week held both good and bad news. On the
plus side, the senate placed its healthcare reform bill on the floor and the
CBO agreed that the 2018 Trump budget deficit would decrease (though not as
much as estimated by Trump). The
negative---Trump can’t get free of the Russian connection tar baby. As a result, the dems are working hard to
force the issue in hopes of delaying any legislation---so far
successfully.
Finally, the Fed
reversed course yet again, now on a more dovish course.
More on both
below.
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; though developments this week
were promising.
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
continues to be plagued with the Russian connection/Comey firing problems. 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] that said, the GOP is fighting back. This week, senate majority leader McConnell
delayed the beginning of the August recess in order to work on the GOP agenda
and then on Thursday presented the revised senate version of healthcare reform. I went through this in our Morning Calls---the
bottom line being that it is not a perfect bill but it does provide improvements.
I am hoping for further advances as it
works its way toward becoming a bill. I
cling to the theory that the legislative process is ugly and painful but that
ultimately if the objective is beneficial to the electorate, there is hope of
progress---‘hope’ being the operative word.
[c] the CBO provided a relatively positive review of
Trump’s 2018 budget proposal. Again, I covered
this in the Morning Calls---the bottom line is that while the CBO poo pooed the
estimated revenue increases, it did agree with the cost reductions. While it still has to be passed by congress,
at least it is the first time a president has proposed a budget with a lower deficit
in the last sixteen years.
That said, the reported June Treasury budget deficit was a disappointment
in that revenues were lower than expected {somebody please explain to me how
tax revenues can be declining in a supposedly growing economy where corporate
profits are supposedly increasing} and expenses were up due to increased
defaults in student debts.
For those of
you who missed Jamie Dimon’s rant on our political class, here is the
transcript. Hold your applause please.
(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 you know,
Yellen provided the Fed’s mandatory semiannual Humphrey Hawkins testimony this
week. In it, she backed off unwinding
QE---maintaining the tradition of keeping everyone scratching their heads
wondering what the f**k these guys are thinking about. Of course, anything makes sense when you
choose to ignore the facts.
Unfortunately,
one can disregard reality for only so long before it hits you in the face with
a two by four. Yellen & Co seemed to
have arrived at that juncture. The problem
is that in accepting that all is not well, it has elected to correct the
problem by selecting a nonoptimal solution; to wit, it decided to slow the rate
of rise in the Fed Funds rate {which is meaningless at this moment in the
economic scheme of things} but to go ahead with unwinding its grossly bloated
balance sheet {which is quite meaningful in the Market scheme of things}. Sure its initial moves will be baby steps;
but, in my opinion, it is QE that is most responsible for the gross mispricing
and misallocation of assets and its reversal will be felt the most powerfully
in the pricing and allocation of assets.
Goldman revises
odds of a rate hike (medium):
In short, the
Fed seems to have recognized that its ostrich strategy was damaging its
credibility but then decided to deal with reality by employing its least optimal alternative strategy---sort of
like it has done every other time it has tried to normalize monetary policy.
(4) geopolitical
risks: the good news is that ISIS appears to be on the run in Iraq and
Syria. The bad news is that [a] the US
and North Korea continue their missile firing extravaganza, [b] the US is
selling missiles to Poland and Romania, [c] and the Gulf States are still
threatening sanctions against Qatar. Nothing
may come of any of these problems; but they all pose a risk which we must
remain aware of.
(5)
economic difficulties around the globe. The stats were scarce this week. The only notable data was out of China which reported
inflation in line and a booming trade number.
Oil remains a
factor in global economic health and its price continued its roller coaster
ride this week, most of it brought on by rising inventories. We learned this week that [a] Nigeria is not
willing to stand by its proposed production allocation and [b] none other than
Saudi Arabia was violating its production quota under the recent OPEC agreement. The point here is that 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’.
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. Clearly,
the progress made in the senate on healthcare and the CBO positive review of
Trump’s FY 2018 budget are positives steps in that direction.
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 21637, S&P 2459) moved to the upside out of their one month trading
range; low volume and unimpressive breadth notwithstanding. So they appear to have regained 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.
The VIX (9.5) declined
another 3 %, finishing below the lower boundary 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 the lower boundary of its long term trading
range (if it remains there through the close next Thursday, it will reset to a
downtrend).
The long
Treasury rebounded just enough to end on its 200 day moving average as well as
the lower boundary of its very short term uptrend. Certainly not a decisive move and it leaves
me uncertain on direction and what bond investors are thinking about.
The dollar got
hammered, ending in a very short term downtrend and below its 100 and 200 day
moving averages. It is starting to rival
GLD as the most discouraging chart that I watch.
GLD, on the
other hand, moved up strongly---not too surprising in that GLD and the dollar
tend to move in opposite directions. It
finished above the upper boundary of its very short term downtrend and seems to
be moving toward a challenge of its 200 day moving average.
Bottom line: stock
investors continue to view bad news (struggling economic growth) as good news---because
they got plenty of bad news this week and prices were up. GLD and UUP investors seem to agree that the
news was bad because they reacted as they traditionally do. The somewhat confusing element is bonds. Given the TLT’s pin action, bond investors
appear uncertain about whether the economy is weak. As you know, I believe bond investors are
usually more in tune with global economic/political trends than others; so if
they are unsure, I am cautious in my expectations.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (21637)
finished this week about 66.6% above Fair Value (12990) while the S&P (2459)
closed 53.2% 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 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
continued to point to a weak economy; and the Fed’s renewed dovishness seems to
lend credence to that notion. 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.
There was a lot going
on related to fiscal policy this week.
The good news was that the senate made a step forward on healthcare and
the CBO gave a more upbeat scoring to the Donald’s FY 2018 budget than I would
have imagined. I am not jumping up and down for joy but any progress is still
progress. To be sure, I am not altering or
even contemplating altering our forecast given these recent developments. But I am encouraged and so, by definition,
closer to any change in outlook---which, in turn, would be a plus for equity
valuations in the long run (‘long run’ being the operative words).
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.
I guess my point
here is that the fiscal policy is creeping forward in spite of Trump/GOP
actions. Nonetheless, if, for whatever
reason, their agenda advances that is likely to have a positive impact on
business, consumer and investor sentiment.
On the other hand, I think that Street enthusiasm for a significant
improvement in the long term economic and profit growth is certainly premature. This should 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, Ms. Yellen, God bless her, just keeps making a mess of
monetary policy. As I noted above, this
week, the Fed begged off of rising interest rates because of worries about the
economy but stated it would continue to unwind its balance sheet. The result I believe will be that lower interest
rates will do little for the economy but shrinking the balance sheet will start
to put pressure on asset prices. As you
know, I have long time believed that correcting the mispricing and
misallocation of assets was an inevitable result of dismantling QE. According to Yellen, that process will begin
this year and I believe the results will be as I have expected.
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 and recent developments
in fiscal policy, that is not enough to alter the gross mispricing of assets. 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. Plus, there is a tiny ray of hope that fiscal
policy could be making progress though its timing and magnitude are unknown. 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 7/31/17 12990
1605
Close this week 21637 2459
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.
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