8/26/17
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 20875-23304
Intermediate Term Uptrend 18745-25996
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 (?) 2437-2722
Intermediate
Term Uptrend 2226-3000
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. The
data flow this week was mixed: above estimates: month to date retail chain store sales, weekly
jobless claims, the August Richmond and Kansas City Feds’ manufacturing indices,
the August Markit flash services PMI; below estimates: weekly mortgage and
purchase applications, July housing starts, July existing home sales, the July Chicago
national activity index, the August Markit flash manufacturing PMI; in line
with estimates: July durable goods orders.
But the primary
indicators were negative: July housing starts (-), July existing home sales (-)
and July durable goods (0). So this is
an easy call---negative. Score: in the
last 98 weeks, twenty-nine were positive, fifty-three negative and sixteen
neutral.
This brings to
an end the four week string of neutral ratings.
Last week, I opined that while too early to make the call, that series
of mixed data could mean that the economy ceased to deteriorate. Clearly ‘too early’ were the operative
words. Still there is the question,
which was the outlier: this week or the preceding four?
Overseas, the
numbers were scarce but the positive news out of Europe continued reinforcing
its removal from the global ‘muddle through’ scenario.
On fiscal policy, the good news is that
Trump delivered a sound foreign policy speech on Monday; the bad news is that
he screwed it up on Tuesday, saying that he would (1) shut down the government
if congress didn’t finance the southern wall and (2) terminate NAFTA. According to The Art of the Deal, threats are
all part of the negotiating process. But
if he makes good on those threats, it will likely make enactment of tax reform
all the more difficult.
To be sure, Ryan and McConnell, who were
joined Thursday night by Gary Cohn, are trying keep the Trump/GOP tax reform on
track. But at this point, if we get reform,
it will be in spite of the Donald not because of. In my opinion, the more he threatens, the
more he insults the very people he needs to accomplish his agenda, the less likely
he is to achieve it---The Art of the Deal notwithstanding. I want to be hopeful because his goals are
worthy; but I am distressed by his actions, tweets, etc. which, in my opinion, lower
the odds of success.
Bottom line: this
week’s US economic stats were 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. 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 the Washington morality play
unfolds.
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 and getting worse by the day.
Short term, the economy may be flattening out;
though that doesn’t alter our recession/stagnation forecast. A pickup in global economic activity may have
halted further deterioration---‘may’ being the operative word.
The negatives:
(1)
a vulnerable global banking system. Nothing this week.
(2)
fiscal/regulatory policy. There was some action this week was on the
trade front:
[a] the
first round of negotiations for modernizing the NAFTA trade treaty wrapped
up. There was no statement released; but
Trump added his two cents worth, saying that he didn’t believe that much will
be accomplished and, if so, he would terminate the agreement. I opined in
Thursday’s Morning Call that I thought that this was just part of his
negotiating technique.
[b] the
US and South Korea began discussions on adjustments to their trade
agreement. My guess is that if things
don’t go swimmingly, the Donald will make the same implied threat of trashing
the treaty. Ditto on his negotiating
technique.
[c] the
US imposed sanctions on several Chinese and Russian individuals/companies that
were trading with North Korea in violations of the sanctions on it.
As you
know, I have to date considered Trump’s efforts on trade a potential plus for
the US economy. I believe that his point
that the US has shouldered more than its fair share of responsibility for
improving trade and defending the globe is a valid. We simply don’t have the resources to play
the benign benefactor for the rest of the free world. Not that we shouldn’t do our part. But our charity is helping to bankrupt
us. So I accept that playing hard ball
with those we are negotiating with is all part of the process. However, doing it in public, in my opinion,
backs our partners against the wall, makes the whole process more difficult and
lessens the odds of achieving our goals.
Of course, I didn’t author ‘The Art of the Deal’, so what do I know?
In
another negotiating gem, Trump threatened to shut down the government if
congress didn’t fund the southern wall.
I understand that building ‘the wall’ was a big campaign pledge; and I understand
that he might be willing to go to the mat to get it done. But again, he has yet to prove that negotiating
in public is the way to accomplish his goals; and until it does, I remain a
skeptic. That said, apparently the bluff
is working because many believe that a shutdown will occur [I guess that means that
it is not a bluff].
On the
other hand, hopeful rhetoric came from Paul Ryan who assured us that congress
would pass tax reform and from Gary Cohn who promised that Trump would focus on
tax reform this fall. It makes sense to
me that tax reform would be easier to accomplish than healthcare reform. However, [a] the GOP congress is so dysfunctional
that I think the burden of proof lies with them; so for the moment I am hopeful
but skeptical that republican leadership can deliver, especially if the Donald
keeps up his verbal assault on anything that moves on capitol hill and [b] if
the final product does not favor the middle class and/or is not revenue
neutral, it will likely be more of a negative than a plus.
While I disagree
with the author’s more upbeat assessment of the economy, I do think that he
nailed the political/fiscal environment (medium):
(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.
Yellen and
Draghi have come and gone; and to quote George Costanza, the show was about ‘nothing’. Current monetary policy was basically ignored
by both; so Market expectations should hardly change; though concerns were assuaged
by some who feared that the comments by one or both would be hawkish. Not so.
Jackson Hole was a barely reportable event. For those who want to agonize their way
through the speeches, the links are below.
Yellen’s
comments:
Draghi’s comments:
(4) geopolitical
risks: the North Korean/US standoff did another U turn as [a] the US imposed
the aforementioned sanctions on Chinese and Russian individuals/companies, [b]
the US and South Korea began {annual} war game exercises [c] Russia flew
nuclear capable bombers near the Korean peninsula and [d] North Korea cranked
up the rhetoric. We can only hope this remains
a slow simmer.
***overnight, North
Korea launches three missiles.
Still there
remains plenty of hotspots that could explode any minute: Syria, the Qatar
sanctions, US/Russian confrontation, the US sanctions on Chinese and Russian
individuals/companies, Trump’s aggressive language on Iran and Venezuela.
I am not trying
to fear monger war; but I do think that Trump’s aggressive attitude toward
foreign opposition is overdone and increases the risk of a costly misstep.
(5)
economic difficulties around the globe. This week, the stats out of Europe were mixed
to positive: August German confidence remained high but declined, the August
Market EU manufacturing, services and composite PMI’s were better than
estimates, second quarter UK GDP was in line but household spending was weak.
In sum, our
outlook remains that the European economy is out of the woods.
Bottom
line: our near term forecast is that the
US economy is stagnate though there is a possibility that the improved
regulatory outlook and a now growing EU economy may halt any worsening. Further, 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.
That said, this
week the Donald again snatched defeat from the jaws of victory, completely
undoing a positively received foreign policy speech by blasting the ongoing NAFTA
negotiations, congressional leadership and threatening to shut down the
government---further abetting the demise of the Trump/GOP fiscal program. I dwell on this because, at the moment, in my
opinion, the single biggest factor that could impact a change in the future
long term US secular economic growth rate is the success or failure of the
Trump/GOP fiscal program.
To be sure,
Trump’s drive for deregulation and improved bureaucratic efficiency is and will
remain a decided plus. As you know, I
inched up my estimate of the long term secular growth rate of the economy
because of it. But the order of
magnitude of its effect I believe is less than the enactment of healthcare, tax
reform and infrastructure spending would be.
The
Market-Disciplined Investing
Technical
The indices
(DJIA 21813, S&P 2443) had another volatile day, smoking to the upside
early on, then giving a big part of it back throughout the rest of the day. Volume was down; breadth improved. The S&P remains in focus as it (1) toys
with the lower boundary of its short term uptrend, (2) is developing a very
short term downtrend and (3) also could potentially be forming a head and
shoulders pattern. To be clear, the
index is above its 100 and 200 day moving averages and in uptrends across all
timeframes. So the aforementioned
potential negatives are just that---potential negatives. Until there is some follow through on any of
them, nothing has changed. Meanwhile,
the Dow isn’t close to challenging any support level.
The VIX (11.2) fell
7 ¾ %, leaving it below the upper boundary of its short term downtrend and (1)
its 100 day moving average (now support; if it remains there through the close
on Tuesday, it will revert to resistance) and 200 day moving average (now
support; if it remains there through the close on Wednesday, it will revert to
resistance). However, it still finished
above the lower boundary of a developing very short term uptrend. I am left questioning whether or not the VIX
has bottomed.
The long
Treasury was up strong, ending above its 100 and 200 day moving averages (both
support), the lower boundaries of its short term trading range and its long
term uptrend and has now made a third short term higher high. That is a lot of support.
The dollar got pounded,
closing in a short term downtrend, below its 100 and 200 day moving averages
and right on the lower boundary of its short term trading range. If that support level is successfully
challenged, there is not much support for another 3% on the downside.
GLD was up on volume, finishing above the lower
boundary of its very short term uptrend, above its 100 and 200 day moving
averages (both support) and pennies away from the upper boundary of its short
term trading range.
Bottom line: the
S&P continues to struggle, technically speaking, over the short term. Whether or not this pin action turns into
something negative remains to be seen. In the meantime, long term its uptrend
remains intact supported by a less technically challenged DJIA.
TLT, GLD and UUP
continue to point to a weak/sluggish economy, lower inflation and soft interest
rates.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (21813)
finished this week about 67.3% above Fair Value (13032) while the S&P (2443)
closed 51.7% overvalued (1610). ‘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 reflect sluggish to little growth. If I am correct about the economy slowing/stagnating,
short term that means Street economic growth 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.
Much of the
Street economic growth expectations are grounded on fiscal policy reform. Unfortunately, that is in disarray not only
because the republican congress can’t get its house in order but also because
the Donald keeps shooting himself (and the odds of achieving his fiscal policy
goals) in the foot. What is bothersome
is that it is serial behavior that I fear will have the cumulative effect of
trashing the odds of any policy success.
I just hope that I am wrong on this call. The good news is that the worst case scenario
is gridlock which is not all that bad. Nonetheless,
as I said, Street economic growth expectations are higher than mine; so if I am
correct that in turn means lower equity valuations based on slower growth
estimates.
However, fiscal
policy is a distant second where it comes to Market impact. The 800 pound gorilla for equity valuations
is central bank monetary policy.
Unfortunately, this crowd continues 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.
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. Stock
prices have ballooned and are now at or near historical extremes in valuation; 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 further increase that growth assumption 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 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 8/31/17 13032
1610
Close this week 21813
2443
Over Valuation vs. 8/31
55%overvalued 20199 2495
60%overvalued 20851 2576
65%overvalued 21502
2656
70%overvalued 22154 2737
* 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.
