The Closing Bell
9/30/17
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 21243-23722
Intermediate Term Uptrend 18941-26272
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 (?) 2483-2758
Intermediate
Term Uptrend 2257-3031
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 a marginally higher upward bias to equity valuations. The
data flow this week was mixed: above estimates: month to date retail chain
store sales, weekly jobless claims, August durable goods, the September Dallas,
Richmond and Kansas City Feds’ manufacturing indices, the September Chicago
PMI, the August trade deficit; below estimates: August new home sales, weekly
mortgage applications, August pending home sales, September consumer confidence
and consumer sentiment, second quarter revised corporate profits, August durable
goods, ex transportation, the August Chicago Fed national activity index; in
line with estimates: the July Case Shiller home price index, second quarter
revised GDP, August personal income and spending.
The primary
indicators were also mixed: August new home sales (-), August durable goods (+)/ex
transportation (-), revised second quarter GDP (0), August personal income (0)
and spending (0). The call is neutral. Score: in the last 103 weeks, twenty-nine
were positive, fifty-six negative and eighteen neutral.
Overseas, numbers
out of Europe were mixed though the Japanese data showed improvement.
On the fiscal front,
(1)
the GOP tried again to resurrect the overhaul of
healthcare and failed. Aside from
keeping the American people saddled with Obamacare, it also eliminates any cost
savings that could be applied to tax reform,
(2)
the impact of Hurricanes Harvey, Irma and Maria. Damage estimates from them are now in $150-$200
billion plus range. To reiterate, this
will add to the deficit/debt and is not an economic plus no matter what the
chattering class alleges,
(3) the
lead story this week was the Trump/GOP tax reform package. I have gone over the major provisions, so I won’t
be repetitious. For me, the important
takeaways were (1) it is not revenue neutral and (2) it will have a difficult
time getting enacted. More on that
below.
Bottom line: this
week’s US economic stats were mixed, confirming the pattern for the last two
years---the economy struggling to keep its head above water. At some point, I would think that the
improving European economy would have some positive influence on our own; but
for the moment, that is not happening.
Longer term, with
the national debt now larger than GDP, I am less confident in my upgrading our
long term secular growth rate assumption by 25 to 50 basis points based on
Trump’s deregulation efforts. In addition,
any further increase in that long term secular economic growth rate assumption
stemming from enactment of the Trump/GOP fiscal policy is also up to question.
Our (new and
improved) forecast:
A now
questionable pick up in the long term secular economic growth rate based on
less government regulation. This hoped
for 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. Unfortunately,
any expected increase in the secular rate of economic growth could be rendered
moot if tax reform (assuming its passes) increases the national debt and the
deficit.
Short term, the
economy is struggling and will likely continue to do so; though the improving
global economy may at some point have an impact.
The
negatives:
(1)
a vulnerable global banking system.
(2)
fiscal/regulatory policy.
The Donald still hasn’t gotten the message. Random attacks [this time on the NFL] are a
distraction from governing. It bothers
me that he is wasting time and political capital on non-crucial issues. ‘Every minute he spends dicking around with
these issues is a minute not spent on healthcare reform, tax reform and keeping
the public safe.’
Speaking of reform:
[a] healthcare reform went down again and, with it, any
potential cost savings that could be used to pay for tax reform,
[b] Trump did present his/GOP tax reform bill which
delivered on the lower, simpler, fairer {?} tax regulation promise. While I believe that, if passed, it would be
a plus for the economy {i} we have no idea of the likelihood of enactment and
{ii} we can be fairly certain that, in its current form, it will not be revenue
neutral. As you know, I have long argued
that a heavily indebted country adding still more debt, even if it is intended
to stimulate growth, is unlikely to achieve its goal of returning to its historical
long term secular economic growth rate.
The Tax Policy Center released its analysis of the tax
proposal on Friday afternoon. Bottom
line, ‘fairer’ may have to be dropped from the description of the benefits of
the plan (medium):
And as usual, David Stockman has a few choice words on
the subject for the ruling class and the tax reform proposal (medium):
And remember that the US national debt is going up
whether or not there is tax reform because {i} congress just raised the debt
ceiling and [ii] the cleanup and repair expenses from this hurricane season are
not yet in the budget mix.
I am not saying that a revenue neutral tax reform package
won’t be a positive impact; I am saying that it won’t be as big as many hope.
[c] finally, this week the US slapped tariffs on a Canadian
aircraft manufacturer. While {i} this
action is a long way from being implemented and {ii} we don’t know if this is
just more bluff as part of the ongoing NAFTA negotiations, trade wars, tariffs,
border taxes are impediments to global growth and as such, I believe, if
implemented, it would be an economic negative.
My
bottom line on this issue: [a] if the fiscal agenda doesn’t get enacted, it is
not bad news. The result would be
continued gridlock and historically, that has been good news. However, it would mean that the potential
economic benefits from tax reform and infrastructure spending would not occur
and [b] even if tax reform and infrastructure spending do happen but further
increase the deficit spending and the federal debt, that would be a negative,
in my opinion.
(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.
This week’s big
monetary news was the Yellen [and other Fed officials] speech that [a]
reinforced the impression that the Fed is confused, in disarray and likely
scared to death of the market related repercussions of ending QE, [b] but
equally scared of the economic repercussions of not ending it. At the moment,
it appears that the latter has Yellen’s vote, so the unwinding of QE begins
next month.
It just needs
to be done faster (must read)
Of course, the
Fed isn’t the only central bank that has been pursuing aggressive QE policies---they
all have. But it may be that the latest
Fed move has provided the opening for them all to begin steps toward monetary
policy normalization: [a] an ECB official said that it should slow the pace of
asset purchases and [b] the Bank of England’s Carney said that he was
considering ‘taking his foot off the accelerator’.
You know my
bottom line: when QE starts to unwind, so does the mispricing and misallocation
of assets. That thesis is about to be
tested.
(4) geopolitical
risks: Domestic issues held the
headlines this week, but tensions between the US and North Korea, Iran and
Russia remain high. Nonetheless, we did
get some good news this week: [a] the Chinese ordered all North Korean
businesses to close by year end {this assumes that they will really follow
through} and [b] Iran said that it would abandon the nuclear deal {is this a
face saving move or a calculated risk that the US can’t get the rest of the
world back on board with sanctions? I
have no clue}.
This story
isn’t over and there remains a decent probability of an unpleasant
outcome.
(5)
economic difficulties around the globe. This week:
[a] the
September German business confidence was below forecasts while August inflation
and unemployment declined; UK GDP growth was below estimates,
[b] the
September Japanese Markit flash manufacturing index was strong, CPI was above
expectations but the core number was in line, industrial production was above
consensus while retail sales were below.
Despite the mixed data out of Europe, our
outlook remains that its economy is out of the woods. The improved Japanese stats are a hopeful
sign; but remember the Chinese numbers improved for a short time only to fall
back.
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 be stimulative. 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.
To be sure,
Trump’s drive for deregulation and improved bureaucratic efficiency is and will
remain a plus. As you know, I inched up
my estimate of the long term secular growth rate of the economy because of it. But I fear that thesis is about to be tested
if the congress passes non-revenue neutral tax reform---however, simpler and
fairer it may be.
The
Market-Disciplined Investing
Technical
The indices
(DJIA 22405, S&P 2519) keep on truckin’.
Volume was up and breadth continued to strengthen. Both remain above their 100 and 200 day
moving averages and are in uptrends across all time frames.
The VIX (9.5) fell
again It ended below the upper boundary
of its short term downtrend, below its 100 and 200 day moving averages and
below the lower boundary of its long term trading range for a third day. The question remains, did the VIX bottom in
July?
The long
Treasury was up, finishing above its 200 day moving average (support) and the
lower boundaries of its short term trading range and its long term uptrend. But it ended below its 100 day (I made a
mistake previously saying that it was the 200 day moving average) for a third
day, reverting to resistance.
The dollar was down,
remaining in its short term downtrend and below its 100 and 200 day moving
averages. However, it has negated its
very short term downtrend.
GLD fell, but
still ended above its 100 and 200 day moving averages (both support) and the
lower boundary of a short term uptrend. However,
it is developing a very short term downtrend.
Bottom line: long term, the indices remain
strong viz a viz their moving averages and uptrends across all timeframes. Short
term, they are above the resistance level marked by their August highs, meaning
that there is no resistance between current price levels and the upper boundaries
of the Averages long term uptrends.
On the other
hand, all those gap openings from two Monday’s ago still need to be
closed. Plus while the nonstock indices are off their highs
(lows) from that Monday, each has only challenged one of a number of resistance
(support) levels. So it is not at all
clear that reversals are occurring versus just some consolidation. In economic terms, the question remains as to
whether they are starting to discount a stronger economy/higher rates.
I remain
uncomfortable with the overall technical picture.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA and the
S&P are well above ‘Fair Value’ (as calculated by our Valuation Model). However, it could be rising based on a new set
of regulatory policies which could lead to improvement in the historically low
long term secular growth rate of the economy (depending on the validity of
Reinhart/Rogoff); 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 reflect sluggish to little growth.
On the fiscal
front, congress failed at its second try at healthcare reform and robbed itself
and the electorate of any cost saving that could be applied to tax reform. Speaking of which, the Trump/GOP tax reform proposal
was presented on Wednesday. While it clearly
hasn’t been passed, if it does in its current form, it will raise the
deficit/debt. To be sure, a simpler, fairer
(?) tax code is a plus and may add marginally to the secular growth rate. However, I remain convinced that, given the
magnitude of the current national debt, the current proposal will not provide
the impetus to economic growth many hope for.
As a result,
even if passage is achieved, I believe that Street estimates for economic and
corporate profit growth are too optimistic based on the improving economy,
fiscal reform narrative. And when it
wakes up from this fairy tale that could, in turn, lead to declining growth
expectations as well as valuations.
That said,
fiscal policy is a distant second where it comes to Market impact. The 800 pound gorilla for equity valuations
is central bank monetary policy based on the thesis that (1) QE did little to
help the economy but led to extreme distortions in asset pricing and allocation
and (2) hence, its unwinding will do little to hurt the economy but much to
equities as the severe perversion of security valuations is undone.
That thesis is
about to get tested with the Fed announcing the unwind of its balance sheet and
other central banks are making noises like they could follow suit.
Bottom line: the
assumptions on long term secular growth in our Economic Model may be beginning
to improve as we learn about the new regulatory policies and their
magnitude. Plus, there is a ray of hope
that fiscal policy could further increase that growth assumption though its
timing and magnitude are unknown. On the
other hand, we don’t know if the size of the national debt would negate any
potential positive. In any case, I continue to believe that the current Street
narrative is overly optimistic---which means Street models will ultimately will
have to lower their consensus of Fair Value for equities.
Our Valuation
Model assumptions may be changing depending on the aforementioned economic
tradeoffs impacting our Economic Model.
However, even if tax reform proves to be a positive, 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 9/30/17 13074
1615
Close this week 22405
2519
Over Valuation vs. 9/30
55%overvalued 20264 2503
60%overvalued 20918 2584
65%overvalued 21572
2664
70%overvalued 22258 2745
* 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.
