The Closing Bell
9/2/17
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 20966-23475
Intermediate Term Uptrend 18800-26131
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 (?) 2447-2732
Intermediate
Term Uptrend 2233-3007
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 well above average and, in the end, slightly weighed to
the negative: above estimates: the June
Case Shiller home price index, August and month to date retail chain store
sales, the ADP August private payroll report, weekly jobless claims, August
consumer confidence, the August Dallas Fed’s manufacturing index, the August
Chicago PMI, the August ISM manufacturing index, revised second quarter GDP;
below estimates: weekly mortgage and purchase applications, the July pending
home sales index, July construction spending, August nonfarm payrolls, August
consumer sentiment, July personal spending, August light vehicle sales, July
retail inventories, July wholesale inventories, the August manufacturing PMI,
July export and import prices, revised second quarter corporate profits; in
line with estimates: July personal income.
The primary
indicators were solidly negative: revised second quarter GDP (+), July personal
income (0), July construction spending (-), July personal spending (-), August
nonfarm payrolls (-). So again, an easy
call---negative. Score: in the last 99
weeks, twenty-nine were positive, fifty-four negative and sixteen neutral.
It would appear
that the four week string of neutral ratings was just a brief respite in the midst
of slowing economy. I would still like a
bit more data before making that call.
Overseas, the EU
data continues to improve while the Chinese numbers were mixed, but getting
better.
The other
notable item on the economic front was the impact of Hurricane Harvey on Texas
and Louisiana. All we have at the moment
are estimates of the damage, so we really don’t know the ultimate effect. There is talk among the financial class that
this tragedy will prove beneficial in an economic sense; that is, all the reconstruction
work and replacement spending on lost items will be stimulative.
I have a hard time with this narrative (1) it
makes no mathematical sense to argue that destroying $150 billion dollars in
assets is a positive economically because [a] that money could have been spent
on something else which would have been additive to the economy and [b] many of
those assets will never be replaced.
First of all, insurance doesn’t cover flood damage. There are many victims that simply won’t be
able to afford to replace lost items.
Parts of Houston are like the ninth ward in New Orleans---houses will get
scrapped and never rebuilt. Plus, what
bank is going to lend the money and what insurance company is going insure?,
(2) as I noted earlier this week, if the aforementioned was a valid argument,
then Hiroshima would have been economically stimulative for Japan.
http://www.zerohedge.com/news/2017-09-01/nobody-has-eat-losses-houstons-hot-mess-conditioned-america
Harvey wreaking
havoc in the chemical industry (medium):
And if that wasn’t
enough; beware Hurricane Irma (medium):
Here is another
problem that almost no one is talking about (you can ignore the politics if you
like):
The other item I
have to mention is that Trump went an entire week during which he made two
major speeches and never insulted or threatened anyone or made some lame, factually
challenged statement. If he can just
keep doing that, the odds of passage of some or all on the Trump/GOP fiscal agenda
will go up.
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. 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, 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.
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 hurdle debt
poses to long term economic growth (medium):
The
negatives:
(1)
a vulnerable global banking system. Nothing this week.
(2)
fiscal/regulatory policy. for the first time in a while, Trump actually
made it through the week without stepping on his own dick:
[a] he acted and sounded presidential in his handling
of the hurricane tragedy in Texas and Louisiana,
[b] he kept his cool after the disturbing North Korean
launch of a missile that over flew Japan.
No ‘fire and fury’ or other bombastic rhetoric. I am not suggesting that there will be no repercussions. I am just saying that hopefully he is
adopting Teddy Roosevelt’s strategy of ‘talk softly but carry a big stick’.
I don’t
know if we just got lucky or the Donald is finally reigning himself in. We will know that soon enough. But if he is gaining some self-control, it
would be a plus for the implementation of the Trump/GOP fiscal agenda. That doesn’t mean that it will get passed; it
just means that the odds would go up.
***late yesterday, Trump blinked on his threat to shut
down the government if congress didn’t fund the wall, informing congress that
funding for the wall need not be in the legislation raising the debt limit.
[c] Trump presented his proposal for tax reform and
apparently will make a series of speeches promoting it. The major points were simplifying
the tax code, lowering corporate tax rates, lowering middle class tax rates and
repatriating the foreign profits of US firms. On the surface, it sounded
great. However, it was woefully short of
details, the most important of which was where the money comes from to pay for
it.
But just
to reiterate 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.
Not a lot
occurred on this front this week. The
Bank of Japan said that it would maintain an accommodative monetary
policy. And in an interview, Draghi
sounded the same. So there is no real
news here.
I do think that
the economic fallout from Harvey could very well provide the cover the Fed
needs to do nothing in its September and perhaps even its December
meetings. But I was giving even odds of
nothing occurring anyway; so again, what is new.
My thesis here
remains unchanged: any tightening in monetary policy will have little impact on
the economy but will likely wreak havoc on the securities’ markets.
Counterpoint:
(4) geopolitical
risks: North Korea remained a hotspot as
the regime launched a series of missiles, one of which over flew Japan. That is really a major no no for anyone; and
the good news is that the international community treated as such. Meanwhile, Trump surprisingly kept his cool;
though the US did respond by sending B 1 bombers and the US’s most sophisticated
fighter jets to South Korea. To be sure,
this story isn’t over and there remains a decent probability of an unpleasant
outcome. But for the moment, the US is
acting the part of the adult in the room.
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. Hopefully, this week’s performance marks a
change in his presentation.
(5)
economic difficulties around the globe. This week:
[a] August EU economic
confidence hit a ten year high, inflation was slightly above consensus; the
August EU manufacturing PMI was in line while the UK PMI was above estimates,
German unemployment declined,
[b] August
Chinese industrial profits increased but at a slower rate than anticipated;
August Chinese manufacturing PMI and Caixin PMI came in above expectations
while the services PMI was below.
In sum, our
outlook remains that the European economy is out of the woods. In addition, the Chinese economy seems to be
improving; though it is too soon to change our forecast.
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.
Fortunately, the
Donald went the entire week without pissing anyone off or sticking his foot in
his mouth. We can only hope this is the
beginning of a trend because if it is, the odds of some kind of fiscal reform
probably goes up. 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 21987, S&P 2475) ended the week on a high note with much improved
breadth but weaker volume. Both are
above their 100 and 200 day moving averages and are in uptrends across all time
frames. The only impediment to a move on
the upper boundaries of their long term uptrends is the resistance offered by
their former all-time highs.
The VIX (10.1) fell
another 4 ½ % on Friday, leaving it below the upper boundary of its short term downtrend,
below its 100 day moving average for the third day, reverting to resistance, below
its 200 day moving average for the third day (if it remains there through the
close next Monday, it will revert to resistance) and below the lower boundary of
a developing very short term uptrend. It
is again challenging the lower boundaries of its former intermediate and long
term trading ranges. The question as to whether
or not the VIX has bottomed is about to be answered.
The long
Treasury declined 1% on volume, but ended 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. The negative in this chart is that this week
it touched a prior resistance level and fell back. However, this is only a problem if it fails
to make a higher low.
The dollar rose,
but still finished in a short term downtrend and below its 100 and 200 day
moving averages and in a series of six lower highs. The only good news is that it remained above the
lower boundary of its short term trading range.
GLD had a good day (week), ending above the lower
boundaries of its short term and very short term uptrends and above its 100 and
200 day moving averages (both support).
Bottom line: the
Averages are now back in sync and moving higher. The level to watch now is their former all-time
highs. Surpass that level and there will
be no resistance until they meet the upper boundaries of their long term
uptrends.
On the other
hand, the performances of TLT, GLD and UUP are not reflecting an improving
economy; if that is what has equity investors jiggy. I continue to be uncomfortable with the overall
technical picture.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (21987)
finished this week about 68.1% above Fair Value (13074) while the S&P (2475)
closed 53.2% overvalued (1615). ‘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 reflect sluggish to little growth. Street economic growth expectations are more
optimistic---grounded on fiscal policy reform.
This got a boost this week from (1) the Trump tax reform proposal;
though to be fair, there were few details and nothing about what it would cost
and (2) Trump acting like an adult. In
two speeches, he remained on script, did not insult or threaten anyone, did not
respond to the media baits and avoided any volatile factually challenged
comments. Now if he can just keep restraining himself, we might actually get
some pro growth economic fiscal policies.
That said,
gridlock is not the worst thing that could happen. Indeed, a tax/infrastructure bill that explodes
the federal debt/deficit even higher would be more economically detrimental
than nothing happening.
In any case, I believe
that Street estimates for economic and corporate profit growth are higher than
my own and that could in turn lead to declining growth expectations as well as
valuations. 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.
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.
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 9/30/17 13074
1615
Close this week 21987
2475
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.
No comments:
Post a Comment