The Closing Bell
9/16/17
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 21099-23578
Intermediate Term Uptrend 18856-26197
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 (?) 2466-2750
Intermediate
Term Uptrend 2245-3019
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 basically mixed: above estimates: weekly mortgage and purchase applications,
month to date retail chain store sales, weekly jobless claims, the August small
business optimism index, the September NY Fed manufacturing index, August PPI;
below estimates: August retail sales, preliminary September consumer sentiment,
August industrial production, August wholesale inventories/sales, August CPI; in
line with estimates: August CPI, ex food and energy.
However, the
primary indicators were negative: August retail sales (-) and August industrial
production (-). So the call is negative. Score: in the last 101 weeks, twenty-nine
were positive, fifty-five negative and seventeen neutral.
Update on big
four economic indicators (medium):
NY Fed, Atlanta
Fed, Goldman slash third quarter GDP estimates (medium):
Overseas, the data
was negative. Of particular note was a
series of bad numbers out of China. As
you know, I have been paying special attention to China of late as it seemed to
be trying to break out of the ‘muddle through’ scenario. The last two week’s stats suggest otherwise.
Three other notable
items on the economic front:
(1)
the impact of Hurricane Irma. This is the second catastrophic natural
disaster in the last month. Estimates
from Harvey are now in $150 billion plus range but it appears that Irma’s
damage will be less than anticipated---not that it isn’t sizable. To reiterate a point, this is not an economic
plus no matter what the chattering class alleges [sort of like lower oil prices
were an unmitigated positive].
(2) Speaker
Ryan announced that the GOP would present a tax reform bill by 9/25. However, that didn’t stop Trump from pursuing
his new Clintonesque triangulation strategy by conferring with dems on the
subject. Whether that is good news or
bad news depends its enactment and how revenue neutral it is [or not],
(3) the
US national debt achieved the $20 trillion mark [versus GDP of $19 trillion] and
will grow by $700 billion in FY2017---something for which no one should be
proud; and it makes a revenue neutral tax reform bill all the more important.
I want to reemphasize
a point that I have made several times.
If the Reinhart/Rogoff study is anywhere near correct [countries with
national debt larger than 90% of GDP cease to grow], then the current level of
debt may be far more important to growth [or the lack thereof] than any tax
reform/infrastructure bill. Clearly,
Reinhart/Rogoff is backward looking and is at best a hypothesis, not some immutable
law. Nonetheless, it is based on a lot
of data; so I believe that we have to keep it in mind as we analyze the
potential results of any tax reform/infrastructure legislation.
Bottom line: this
week’s US economic stats were negative, confirming the pattern for the last two
years---the economy struggling to keep its head above water. The question is, has it stopped sinking? 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 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
negatives:
(1)
a vulnerable global banking system.
(2)
fiscal/regulatory policy.
The Donald is almost on a roll. To be sure, the tone of his tweets and his
general demeanor continue to show a marked change. In addition, he was making great strides in
breaking the extreme partisanship that has characterized congress for the last
16 years.
However, Wednesday night, the Donald met with
democratic congressional leaders during which the ‘dreamers’ and the ‘wall’
were apparently discussed; and the result was not what I would want. The last two days of the week witnessed an
endless stream of he said, she said back and forth between Trump and the dem
leaders about what was allegedly agreed to---or not.
To be clear, neither of these issues makes a tinker’s
damn to the economy. So why am I wasting
space discussing it? Because the dem’s
version would be a step too far for the GOP, in that, Trump gave up on funding
the ‘wall’ and agreed to amnesty for the ‘dreamers’---both important issues to
the GOP. Although, given all the
wrangling back and forth, it appears that either [a] the dem’s version was
bulls**t or [b] once Trump realized that he had made a bad deal, he renounced
it.
The point here being that the Donald’s debt ceiling compromise
with the dems was likely successful in pushing republicans to find agreement
among themselves on key GOP fiscal agenda policies. But he had given the GOP a chance at a
healthcare agreement and it failed. They
had nobody to blame but themselves. In
this latest case, he may have made a deal [and subsequently welched on] on two social
issues that the GOP hadn’t had a chance to vote/agree on. And that could [a] really anger his base and
GOP congressional support and [b] therefore, hinder not help the passage of
his/the GOP’s fiscal agenda---making the odds of tax reform and infrastructure
spending legislation go down. At this
point, it appears that there is/was no agreement; but the dispute over it could
put a hitch in the tax reform gitty up.
Speaking of which, the GOP said that it would present
a tax reform bill on 9/25. The keys to
watch for are [a] did this wall/dreamer brouhaha poison Trump’s relations with
the congressional GOP, [b] whether or not the republicans have enough support
within their caucus {and/or with the aid of some dems} to get the measure passed
and [c] whether or not the result is revenue neutral---ex any funny accounting
{Mnuchin has already hinted that it would be revenue neutral based
on a GDP growth rate of 3%. Boys
and girls, that is not revenue neutral.}
Now we wait.
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,
[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 and [c] if Reinhart/Rogoff are right, it may not matter either
way.
(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
monetary news came from across the pond.
Both the Swiss National Bank and the Bank of England left rates and
their bond buying programs unchanged.
However, the BOE did say that it expected to begin normalizing its QE in
the near future.
So now we have four
possible reasons why the Fed may start to unwind QE whether it likes or not:
[a] a weakening dollar {hurts trade relations}, [b] Trump has the opportunity
to replace three members on the FOMC board {could tilt to a less Keynesian
philosophy}, [c] the BOE could force their hand {hurt the dollar even more} and
[d] the tax reform bill is highly stimulative, at least in appearance {giving
the Fed cover to withdraw QE}.
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.
The Fed has no
credibility (medium):
(4) geopolitical
risks: North Korea remains a focus as an
international hotspot. The good news is
that [a] the UN Security Council, including China and Russia, passed another
round of sanctions against North Korea, albeit less onerous than the US
originally proposed and [b] Trump continues to act like the adult in the room. The bad news is that North Korea ramped up the
threats to both Japan and the US on Thursday and then fired a missile on Friday.
This story
isn’t over and there remains a decent probability of an unpleasant
outcome.
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.
A glimmer of
hope (medium):
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, the last couple of week’s
performance marks a change in his presentation.
(5)
economic difficulties around the globe. This week:
[a] August UK
CPI was above expectations; the Swiss National Bank lowered its 2017 GDP growth
projections,
[b] August Chinese
inflation was a bit hotter than anticipated; its retail sales, industrial
production and fixed investment were below consensus.
Our
outlook remains that the European economy is out of the woods. But the stats out of China the last two weeks discourage
any thought that it might be a candidate for removal from the ‘muddle through’
scenario.
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.
For better or
worse, with the debt ceiling deal, the Donald has likely altered the political
dynamics in Washington. Plus, he took a
similar step this week on tax reform---sitting down with the dems thereby
avoiding being totally dependent on the GOP to accomplish this goal. That said, I have no idea if this is good
news or bad news.
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 believe that the order of magnitude of
its effect is less than the enactment of healthcare, tax reform and
infrastructure spending would be.
On the other
hand, the latest data on the national debt may make all this irrelevant.
The
Market-Disciplined Investing
Technical
The indices
(DJIA 22268, S&P 2500) had a good day and a good week, both closing on all-time
highs. Volume rose, but that was largely
a function of quadruple expirations; breadth continued strong. Both remain above their 100 and 200 day
moving averages and are in uptrends across all time frames.
The VIX (10.0)
was down 5% on Friday in a poor week. It
is below the upper boundary of its short term downtrend, below its 100 day
moving average (now resistance), below its 200 day moving average (now
resistance) and below the lower boundary of a developing very short term
uptrend. The question as to whether or not the VIX has bottomed remains open,
but it appears that it is about to be answered.
The long
Treasury was up again, finishing above its 100 and 200 day moving averages
(both support) and the lower boundaries of its short term trading range and its
long term uptrend but below the resistance level marked by its August
high.
The dollar was
down again, remaining in short term and very short term downtrends and below
its 100 and 200 day moving averages and in a series of seven lower highs. It has closed last Monday’s gap open, meaning
that there is nothing, technically speaking to pull it upward.
GLD decline, but
still ended above the lower boundaries of its short term and very short term
uptrends, above its 100 and 200 day moving averages (both support) and has made
a fourth higher low.
Bottom line:
long term, the indices remain strong viz a viz their moving averages and
uptrends across all timeframes. Short term, the Dow closed above the resistance
level marked by its August high, putting it back in sync with the S&P. That also means 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 Monday gap openings among the major indices still need to be
closed.
Finally, the
unambiguous performances of TLT, GLD and UUP continue to point at a weakening
economy.
I remain
uncomfortable with the overall technical picture.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (22268)
finished this week about 70.3% above Fair Value (13074) while the S&P (2500)
closed 54.7% overvalued (1615). ‘Fair
Value’ may 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 (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. To be sure, the odds of some action on fiscal
policy got a boost last week (1) with the Trump/dem debt ceiling/Harvey funding
deal and (2) Trump’s apparent willingness to bring the dems in on the tax
reform legislation. On the other hand,
the wall/dreamers fiasco could hurt Trump’s already strained relations with the
GOP and their willingness to cooperate.
Even if no
damage has been done that doesn’t mean that the economic outlook will
necessarily improve. Certainly, revenue
neutral tax reform would be a plus in terms of fairness but the current size of
the national debt may impede any positive impact on GDP growth. Of course nothing could happen (not bad, just
not good). Or congress could pass a
tax/infrastructure bill that explodes the federal debt/deficit even higher---and
that would be economically detrimental, in my opinion.
In any case, I
believe that Street estimates for economic and corporate profit growth are too
optimistic based on an improving economy, easy Fed, 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. 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 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 as the
severe perversion of security valuations are undone.
Given the
universal hesitancy of central banks to correct this problem, the question has
been what circumstance would force one or more of them to take the step toward
normalization. Until recently, the answer
was nothing more than a guess. Now there
appear to be developments which I outlined above that could provide that answer. This is not to say that any one or
combination of more will in fact start the ball rolling. But, in my opinion, sooner or later it is
going to happen and the great unwinding of asset mispricing and misallocation
will begin. 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 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 22268
2500
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.
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