The Closing Bell
9/23/17
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 21193-23762
Intermediate Term Uptrend 18888-26219
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 (?) 2473-2757
Intermediate
Term Uptrend 2251-3025
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 tilted to the negative: above estimates: August housing permits, weekly jobless claims,
the September Philly Fed manufacturing index and the August leading economic
indicators; below estimates: the September housing market index, August housing
starts, August existing home sales, month to date retail chain store sales, the
September Markit flash services and composite PMI’s, the second quarter trade
deficit, August import/export prices; in line with estimates: the September
Markit manufacturing PMI.
However, the
primary indicators were mixed: August housing starts (-)/ building permits (+),
August existing home sales (-) and the August leading economic indicators (+). Given the
overall count, the call is negative.
Score: in the last 102 weeks, twenty-nine were positive, fifty-six
negative and seventeen neutral.
Overseas, the data
was again quite positive for the EU.
However, the bad news from China keeps on coming. This week Moody’s and S&P downgraded its
credit rating due to its excessive level of debt.
The lead story
this week was the Fed’s decision to begin unwinding its balance sheet. For me, the most important point coming out
of the subsequent narrative was how adamant it was that the timetable for
completion of normalization was pretty much set in stone. Assuming this is just
not more Fed double speak, that means that there won’t be any more of the past ‘on
the one hand, on the other hand’ waffling as an excuse to stay accommodative. More on all this below.
On the fiscal front,
(1)
the GOP tried to resurrect the overhaul of healthcare
and again McCain’s conscience just wouldn’t allow him to vote for it [jerk off]. 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 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, this will add to the
deficit/debt and is not an economic plus no matter what the chattering class
alleges,
(3) the GOP is set to announce its tax reform package
on Monday. More below but the bottom
line is, if it is not revenue neutral, I fear it will do little by way of
stimulating the economy,
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 now
questionable 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. On the
other hand, 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 continues to exercise control over his
mouth which in itself assists accomplishing the Trump/GOP fiscal agenda. I would make one exception to that comment---which
was the hot tongue he laid on North Korea, Iran and Venezuela at the UN this
week. I don’t have a problem with doing
it in private; but I worry that making an existential threat to North Korea in
public could make a misstep more likely.
That said the republicans are still trying
to move forward with their agenda.
(1)
they attempted to give healthcare reform another try;
but failed [thank you again Mr. McCain].
Now whatever cost savings might have been produced by this measure is
lost,
(2)
the GOP has promised us a tax reform package this
coming Monday. The major selling point
that the republicans keep pointing to is middle income tax cuts with the higher
brackets staying current levels. That
this bill will simplify and make the tax system more fair is a big plus.
However, that it will be stimulative---a second
selling point---I believe is questionable.
As you know, I keep referring to the Reinhart/Rogoff study that
indicates that developed countries with national debt more than 90% of GDP grow
at lower secular rates than normal and sometimes don’t grow at all. With the US at 100% debt to GDP, that
suggests that any tax reform will not be as stimulative as it is being
sold. In fact, Secretary Mnuchin has
said that the tax reform measure will be revenue neutral assuming a 3% GDP growth. Since our GDP isn’t even growing at
that rate now, if Reinhart/Rogoff are correct, then GDP growth would never
reach that level. The only thing that
would grow is the national debt.
(3)
speaking of which remember [a] our leaders just raised
the national debt limit which itself is an increase in the deficit/debt and [b]
none of this takes into account the money that will be spent repairing the
damage from Hurricanes Harvey and Irma.
So whatever the deficit/debt is projected to be now, it will only get
bigger as these bills come due.
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
news was the FOMC meeting, following statement and the subsequent Yellen press
conference. The key takeaway is that Fed
will begin unwinding its balance sheet next month. I hit this subject hard in our Thursday
Morning Call, so I won’t be repetitious except for the conclusions:
[a] I was wrong
about the Fed remaining dovish. It has apparently
decided that it has dallied too long, that there is no miracle that is going to
save it and so it is time to bite the bullet and begin normalizing its balance
sheet---which, of course, officially extends its perfect record of never
correctly managing the transition from tight to easy money,
[b] even more
surprising, Yellen seemed adamant in stating that the unwind of QE was a firm
commitment and not likely to be altered by short term economic
considerations---meaning, it now runs the risk of staying too tight too long
just as it stayed too easy too long.
That said, this crew’s history is to waffle at the slightest hint of
economic weakness. So healthy skepticism
seems appropriate,
[c] it used an improving
economy as the reason for the start of the transition. As you know, I have long held that {i} the
Fed economic model was broken and it never had a good grasp on what was really occurring
in the economy. Yellen as much as
admitted that in saying that the Fed couldn’t figure out why inflation was so
low---news flash the economy isn’t as strong as you believe. The point being that I see no reason to
assume their image of an improving economy is anymore valid today than in the
past, and [ii] no matter that, unwinding QE has never been about the economy
but rather fear of a Market hissy fit.
http://blog.knowledgeleaderscapital.com/?p=13520 (must read)
This latter
point is a key to my Market outlook---when QE starts to unwind, so does the mispricing
and misallocation of assets. That thesis
is about to be tested.
In other
central bank news, the Bank of Japan left its monetary policy unchanged. Plus Bank of England’s director Carney walked
back his hawkish statement of last Friday---as I feared would happen. The $64,000 question is, has the Bank of
England, the Bank of Japan and the ECB been waiting for the Fed to begin the
great transition to normalized monetary policy before following suit?
(4) geopolitical
risks: Trump fell back to his old ways
this week, threatening to destroy North Korea and to withdraw from the Iran
nuclear arms agreement. In response,
both parties ramped up their own rhetoric, with North Korea threatening to test
a hydrogen bomb in the Pacific.
The latest from
Syria (medium):
My opinion hasn’t
changed: I have no problem conveying this message in private; but publicly, it
raises the issue of saving face and hence could lead to a misstep.
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 EU flash manufacturing and services PMI’s were above forecasts; August
UK retail sales were strong; German PPI was in line,
[b] August Japanese
exports were well ahead of expectations,
[c] Moody’s downgraded China’s credit
rating.
Our outlook
remains that the European economy is out of the woods. But the stats out of China the last three
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.
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 22349, S&P 2502) had a mixed day (Dow up, S&P down), though both
closed near the flat line. Volume inched
higher; breadth weakened further. Both
remain above their 100 and 200 day moving averages and are in uptrends across
all time frames.
The VIX (9.6) was
off slightly, leaving it below the upper boundary of its short term downtrend,
below its 100 and 200 day moving averages.
It is now below the lower boundary of its long term trading range, drawing
near its former all-time low (8.8). The
question as to whether or not the VIX has bottomed is about to be answered.
The long
Treasury rose, 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. It is also up both of the
two days following the hawkish conclusion of the FOMC meeting. On the other hand, yields on shorter term
maturities continue to increase, meaning that the yield curve is
flattening. Historically, that has
pointed to a weakening in the economy---not the consensus view right now and
certainly not in line with the reasons the Fed gave for the start of its
balance sheet unwinding.
The dollar declined,
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---also indicating
the dollar investors are not persuaded that a stronger economy/higher rates are
on the way.
GLD continued to
fall, but still ended above its 100 and 200 day moving averages (both support)
and the lower boundary of a short term uptrend.
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.
Finally, TLT and
UUP investors are not supporting the stock boy’s or the Fed’s scenario of an improving
economy/higher rates.
I remain
uncomfortable with the overall technical picture.
https://www.advisorperspectives.com/commentaries/2017/09/22/a-statistical-take-on-the-fourth-quarter
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (22349)
finished this week about 70.9% above Fair Value (13074) while the S&P (2502)
closed 54.9% overvalued (1615). ‘Fair
Value’ may be changing 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, the electorate was once again be robbed of the benefits healthcare
reform and with it any cost saving that could be applied to tax reform. The GOP tax reform proposal will be presented
on Monday. Early indications of its
provisions suggest that will make our system fairer and simpler. However, right now we don’t know how the
numbers are going to work. And until we
do, the thought that it will create a marked improve in the long term secular
growth rate of the economy may very well be wishful thinking.
Not that it will
have no impact; but the assumption that the US could be back on track for a 3%+
growth rate is probably incorrect based primarily on the fact that the national
debt now equals 100% of GDP and it is about increase. Remember, (1) the debt ceiling has just been
raised [meaning additional debt financing], (2) Harvey and Irma repair are
expenses not in the current budget [meaning additional debt financing] and (3) at
the moment, the GOP tax reform bill appears not to be revenue neutral, i.e. it
will require additional debt financing.
That means the supply/demand dynamics in the bond market is about to
change. In addition, the new bond buyers
will have a completely different motive for buying [earn a return] than the Fed
[expand the liquidity in the financial system].
At the risk of being repetitious, that is all bad news if
Reinhart/Rogoff are correct.
In any case, 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. 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.
That thesis is
about to get tested with the Fed announcing the unwind of its balance sheet.
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.
Estimating future market
returns (short):
DJIA S&P
Current 2017 Year End Fair Value*
13200 1630
Fair Value as of 9/30/17 13074
1615
Close this week 22349
2502a
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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