11/18/17
I am taking Thanksgiving week off.
If this Market gets squirrelly, I will be in touch. Otherwise, enjoy your holiday.
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%
2018 estimates
(revised)
Real
Growth in Gross Domestic Product 1.5-2.5%
Inflation +1.5-2%
Corporate
Profits 5-10%
Current Market Forecast
Dow
Jones Industrial Average
Current Trend (revised):
Short
Term Uptrend 21819-24555
Intermediate Term Uptrend 19280-26611
Long Term Uptrend 5751-24198
2016 Year End Fair Value
12600-12800
2017 Year End Fair Value
13100-13300
2018 Year End Fair Value
13800-14000
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Uptrend 2550-2825
Intermediate
Term Uptrend 2302-3074
Long Term Uptrend 905-2763
2016 Year End Fair Value
1560-1580
2017
Year End Fair Value 1620-1640
2018
Year End Fair Value 1700-1720
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 higher upward bias to equity valuations. The
data flow this week was mixed: above estimates: October housing starts, the
November housing index, weekly mortgage and purchase applications, October
industrial production/capacity utilization, September business
inventories/sales, October import/export prices; below estimates: month to date
retail chain store sales, weekly jobless claims, the October small business
confidence index, the November NY, Philadelphia and Kansas City Feds’
manufacturing indices, the October budget deficit, October PPI; in line with
estimates: October CPI, October retail sales/sales ex autos.
However, the primary
indicators were upbeat: October housing starts (+), October industrial
production (+), October retail sales/ex autos (0). The call is positive: Score: in the last 110
weeks, thirty-four were positive, fifty-six negative and nineteen neutral.
Perhaps more
important, the trend over the last six weeks has been mostly upbeat, likely confirming
that the economy is starting to show a little life. That notion is supported by the most recent
read of the big four economic indicators which have been positive for the last
eight week. Accordingly, I am bumping up
my 2018 GDP/corporate profit growth forecast. In qualitative terms, I would characterize
this change as an improvement from sluggish to below average growth driven
mostly by cyclical as opposed to secular factors.
Overseas, the
pattern remains the same: strength in Europe which is likely contributing to a
pick in growth here; not so much in the rest of the globe. Indeed, the Chinese
data has shown a marked deterioration since the conclusion of the Chinese Communist
Party Congress; and that will likely be aggravated by the recent tightening in
standards for the financial industry which are being implemented to halt the
excessive use of debt.
In fiscal
policy, the house and senate passed their versions of tax reform, though the
reconciliation process will be a lot more difficult. To be fair, I do think that some tax bill
will be passed but I doubt it will be ‘reform’, ‘simpler’, ‘fairer’ or
‘pro-growth’. Our (new and improved) forecast:
A pick up in the
long term secular economic growth rate based on less government
regulation. This increase in secular growth
could be further augmented by pro-growth fiscal policies including repeal of
Obamacare and enactment of (revenue neutral) tax reform and infrastructure
spending. But the odds of that occurring
lessen daily. Further, any expected
increase in the secular rate of economic growth would likely be rendered moot
if tax reform (assuming its passes) increases the national debt and the deficit.
Finally, cyclical
growth appears to be turning up though I am not sure whether it is a function
of organic or a pickup in international growth. As a result, I have raised our
2018 growth forecast.
The
negatives:
(1)
a vulnerable global banking system. Nothing new.
(2)
fiscal/regulatory policy.
I don’t
know why I bother even commenting on fiscal policy because it gives it a status
that it doesn’t deserve---passage of the house and senate versions of a tax
bill notwithstanding. The truth is that there
is no coherent fiscal policy because the ruling class gives no weight to controlling
costs/reducing spending. They just want to
either spend more or cut taxes. The tax
legislation in its current form changes nothing. I hate to beat this horse to death. There is little more that can be said.
Side by
side comparison of the house and senate bills (medium):
You know
my bottom line, too much debt stymies economic growth even if it partly comes
from a tax cut.
Stockman
on the tax reform measures (medium and a must read):
(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.
Little news
this week on monetary affairs, though
[a] the Chinese
fixed income markets are starting to exhibit signs of heartburn, suggesting
something is going within the labyrinth of policy making. To be sure, nothing may be occurring other
than the workings of an inefficient financial system. Or it could be the results of the aforementioned
crack down on speculative lending practices.
Whatever, it bears watching and
[b] Draghi made
another of his ‘everything is awesome’ speeches but made no mention of stepping
up the unwind of EU QE.
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. (also a must read)
(4) geopolitical
risks: little to add.
(5)
economic difficulties around the globe. The stats this week were in line with recent
trends.
[a] German third quarter GDP was strong; third quarter
UK inflation was below estimate as was October unemployment,
[b] October Chinese industrial production and fixed
asset investment were below consensus while retail sales were above; the
Chinese equivalent of the Fed’s Beige Book showed slowing growth throughout the
economy,
[c] third quarter Japanese GDP was strong.
The bottom line
remains the same: Europe gaining strength, Japan may be improving, China a big
question.
Bottom
line: the US economy growth rate appears
to be improving as a result of a combination of the positive impact on its
secular growth rate brought on by increasing deregulation and a cyclical
component of a late stage recovery helped by a better performance of the EU
economy. Unfortunately, I don’t believe
there is much chance of returning to a more normal secular long term rate of
growth because of (1) too much debt that will not be assuaged by the recently
announced tax bill, in its current form and (2) a failed Fed QE policy that has
done little for growth but led to exaggerated moves in asset pricing and
allocation.
The
Market-Disciplined Investing
Technical
The indices
(DJIA 23358, S&P 2578) seem to have entered into some kind of consolidation
phase, failing to follow through on Thursday’s strong pin action which in turn
had reversed a week of drifting lower.
Volume fell and breadth weakened.
But the bottom line remains that both of the Averages remain above their
100 and 200 day moving averages and are in uptrends across all time
frames. The assumption is that stock
prices are going higher.
The VIX (11.4)
was down another 3%, but still finished above the upper boundary of its former
short term downtrend (now a trading range), above its 100 day moving average
(now support), above its 200 day moving average (now support) and above the
lower boundary of its long term trading range.
Following its recent pattern of not trading inversely to stock prices,
it was down on a down day. More clarity
is needed to get a sense of what is going on.
The long
Treasury was up ¾ %, ending above its 100 day moving average (now support),
above its 200 day moving average (now support) and above the lower boundaries
of its short term trading range and long term uptrend. The only negative is that TLT has not
re-established a very short term uptrend.
(economic weakness or a safety trade?)
The dollar fell,
finishing below its 200 day moving average (now resistance), below the upper
boundary of its short term downtrend, but above (though closing in on) its 100
day moving average (now support). It
appears that UUP is confirming its downtrend---which suggests economic weakness
or flight from the dollar.
GLD was up 1 ¼%,
closing well above its 100 day moving average (remember that it has violated this
moving average five times in the last week; if remains there through the close
on Tuesday, it will set as support), above its 200 day moving average (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.
The technical assumption has to be that stocks are going higher.
Strength in TLT
and GLD along with weakness in UUP suggest a slowing economy---certainly not
the narrative from stock land. That
said, the TLT, GLD, UUP trends are all very short term, so it is too soon to be
drawing any conclusions.
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, ‘Fair Value’ could be rising based
on a new set of regulatory policies which would lead to improvement in the
historically low long term secular growth rate of the economy (depending on the
validity of Reinhart/Rogoff; also note an improvement in the cyclical growth
rate resulting from better growth overseas doesn’t affect the secular growth as
calculated in our Model); 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 economy
appears to have picked up a little steam as it reaches the late stage of its
anemic recovery. I have raised my 2018
GDP and corporate growth estimates; but even on that forecast, stocks in general
are generously valued. So this upgraded
outlook will do little to alter values in our Model.
The GOP made progress
on its tax reform with both the house and senate passing its own separate
version. I am going to give them the
benefit of the doubt and assume passage of some sort of tax bill. However, while I believe it may score
political points with the electorate and price points with investors, I also
believe that it will do little to promote secular economic growth. As a result, if stocks fly on tax cuts, they
will discount even more future growth that is either not there or so far in the
future as to not be really relevant to today’s valuations.
In short, even
if passage is achieved, I believe that Street estimates for economic and
corporate profit growth based on the improving economy, fiscal reform narrative
are too optimistic. And when it wakes up
from this fairy tale that could, in turn, lead to declining 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, albeit at
an agonizingly slow pace, as the Fed and other central banks inch their way
toward monetary normalization.
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 (though
fading) that fiscal policy could further increase that growth assumption though
its timing and magnitude are unknown. On
the other hand, if it raises the deficit/debt, I believe that it 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 11/30/17 13158
1625
Close this week 23358
2578
Over Valuation vs. 11/30
55%overvalued 20394 2518
60%overvalued 21052 2600
65%overvalued 21710
2681
70%overvalued 22368 2762
* 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.
