The Closing Bell
11/4/17
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 21659-24365
Intermediate Term Uptrend 19208-26536
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 2530-2805
Intermediate
Term Uptrend 2288-3062
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 higher upward bias to equity valuations. The
data flow this week was positive: above estimates: September personal spending,
October and month to date retail chain store sales, October consumer
confidence, October light vehicle sales, weekly jobless claims, September
factory orders, the October Dallas Fed manufacturing index, the October Chicago
PMI, the October ISM nonmanufacturing index, the October Markit manufacturing and
nonmanufacturing PMI’s, third quarter nonfarm productivity and unit labor costs,
the September trade deficit; below estimates: weekly mortgage and purchase
applications, October nonfarm payrolls, the October ISM manufacturing index; in
line with estimates: the August Case Shiller home price index, September
personal income, the October/revised September ADP private payroll report,
September/August construction spending, September PCE price indicator.
The primary
indicators were a plus: September personal
spending (+), September factory orders (+), third quarter productivity (+), October
nonfarm payrolls (-) September personal income (0) and September/August
construction spending ((0). Given the overwhelming
majority of the stats were positive, the call is a plus. Score: in the last 108
weeks, thirty-three were positive, fifty-six negative and eighteen neutral.
But more
important is the recent trend which has witnessed a surge in upbeat economic
indicator reports. Certainly this week’s
performance makes me think that it is real.
However, it is still too soon to know whether this is another one of the
several head fakes we have received over the last five years or if it is the
real thing. I am going to give it a bit
longer before making the call. Meanwhile,
I am wrestling with several issues on that score:
First, I have
already raised the growth rate based on an improved regulatory environment, so
some of improvement is already reflected in our forecast.
Second, I had
expected to see some cyclical uptick in US economic growth as a result in the
EU economy having escaped from the ‘muddle through’ scenario. The question
being, is this latest progress in the US stats more a function of conditions in
the EU than of organic US expansion.
Third, we have
seen no negative fallout from Hurricanes Harvey, Irma and Maria plus the Napa
fires. As you know, I expected some
negative consequences. So far I am
totally wrong---except maybe this week’s nonfarm payroll number.
Overseas, the numbers
were mixed: the EU continuing to show solid growth, China not so much. Indeed, I wonder if the closing of the
Communist Party Congress will presage a stream of ‘catch up’ bad news.
It was a big
week in the realm of fiscal/monetary policy.
Big in the sense of anticipated announcements (the tax bill, Trump’s Fed
chair nominee, the FOMC meeting). But in
terms of improving your and my lot in life, they were pretty pathetic
attempts. More below.
Our (new and
improved) forecast:
A questionable (though
increasingly less so) 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 and enactment of tax reform and
infrastructure spending---‘could’ being the operative word. Unfortunately, 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.
In addition, the
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. I may raise our 2018
growth forecast as a result.
The
negatives:
(1)
a vulnerable global banking system. Nothing this week.
But please note this (medium and today’s must read):
(2)
fiscal/regulatory policy.
Yes,
Virginia we have a big, beautiful tax bill---not. I ranted longer than I should have in
Friday’s Morning Call to subject you to a second dose. The bottom line though is, [with the caveat
that I haven’t read all 400 pages of the proposed bill] it is not simpler, it
is not fairer and it is not revenue neutral.
So what is not to like? The good
news is that enough parties are calling foul, that it will change. I hope for the better.
I did
find one additional piece of information Friday afternoon: there was a cut in
corporate loopholes of $1 billion---that’s compared to the ~$800 billion in tax
savings from the bill.
Okay, I
am going to rant some more. Recall that
corporate stock buybacks are at record highs.
That means that managements have spent a lot of dough on these buybacks
that could otherwise been used for capital investment and creating new job. And they did for a very good reason---to jack
up earnings to which their bonuses are tied.
So I ask, is giving them another $800 billion to spend really going to
change their investment/hiring policies?
I don’t think so. Now it can be
argued that part of the tax breaks go to smaller businesses who will spend the
money on investing or hiring. So I ask,
why can’t the corporate tax rate be graduated just like individual tax
rates?
Here is
an analysis from one of my favorites with less sarcasm as my own (medium):
A bonus
analysis from another of my favorites (medium):
You know
my bottom line, too much debt stymies economic growth even if it partly comes
from a tax cut.
(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.
Trump announced
his selection for the next Fed chairmanship.
It was Jerome Powell, a dove. Therefore,
I see nothing that will change the speed of the unwinding of QE---so this is
going to be a slow agonizing process.
Which will just make the Fed’s current mistiming in the normalization in
monetary policy agonizing---the risk being that the Fed is so far behind the curve
that the economy starts to weaken just as it is starting to squeeze. (must read):
The FOMC met and left policy and its basic outlook
unchanged, though the narrative was slightly more hawkish as a result of the
recent trend of good numbers. That is
not change my view of monetary policy. I will note that the Fed let $6 billion
of bonds run off the last two days of October.
That’s compared to a $10 billion commitment for the month.
In other
central bank news, the BOJ left rates and QE unchanged while the Bank of
England raised key interest rates but promised not to do it again unless it
absolutely, positively has to.
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 continued to hold
the headlines this week, but tensions between the US and North Korea [who just
announced that there would be another missile test], Iran and Russia remain
high.
None of these
issues has been resolved; and there remains a decent probability of an
unpleasant outcome in any one of them.
(5)
economic difficulties around the globe. This week:
[a] the October
EU inflation rate declined; the October EU and UK manufacturing PMI’s were
above consensus as was the UK services PMI; October German unemployment
declined,
[b] the October
Chinese manufacturing and services PMI’s were below expectations; while the
Caixin manufacturing PMI was in line, the services PMI was above estimates and
the composite PMI was below.
Europe remains
strong. Perhaps it is finally having an
impact on the US economy. Anything that
will get us back to our {I believe reduced} long term secular growth rate is a
plus. The Chinese data turned negative
again as the Chinese Communist Party Congress wrapped up [I tol’ you].
Bottom
line: our near term forecast is that the
US economy growth rate should be improving as a result of a better regulatory
outlook, though until very recently the signs of that pick up have been lacking. That could be changing augmented by a now
growing EU economy. More data is need to
make that call, but I am hopeful. Unfortunately,
the economy remains saddled with (1) too much debt that will not be assuaged by
the recently announced tax bill, in its current form and (2) a Fed that has
long since missed the deadline for normalizing monetary policy---a condition
that will likely only be perpetuated by the newly nominated Fed chair.
The
Market-Disciplined Investing
Technical
The indices
(DJIA 23539, S&P 2587) were up on the day (still the relentless drive
higher). Volume was down (fifth day in a
row), but still high; breadth improved.
Both remain above their 100 and 200 day moving averages and are in
uptrends across all time frames.
The VIX (9.1)
was down 8 %---finishing below the upper boundary of its short term downtrend,
below 100 day moving average (now resistance), below its 200 day moving average
(now resistance), below the lower boundary of a very short term uptrend, voiding
that trend and now below the lower boundary of its long term trading range (if
it remains there through the close on Wednesday, it will reset to a downtrend). It is on the verge of a directional change,
indicating continued higher stock prices.
The only remaining question is, will it successfully challenge its July
low 8.8)?
The long
Treasury was up, ending above its 200 day moving average (now support), above
the lower boundaries of its short term trading range and long term uptrend, above
the upper boundary of its very short term downtrend (voiding that trend) and above
its 100 day moving average (now resistance; if it remains there through the
close on Monday, it will revert to support).
It is a short hair away from a trend change---pointing to lower long
term rates.
The dollar rose,
still ending below its 200 day moving average (now resistance), but right on the
upper boundary of its short term downtrend, above its 100 day moving average
(now support), continues to develop a very short term uptrend. Again, a trend change at hand, but this
suggesting higher interest rates.
GLD fell,
finishing below its 100 day moving average (now resistance), above but very
close to its 200 day moving average (support) and the lower boundary of a short
term uptrend. Again, potential trend
change, this looking at higher interest rates.
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.
Trading in UUP,
GLD and TLT were again out of sync with themselves, the VIX and stocks, but seem
to be pointing at a change in trends---in different directions.
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 economic stats
continue to improve though it has been too short a time to revise out forecast. Overseas, the sustained increase in the rate
of economic growth in Europe could be contributing to our better performance.
However cautious
I may be, stock prices are rising as investors are seemly willing to make, or
at least begin to make, the bet that the economic growth rate will soon pick
up. Not to beat a dead horse, I think
that if equities were more reasonably priced that would make sense. However, with stocks at all-time high
valuations, it seems that nirvana has already been discounted. So the current rise seems to be double
counting.
On the fiscal
front, the ruling class continues to make a mess of policy. The fact that tax reform is a political
necessity for the GOP speaks to just how little it is willing to actually accomplish
in terms of enacting reform that is simpler, fairer and not being a drag on the
economy just to say they passed a bill.
True, it will almost certainly be revised. Hopefully for the better. However, I remain convinced that, given the
magnitude of the current national debt, any (near) non-revenue neutral changes
to the tax code 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 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 with the Fed announcing the unwind of its balance sheet and
other central banks making noises like they could follow suit. Of course, it will be a Chinese water torture
test because (1) with the likely Powell appointment, our Fed will continue to
drag its feet normalizing QE, (2) the Bank of England raised rates and then apologized
for it, promising to never do it again unless it was faced with war, famine, pestilence
and death, (3) meanwhile, the Japanese just keep digging a deeper hole and (4)
who knows what the new Chinese five year plan will mean of monetary policy.
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 23328
2575
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.
No comments:
Post a Comment