The Closing Bell
3/30/18
Statistical
Summary
Current Economic Forecast
2018 estimates
(revised)
Real
Growth in Gross Domestic Product 1.5-2.5%
Inflation +1.5-2%
Corporate
Profits 10-15%
Current Market Forecast
Dow
Jones Industrial Average
Current Trend (revised):
Short
Term Trading Range 21691-26646
Intermediate Term Uptrend 13057-29262
Long Term Uptrend 6410-29847
2018 Year End Fair Value
13800-14000
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Uptrend 2461-3223
Intermediate
Term Uptrend 1254-3068
Long Term Uptrend 905-2963
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 slight upward bias to equity valuations. The
data flow this week was weighed very slightly to the negative: above estimates:
weekly mortgage/purchase applications, February pending home sales, month to
date retail chain store sales, January Case Shiller home price index, weekly
jobless claims, February Chicago Fed national activity index; below estimates: March
consumer confidence and consumer sentiment, March Dallas and Richmond Feds’
manufacturing index, March Chicago PMI, the February trade deficit; in line
with estimates: revised fourth quarter GDP growth, the price index and
corporate profits, February personal income and spending.
The primary
indicators were neutral: revised fourth
quarter GDP growth, price index and corporate profits (0) and February personal
income and spending (0). Given the tally
of the primary indicators, the call is neutral.
Score: in the last 129 weeks, forty-four were positive, sixty negative
and twenty-five neutral.
While this week’s
cumulative data was neutral, it puts something of a damper on the notion that last
week’s very positive results plus the blowout jobs report three weeks ago could
be signaling that the US economic growth rate is improving. I remain open to the possibility though there
seems little reason at present for a revision of my forecast. My current thinking remains that (1) the
initial surge in economic activity following the tax bill was more likely
attributable to post hurricane/wild fire recovery spending than the much touted
jump in wages/cap ex spending and, thus, (2) the tax bill will not be proven
fairer, simpler or pro-growth.
The overseas
stats were negative: mixed out of Europe, disappointing from Japan ---so
a second week of sloppy numbers from the EU. As you know, Europe has been the bright spot
in the global economy; and two weeks in a row of poor numbers don’t make a
trend. Japan, on the other hand, has been struggling for growth; clearly, it still
is.
Washington was
fairly quiet this week---thank God for small favors. However, trade remained center stage. The good news is that the US and South Korea
reached a trade agreement, which didn’t alter the prior agreement all that much
but it was slight win for the US; and, more importantly, it removed the potential
for a trade war with the South Koreans. There
is a picture starting to develop here that Trump’s bark dwarfs his ultimate
bite---meaning the odds of achieving acceptable agreements with other trading
partners are going up. That too is good
news.
The bad news is
that the Donald keeps pouring in on with China.
This time threatening to limit Chinese investments in the US. Of course, having just said that his ‘art of
deal’ tactics involve talking loudly and carrying a small stick, my hope is
that the US can reach an accord with China.
The other item
worth mentioning is Trump’s reintroduction of his infrastructure plan. Now, as it was when first presented,
congressional sources say that it is dead on arrival.
Our (new and
improved) forecast:
A pick up in the
long term secular economic growth rate based on less government
regulation. As a result, I raised our economic
growth forecast. Many had hoped that this increase in secular growth could be further
augmented by pro-growth fiscal policies including repeal of Obamacare, enactment
of tax reform and infrastructure spending and a fairer trading agenda. The bad news is that it appears the positive
effects of the tax bill may have dwindled; and at the moment, there is no
cause, in my opinion, to assume it will lead to improvement in the long term
secular economic growth. Indeed, my
original assessment of it may prove spot on, i.e. the bill was not fairer,
simpler or pro-growth. The good news is
that while Trump’s approach to free/fair trade is stomach churning, to date, his
bark is proving much worse than his bite and it seems to be yielding positive
results (South Korea). If he can achieve
the same kind outcome with NAFTA, the EU and China, then it would be a definite
plus for economic growth. At this point,
our forecast remains economic growth at a slightly better long tem secular rate
but still below historical standards.
The
negatives:
(1)
a vulnerable global banking system. Nothing new this week except this new bit of
information on the subprime mortgage market.
More (medium):
(2)
fiscal/regulatory policy.
Our
ruling class did little to mess with our lives this week as they prepared for
the Easter Holiday.
We did
receive news on trade, some good, some bad.
I don’t really have anything to add to my comments above.
Friday,
the Donald made a speech touting his infrastructure spending proposal [which he
had introduced months ago]. It went
nowhere then and apparently, it is going nowhere now. So I assume the rhetoric is largely about the
November elections.
But just
to reiterate my take---all other things being equal, a real infrastructure bill
[as opposed to Obama’s which was a welfare bill in disguise] is good news for
the economy. It creates jobs and is an
investment in America. However, when the
national debt is at record levels [as it is now], financing it [i.e. creating
more debt], at the same time as taxes are being cut is a burden on the economy
because the cost of servicing that debt eats up any benefits from growth
created by the tax cuts and infrastructure spending.
[Geeks
note: since any infrastructure spending will have to be paid for by increasing the
national debt, the Treasury has four sources of investors to buy that debt: {i}
consumers, who are at present saving at an historically low rate. But assume they increase their savings. That means that they decrease their spending,
meaning GDP growth slows, {ii} corporate America which would have to use funds that
would otherwise be used for capital spending [i.e. future profit growth], wages
[see above] or dividends and buybacks [also see above], {iii} foreigners, who would
have to use dollars to buy Treasuries; and the only way to get dollars is by the
US running a trade deficit which Trump is trying to lessen, or {iv} the Fed
prints money and puts yet more debt on its balance sheet. While that has worked so far, at some point,
it becomes highly inflationary].
Again, you know my bottom line on this score. Too much debt stymies
economic growth even if it partly comes from a tax cut or infrastructure
spending. And a rapidly expanding
deficit and a tumbling dollar are not just bad for the country, they may push
the Fed to be more aggressive in its tightening policy.
A trade war is a lose/lose proposition.
(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.
It was also a
very quiet week for the Fed. But the ECB
was a busy little beaver, jacking up its bond purchases at the first sign of
Market turmoil---and everyone thinks that it will begin tapering this year.
The bottom line is that the Fed has no good
alternatives. It has left itself in the
same place as every other Fed in the history of Fed; that is, it has waited too
long to begin normalizing monetary policy and now, [a] if there is an increase in
inflation, it must either hold to its dovish ways and risk a big spike in
inflation or begin to tighten policy more aggressively and risk trashing the
Markets or [b] if the US economy slips into recession, it has few policy to
tools to help alleviate its magnitude; and Markets don’t like recessions.
(4) geopolitical
risks: It appears that progress is being
made in the attempt to rein in the Kim Jung Un regime. Un met with the Chinese this week and
professed to be ready to denuclearize.
In addition, the North and South Koreans are set to meet April 27 and
the US and North Koreans sometime in May.
If all this takes place and Un is ready to get rid of his nukes and stop
exporting weapons technology to others, then certainly this would be a major
positive. But I repeat my words of
caution---we have seen this movie before; so it would be folly to assume that
the ending is any different.
(5)
economic difficulties around the globe. The international data this week was negative.
[a] March EU business confidence fell for the third
month in a row; February German unemployment hit a record low,
[b] March Japanese CPI and industrial production were below
expectations while unemployment was above.
The bottom line
remains the same: Europe gaining strength, though last two weeks don’t help that
view. Japan may be improving as is China,
but again this week’s numbers from Japan don’t reflect that.
Bottom
line: the US economy growth rate may be faltering
once again despite the positive impact on its long term secular growth rate
brought on by increasing deregulation, the better performance of the EU economy
and rising business and consumer sentiment.
On the other
hand, if the success of the trade negotiations with South Korea are an
indication that Trump’s ‘art of the deal’ negotiating style can produce further
positive outcomes with NAFTA, the EU and China, then a fairer trading regime
would almost certainly be a plus for the long term secular economic growth
rate. ‘If’ being the operative word,
though the road to achieving any success could a rough one.
That leaves the larger
fiscal issue (for me) which we know with certainty; that is, how the original tax
cut, a second proposed new improved tax cut, increased deficit spending and a potentially
big infrastructure bill will impact economic growth and inflation. As you know, I have an opinion: at the
current level of the national debt, a bigger deficit/debt=slower growth; higher
deficit spending=inflation, even if they are the result of a tax cut and/or
infrastructure spending.
It is important
to note that the negative here is not the impact that tax cuts and increasing
spending have on economic growth---which, in my opinion, are both positive and
negative. It is Fed policy. The central bank has created a no win
situation for itself: [a] if it does nothing and economy accelerates, it risks
inflation. In fact, if LIBOR rates continue to blowout and begin to impact US
rates, the Fed may not even have this option, [b] if does nothing and the
economy stumbles, it has few policy measures available to combat any economic
weakening, [c] if it moves forward with the unwind of QE, it will begin the unwinding
of the mispricing and misallocation of global assets. Whatever the outcome, it will only confirm
what I have said repeatedly in these pages---the Fed has never in its history
managed the transition from easy to normal monetary policy correctly and it
won’t this time either.
The
Market-Disciplined Investing
Technical
The indices
(DJIA 24103, S&P 2640) jumped yesterday, experienced the usual huge intraday
volatility but closed well off of their intraday highs. Volume
was down; breadth improved, but not as much as I had expected. Both of the Averages closed within very short
term downtrends, below their 100 day moving averages (now resistance) but above
their 200 day moving averages. The Dow
finished in a short term trading range but in intermediate and long term
uptrends. The S&P is in uptrends
across all timeframes. In short, the
short term technical picture is a bit cloudy; but longer term, the assumption
is that equity prices will continue to rise.
FANG stocks and the
Averages (short):
The VIX was fell
13 ½ %, but remained in a very short
term uptrend, above its 100 and 200 day moving averages and the lower boundary
of its short term trading range---suggesting volatility will stay with us.
The long
Treasury continued its strong month long bounce off the lower boundary of its
long term uptrend, establishing a very short term uptrend. It is still below its 100 (but near) and 200
day moving averages and in an intermediate term downtrend. So the trend remains down though an initial
challenge appears close. What the
fundamentals are behind the strong uptrend, I haven’t a clue. Though I have a lot of choices---either the
economy is weakening (lower interest rates) or there is a negative event coming
(safety trade) or, as a trader friend suggests, there is a huge short squeeze
going on.
https://pro.creditwritedowns.com/2018/03/the-yield-curve-has-now-flattened-into-the-danger-zone.html
More on LIBOR
(medium):
The dollar was down
slightly, finishing below its 100 and 200 day moving averages and in an
intermediate term downtrend. Most
important, UUP has traded in a very tight range for two months, which is not
usual when bonds are moving big directionally.
GLD edged up but
has still given back almost all of last week’s gains. And that makes no sense in a rising bond market
(lower rates). The good news is that it
held above (just barely) the lower boundary of its short term uptrend as well
as its 100 and 200 day moving averages.
Bottom line: the
technicals of the equity market point higher for the long term. Near term direction is in question; but the
Averages have plenty of support at lower levels. It will take a lot more technical damage
before I question whether or not this bull market is over.
The pin action
in TLT, UUP and GLD remains confusing.
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’ has risen based on a
new set of regulatory policies which will lead to improvement in the
historically low long term secular growth rate of the economy. A further increase could come if Trump’s
drive for fairer trade is successful.
Unfortunately,
the recent decline in the strength of economic activity suggests that any
benefit from enhanced corporate spending stemming from the tax bill was short
lived. Plus neither a second round of
tax cuts nor additional infrastructure spending, in my opinion, will improve
the outlook for economic growth, given the current stratospheric level of debt.
This week, trade
remained center stage with the South Koreans agreeing to a new trade
settlement. If the pattern of these
negotiations (bark real loud, extract some concessions and claim victory) are
repeated with NAFTA, the EU and China, then this whole process will be proven
successful and pro-growth, though I am sure many wish it was a lot less nerve wracking.
On the other
hand, Trump threatened more actions against China. As I have said before, I support Trump’s
effort to reign in the Chinese pirating of US intellectual property; and I
garner hope from the South Korean example that negotiations will prove
successful. However, I am sure that they
will be stomach churning---which the Market is not going to like. It will like even less a lack of success.
The danger of subdued growth and higher
inflation was exacerbated this week by the Trump reintroduction of his
infrastructure bill. I needn’t be
repetitive here; but my bottom line is that the budget deficit and national
debt are already too high to render either deficit spending or tax cuts an
effective growth stimulant. Making them
bigger will only make things worse. In
short, in my opinion, Street estimates for economic and profit growth are too
optimistic and valuations will have to adjust when that reality becomes
manifest.
Even if I am wrong
on all the above points, I don’t believe that a more rapidly improving economy justifies
current valuations and may even exacerbate the real problem (in my opinion) facing
the Markets---which is the need for the Fed to normalize monetary policy. If improved growth led to a continuing tightening
of policy, ending QE, it, in my opinion, would not be good for the Markets,
since they are the only thing that benefitted from QE.
Bottom line: the
assumptions on long term secular growth in our Economic Model have improved as a
result of a new regulatory regime. In
addition, if Trump can repeat the South Korean tariff negotiations model, then
a fairer trade regime will also have a positive impact on secular growth. Finally, I could be wrong and there still may
be a chance that the effects of the tax bill could further increase that growth
assumption.
Unfortunately, the
numbers suggest otherwise. Even worse, the
recently passed spending bill along with the promises of a second round of tax
cuts and infrastructure spending will, in my opinion, inhibit growth. I believe
that more debt will restrain not enhance growth and will likely create
inflationary pressures which will have to be dealt with by the Fed, sooner or
later. In any case, I continue to
believe that the current Street narrative is overly optimistic---which means Street
models 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. That math is simply: the P/E now being paid
for the historical long term secular growth rate of earnings is far above the
norm.
As a long term investor, with
equity valuations at historical highs, I would want to own some cash in my
Portfolio and, if I didn’t have any, I would use any price strength to sell a
portion of my winners and all of my losers.
DJIA S&P
Current 2018 Year End Fair Value*
13860 1711
Fair Value as of 3/31/18 13375
1650
Close this week 24103
2640
* 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
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 50 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.
