The Closing Bell
4/14/18
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 13123-29328
Long Term Uptrend 6410-29847
2018 Year End Fair Value
13800-14000
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Uptrend 2475-3246
Intermediate
Term Uptrend 1265-3080
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 negative: above estimates: March CPI, March import prices; below estimates: weekly
mortgage and purchase applications, month to date retail chain store sales, weekly
jobless claims, April consumer sentiment, February wholesale inventories/sales,
the March small business optimism index, March PPI; in line with estimates:
none.
There
were no primary indicators. Given the
overwhelming count of negative versus positive stats, the call is negative:
Score: in the last 131 weeks, forty-four were positive, sixty-two negative and
twenty-five neutral---confirming my current forecast.
The overseas numbers
were also negative. The most important
is the continuing trend (now four weeks) of poor data from the EU. As you know, Europe has been the bright spot
in the global economy and a positive factor my forecast of an improving US
economy. That notion is now being
seriously tested.
The ruling class
provided its usual dose headline grabbing events---all of which I have covered
in Morning Calls and below: the ongoing battle of words between Trump and Xi on
trade (potentially bad, but probably not), the ongoing battle of words between
Trump and Russia over Syria (potentially bad, but probably not), Trump’s
supposed move to rescind (I know, I have been using the wrong spelling) parts
of the recent spending bill (potentially good but not great) and the release of
the Fed minutes (potentially good for the economy but bad for the Market).
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 that
growth forecast. There is the potential that Trump’s trade negotiations could
also lead to an improvement in our long term secular growth rate---though that
has yet to be determined. On the other
hand, the tax cut and spending bills as they are now constituted are negative
for long term growth (you know my thesis: at the current high level of national
debt, the cost of servicing the debt more than offsets any stimulative
benefit).
On a cyclical
basis, the economy appears to be rolling over, having achieved one of the
longest growth cycles in history. In the
short term that will overwhelm any benefit to the long term secular growth
rate.
The
negatives:
(1)
a vulnerable global banking system.
The bankster misdeeds continue (short):
S&P puts Deutschebank of credit watch negative
(medium):
(2)
fiscal/regulatory policy.
Trade
remained center stage this week with much back and forth between China and the
US. I have gone over it all in our
Morning Calls, so I won’t repeat myself; but the bottom line is that I believe
that the Trump ‘art of the deal’ negotiating style will not precipitate a trade
war and that the US will likely benefit from revised trade agreements with
China and NAFTA. I am just not sure how
much.
Latest
from China (short):
The
other item worth mentioning is that Trump said that he wanted to rescind some
of the spending contained in the ginormous FY2018 budget act. Apparently, he is getting some negative
feedback from the heartland. To be sure,
something is better than nothing. But
his proposed cuts of a couple hundred million dollars aren’t going to have a
major impact on the growth of the deficit/debt which, in turn, does little to
alter my thesis that fiscal policy will prove a drag on economic growth. [And not to be too cynical, I have to wonder
if this move is more about the 2018 elections than a real sense of fiscal
profligacy.]
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.
The Fed
released the minutes of the March FOMC meeting on Wednesday--- which, bottom
line, were just a tad hawkish or as one pundit put it, the Fed is ‘moving into a non-accommodative stance’. (must read):
As you know, I
have been a longtime advocate of unwinding QE; indeed, I believe that it should
have started years ago. It has led to
the mispricing and misallocation of assets which hamper long term economic
growth. So a more hawkish Fed, in my
opinion, is a plus long term. Short term
is the problem. It has waited so long to
begin the normalization of monetary policy that it is executing it at the point
where the economy appears to be at or near rolling over. Certainly, the data support that---the hopey,
feely statements out if the Fed notwithstanding. Tightening monetary policy, especially if
forced to do so by rising inflation, as the economy decelerates adds fuel to any
downward momentum and is not and has never been a formula that is Market
pleasing.
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: The US/Russian faceoff in Syria:
***overnight, hopefully,
this is now over and there is no aftermath (medium):
The circle of
absurdity (medium):
(5)
economic difficulties around the globe. The international data this week was negative.
[a] March UK household spending was very disappointing
as was EU industrial production,
[b] March Chinese PPI and CPI were below estimates and,
in March, it showed a trade deficit,
[c] global PMI fell to a sixteen year low.
The bottom line
remains the same: Europe gaining strength, though the yellow light is flashing
on that assumption; Japan may be improving as is China, but again the recent numbers
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.
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
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 from the impact that tax cuts and increasing spending
have on economic growth is not the only one.
The other 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 24360, S&P 2656) were down yesterday on flat volume and poor breadth. Both of the Averages closed within very short
term downtrends (having made a fourth lower high on Tuesday) and below their
100 day moving averages (now resistance).
They both remain above their 200 day moving averages. The DJIA finished in a short term trading
range but in intermediate and long term uptrends. The S&P is in uptrends across all
timeframes. The short term technical picture remains cloudy; but longer term,
the assumption is that equity prices will continue to rise.
The VIX was down another
6 %, really unusual for a down Market day but in line with several other days this
week in which it traded contrary to its normal inverse correlation. Still it ended in a very short term uptrend,
above its 100 and 200 day moving averages and the lower boundary of its short
term trading range---reflecting the obvious fact that volatility hasn’t gone
away.
The long
Treasury was up, remaining within what is now a strong two month long bounce
(very short term uptrend) off the lower boundary of its long term uptrend. On the other hand, it continues to trade
below its 100 and 200 day moving averages and in a short term downtrend. It is starting to get squeezed between the
lower boundary of its very short term uptrend and its moving averages. A break in this narrowing range would likely
point at a further move in the direction of the break.
The dollar was unchanged
on heavy volume, finishing below its 100 and 200 day moving averages and in an
intermediate term downtrend. UUP
continues to trade in a very tight range, which is not usual when bonds are
moving big directionally.
GLD was up,
finishing above the lower boundary of its short term uptrend and its 100 and
200 day moving averages. On the other
hand, it has been unable to rise above its February high.
Bottom line:
near term the direction of equity prices is in question. As I noted Thursday, the indices are starting
to get squeezed between their very short term downtrends and their 200 day
moving averages---which they have already unsuccessfully challenged four
times.
History suggests
that a break out of this narrowing pennant like formation will set the course
of the Market in the direction of the break.
If it is to the upside then it would support the assumption that the
stock prices remain in a long term uptrend.
If to the downside then it would weaken the bull case and set up a
decline to the lower boundaries of the DJIA’s short term trading range and the
S&P’s short term uptrend. That said,
the Averages have plenty of support at lower levels.
The price
movements yesterday in TLT, UUP and GLD pointed at a weakening economy---the
reverse of Thursday’s pin action. Their performance
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. Of course, some republicans are having buyer’s
remorse over the recent deficit ridden budget---as well they should. Whether they can or will so anything about it
remains to be seen. Even if they do,
deficits and debts have risen to such an extent the economic growth will be
labored. I don’t believe that is
reflected in the price of stocks.
Trade remained
center stage with our negotiations with China the star. Rhetoric aside (as confusing as it may be), I
believe that the Donald has revealed enough about his ‘art of the deal’
negotiating style to be somewhat optimistic.
I am hopeful that this whole process will be proven successful and
pro-growth and that it will be another positive factor for the long term
secular economic growth rate of this country; and, hence, a plus for equity
valuations.
Despite the
positive impact of deregulation and a potential improvement from better trade
deals, the offset is the danger of subdued growth and higher inflation resulting
from irresponsible fiscal and monetary policies. I needn’t be repetitive here; but my bottom
line is that
(1) 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 and Street estimates for economic and profit growth
will prove too optimistic and valuations will have to adjust when that reality
becomes manifest, and
(2)
even worse for the Market is the need for the Fed to
normalize monetary policy, ending
QE---which has led to the gross mispricing and misallocation of assets. That process, 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’s trade policies prove successful, then a fairer trade system
will also have a positive impact on secular growth.
On the other
hand, I believe that fiscal policy will have an opposite effect on economic
growth and that monetary policies, sooner or later, will have to correct the
mispricing and misallocation of assets---and that will be a negative for the
Market.
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 simple: 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.
As a reminder, my
Portfolio’s cash position didn’t reach its current level as a result of the
Valuation Models estimate of Fair Value for the Averages. Rather I apply it to each stock in my
Portfolio and when a stock reaches its Sell Half Range (overvalued), I reduce
the size of that holding. That forces me
to recognize a portion of the profit of a successful investment and, just as
important, build a reserve to buy stocks cheaply when the inevitable decline
occurs.
DJIA S&P
Current 2018 Year End Fair Value*
13860 1711
Fair Value as of 4/30/18 13428
1656
Close this week 24360
2656
* 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.
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