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 13151-29356
Long Term Uptrend 6410-29847
2018 Year End Fair Value
13800-14000
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Uptrend 2488-3259
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 upbeat: above estimates: March new and existing home
sales, April consumer confidence, weekly jobless claims, the April Markit flash
PMI’s, the April Kansas City Fed manufacturing index, the March trade deficit,
first quarter GDP; below estimates: weekly mortgage and purchase applications, month
to date retail chain store sales, the March Chicago national activity index,
the April Richmond Fed manufacturing index, first quarter employment costs; in
line with estimates: March durable goods/ex transportation.
The
primary indicators were also strong: March new home sales (+), March existing
home sales (+), first quarter GDP (+) and March durable goods (0). It is pretty clear that this week was a plus.
Score: in the last 133 weeks, forty-five
were positive, sixty-two negative and twenty-six neutral.
The overseas numbers
were mixed to negative. Most notably,
the EU continues to weaken. As a result,
I am altering our forecast, removing it as a source of support for the US
economy.
Very little occurred
on the political front. Indeed, the
headlines this week were dominated by first quarter earnings reports and
concerns over rising interest rate.
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)
and could potentially offset any positives from deregulation and trade.
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.
Wells Fargo is fined another $1 billion for auto and
insurance fraud---and no one goes to jail.
(2)
fiscal/regulatory policy.
Four
news items:
[a]
apparently, Mnuchin is going to China in the attempt to resolve the trade
disputes,
[b] the
Treasury department cuts 300 regulations from the IRS code,
[c]
Trump is likely to withdraw from the nuclear agreement with Iran and re-impose
sanctions which not only has geopolitical implications but also an economic one,
specifically, the impact on the price of oil,
[d]
there are hopeful signs that a revised NAFTA agreement is close.
While
earnings season and concerns on interest rates held the headlines, the progress
in trade talks and the continuing battle against the entrenched government
bureaucracy have far greater long term implications for the secular growth rate
of this country; those are quite positive.
Having
said that, the turd in the punch bowl remains the excessive level of current national
debt plus the inane drive to push it even higher
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 higher long term rates will ultimately push the Fed to be more
aggressive in its tightening policy.
(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 central
bank news this week came from overseas: the ECB met and left rates and its QE
policy unchanged. Somewhat surprisingly
given the recent dearth in upbeat economic stats out of the EU, Draghi joined
the US dreamweavers painting a future filled with growth.
The Bank of
Japan also met and decided that eight years of zero interest rates and the government
purchasing anything that even looks like a security just isn’t enough. Japan needs more. So it removed the goal posts for ending QE, making
the BOJ a prime contender for the Noble Prize for insanity.
Given the lack
of success of QE to date, I can’t imagine how more of it will be of any benefit
to their respective economies. On the
other hand, more of the same simply adds to the ultimate problem of undoing
it. Clearly, the vast consensus of economists
and investors is not worried about this prospect.
Complicating
the issue is that the Fed has already started to unwind US QE, putting our monetary
policy at odds with the EU and Japan. I
am not sure how that conflict in monetary policies works itself out in the
global asset markets, particularly with respect to the timing of the reversal
of the mispricing and misallocation of assets.
However, I remain
convinced that since the major beneficiary of QE was the asset market, then it
will likely suffer pain when, as and if QE is unwound.
(4) geopolitical
risks: The good news is that the US/Russian
faceoff in Syria appears to have dissipated, North and South Korea have just
reached an agreement to officially end the Korean War and plans for the Trump/Un
meeting are moving forward. The bad news
is that the odds of a US/Iran confrontation are growing.
(5)
economic difficulties around the globe. The international data this week was slightly
negative:
[a] the April Markit EU flash PMI’s were upbeat while economic
sentiment was in line; the April German business climate index was slightly
below consensus; and the UK first quarter GDP was terrible,
[b] March Chinese industrial profits rose 11.6%
year over year versus February’s reading of +16.1%.
I am altering
the bottom line: Europe has joined the rest of the world struggling to maintain
positive economic growth.
Bottom
line: the US long term secular economic growth
rate could improve based on increasing deregulation. In addition, if the success of the trade
negotiations with South Korea can be repeated with NAFTA and China, which
appears increasingly likely, then a fairer trading regime would almost
certainly be an additional plus for the US long term secular economic growth
rate. ‘If’ remains the operative word;
plus we need to see the shape of any new agreement before changing our forecast.
At the same
time, those long term positives are being offset by a totally irresponsible
fiscal policy. The original tax cut, a
second proposed new improved tax cut, increased deficit spending and a potentially
big infrastructure bill will negatively impact economic growth and inflation,
in my opinion. The current level of the national debt and budget deficit are
simply too high to allow the additional economic growth. I believe that a bigger deficit/debt=slower
growth and a higher deficit spending=inflation, even if they are the result of
a tax cut and/or infrastructure spending.
Hence, this is a negative for the long term secular growth rate of the
economy.
It is important
to note that the negative impact that a rapidly growing national debt and budget
deficit have on economic growth is not just long term in nature. There is also a short term effect on Fed
policy which is being dramatically exacerbated by its own irresponsible venture
into QE. As a result, the central bank has
put itself in a no win situation: [a] if I am wrong and the economy accelerates
and the Fed does nothing, it
risks inflation, [b] in fact even if economic doesn’t pick up, but LIBOR rates
continue to blowout and the ten year Treasury pushes through 3%, the Fed may
not even have the option of doing nothing, [c] in either event, if it moves
forward with the unwind of QE, it will begin the unwinding of the mispricing and
misallocation of global assets---which only confirms 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 24311, S&P 2669) had a mixed day (Dow down, S&P up). Volume was flat;
breadth was unimpressive. The S&P ended within a very short term downtrend;
though the Dow again closed above the upper boundary of its former very short
term downtrend. That leaves the Averages
out of sync with respect to this one indicator, meaning that there is little
informational value on direction/momentum.
Both finished below their 100 day moving averages (now resistance) but
above their 200 day moving averages (now support). The DJIA closed 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. Longer
term, the assumption is that equity prices will continue to rise.
The VIX fell another 5 ¼ %,
closing below its 100 day moving average (if it remains there through the close
next Tuesday, it will revert to resistance) but above its 200 day moving
average and the lower boundary of its short term trading range. Additional
weakness would point to higher stock prices.
The long
Treasury rallied ¾ %, pushing further back above the lower boundary of its long
term uptrend which it had unsuccessfully challenged on Wednesday. However, it remains below its 100 and 200 day
moving averages and in a short term downtrend---indicating a lot of resistance
to a further increase in prices (decline in rates). (must read):
The dollar paused
in its rally, but remained above the lower boundary of its newly reset intermediate
term trading range, above its 100 day moving average (now support) and above
its 200 day moving average for the second day (now resistance; if it remains
there through the close next Tuesday, it will revert to support).
GLD was up ½ %, bouncing
off its 100 day moving average, finishing above its 200 day moving average (now
support) and in a newly reset short term trading range.
Bottom line: I
have noted over the last couple of weeks that the Averages were caught in a narrowing
range, bounded on the upside by their 100 day moving averages (plus the S&P’s
upper boundary of its very short term downtrend) and on the downside by their
200 day moving averages. Two Thursdays
ago, the Averages challenged that upper boundary and failed. Wednesday, they challenged the lower boundary
and failed. Now they appear on their way
for another challenge of the upper boundary.
Sooner or later that range will be broken; history suggests a strong
follow up move in the direction of the break.
TLT failed its
second challenge of its long term uptrend and is now in a two day rally. But it faces multiple resistance levels. While the recent increase in the dollar is the
usual reaction to the selloff in Treasuries, it has remained upward bound
though TLT rallied hard on Thursday and Friday---a little confusing. Meanwhile, gold’s response was to be
expected. That said, the recent pin
action in all the indicators suggests a good deal of investor turmoil/confusion
as multiple support/resistance levels are being challenged.
Price
instability/uncertainty remains for the moment.
The question is duration. Patience.
I love my cash.
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 positively impacted
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. A further increase could come if Trump’s
drive for fairer trade is successful. On
the other hand, a soaring national debt and budget deficit are negatives to
long term growth and, hence. ‘Fair Value’.
Moreover, on a
short term basis (this week’s data notwithstanding), 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. I don’t believe that sluggish growth is
reflected in the price of stocks.
The two issues
that held investor attention this week were:
(1)
the course of interest rates. As you know, the ten year Treasury toyed with
the 3% level for most of the week---3% being a psychological break point for
bond investors. Plus the thirty year
Treasury is in the midst of a challenge of its long term [30 year]
uptrend. A breach of these landmarks
would portend a continuing rise in rates.
The question is, why are they rising?
Are interest rates rising because the economy is strengthening which
would normally be accompanied by an increasing demand for credit and a little
inflation; or are they rising because the economy can’t grow any faster and any
resources directed at growth are simply driving prices higher. You know that I believe that the latter is
the case---which will not be good for stocks.
But more data is needed before that forecast pans out---if it pans out,
(2)
we are in the thick of earnings season. As you know, I thought that while anyone with
a heartbeat knew the results would be spectacular [as a result of the tax cut],
the flow of good news would keep investors enthused. As it turns out, the earnings reports have been
coming in as expected; but investors have not reacted that positively. I take that to mean that another catalyst is
needed to get stocks back on an upward track.
I await the good news.
Meanwhile, my
operating scenario is that the positive impact of deregulation and a potential
improvement from better trade deals could very well be offset by the likelihood
of subdued growth and higher inflation resulting from an irresponsible fiscal policy
(expanding the national debt and the budget deficit to the point at which the
cost of servicing the debt/deficit negates any benefit from tax cuts or
infrastructure spending). I needn’t be
repetitive here; but:
(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. 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. Indeed, as I noted above, if long rates
continue to rise, it won’t have a choice.
Since QE led to the gross mispricing and misallocation of assets, the
process of unwinding it, in my opinion, would not be good for the Markets
because they are the only thing that benefitted from QE.
Bottom line: a
new regulatory regime plus an improvement in our trade policies should have a
positive impact on secular growth. On
the other hand, I believe that fiscal policy will have an opposite effect on economic
growth. Making matters worse, monetary
policy, 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 24311
2669
* 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.
No comments:
Post a Comment