The Closing Bell
6/2//18
We are off for our annual anniversary beach trip. Back on the 29th.
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 13307-29512
Long Term Uptrend 6410-29847
2018 Year End Fair Value
13800-14000
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Uptrend 2524-3295
Intermediate
Term Uptrend 1281-3096
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 very upbeat: above estimates: the March Case Shiller
home price index, weekly jobless claims, May nonfarm payrolls, April personal
spending, April construction spending, the May Dallas Fed manufacturing index, the
May Chicago PMI, May ISM manufacturing index, the April trade deficit; below
estimates: weekly mortgage and purchase applications, April pending home sales,
the April ADP private payrolls report, May consumer confidence, May manufacturing
PMI; in line with estimates: April personal income, the second estimate of
first quarter GDP.
The primary
indicators were also quite positive: May nonfarm payrolls (+), April personal
spending (+), April construction spending (+), April personal income (0) and
first quarter GDP (0). This week is
clearly a plus. Score: in the last 138 weeks, forty-seven were positive,
sixty-four negative and twenty-seven neutral.
This week stats
were very constructive; indeed, this may be the most positive week of data this
year. While it is too soon to be
considering a revision in our forecast, it could be signaling an improvement in
the growth rate of the economy. I will
make three observations about these numbers:
(1)
the good news is that production data was consistently
upbeat. That is the most positive aspect
of all the stats in that it could be a sign the corporations are starting to
spend the windfall from the tax cuts. As
you know, the lack of any measureable reinvestment of these funds to date has
been a disappointment to me and has factored into our sluggish growth forecast. If that is starting to change, it is all for
the good,
(2)
on the other hand, the increase in consumer spending
when income is not growing is not a precursor to growth, especially when the
consumer is so heavily indebted,
(3)
and finally, while the jobs number was great, remember employment
is a lagging indicator.
Overseas, the stats
were mixed, which is actually an improvement for the dataflow of the last
couple of months. That said, there is
nothing there to support the ‘global synchronized growth’ narrative.
The important
fiscal development this week was the tariffs imposed on most of our major
trading partners. I covered this in
Friday’s Morning Call; but my bottom line is that it is too soon to be talking
trade war.
Most of the
political news was of the international variety: the US/North Korea summit is suddenly
back on and everybody playing nicey nice.
Good news. Trump is playing hard
ball with our EU allies over sanctions against Iran. I have no idea where this is going; but I can
think of more negative than positive outcomes.
Meanwhile, the Trump/Mueller/Stormy
Daniels/Russia mess isn’t going away. ‘I have no idea where this whole thing ends
up; but at this moment, it is becoming an increasing distraction from the
business of the state. Mostly, that is a
good thing. The more time our ruling
class indulges in self-flagellation, the less time it has to screw with you and
me. My concern is that this ends in
another impeachment circus which historically has never been good for the
Markets.’
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 have lost any steam it might have had, after having
achieved one of the longest growth cycles in history. That said, this week’s data was very upbeat
and may be portending a pickup in cyclical growth.
The
negatives:
(1)
a vulnerable global banking system. Congress passed an amendment to Dodd Frank
this week lessening the regulatory burden on smaller banks. That was probably a positive.
Not positive is that the Fed is considering allowing
greater freedom for the large banks’ prop trading desks. This group was one of the driving forces in
the last financial meltdown. The primary
cause is that the traders are incentivized [through their compensation] to take
risks; but there is no downside since the only ones penalized for their losses are
the taxpayers who have to bail them out.
Also not so positive is the continuing deterioration
in Deutschebank’s balance sheet, as S&P downgrades its credit rating and
the Fed has it on its ‘troubled’ bank watch list. As a reminder, this is Germany’s biggest bank,
it has the globe’s largest derivatives portfolio---counterparty risk being part
and parcel of the last financial crisis.
(2)
fiscal/regulatory policy.
It was a
quiet week for real news. Most of our
elected officials have started their 2018 election campaigns including the president. However, he remains a focal point as a result
of the
[a] the
trade negotiations with China, NAFTA and the EU. In general, the headlines have not been
upbeat in any of the cases---especially with the Thursday’s announcement of the
imposition of steel and aluminum tariff on all three. I covered much of this in Friday’s Morning
Call but my bottom line is that given Trump’s negotiating style this
development doesn’t necessarily mean bad results are forthcoming. Moreover, as long as he is reasonable and
fair, I don’t have a problem with being tough.
However, the risk is overplaying the hand and precipitating a trade war. Any such development would be a major
negative for the economy.
[b]
peace/denuclearization talks with North Korea.
While this negotiating process has proven quite volatile, for the
moment, there is hope of lowering tensions.
That said, the North Koreans have a history of lying and breaking agreements. So caution is the word,
[c] the
march toward imposition of sanctions against Iran. This is causing tremendous heartburn among our
EU allies even more so because it is intertwined with the aforementioned trade
issues. I have no idea how this
situation resolves itself, though it seems that there is a lot more potential
negative than positive outcomes,
[d] the
ongoing sagas of sex and collusion which put ‘Days of our Lives’ to shame. I have no idea how any of this turns out;
however, it almost certainly diverts attention from the running of the
state---which I consider a plus. The
less time this crowd had to mess with you and me, the better.
A trade
war would be a significant negative for the economy. However, it remains to be seen if one will
occur. The more immediate problem is too
much national debt and too large a budget deficit---of which the cost of
servicing will use up productivity impeding economic growth.
(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 its latest Beige Book this week.
I covered this in Thursday’s Morning Call. The bottom line being little change in the
regional Fed’s assessment of the economy.
Perhaps more
important are the risks of a potential trade war and the political unrest in
Italy and Spain. Adverse developments
in either case would likely slow, halt or even reverse the current Fed
tightening policy. I continue to doubt
the effectiveness of QE in stimulating growth so any suspension of QT, in my
opinion, will have little economic impact.
However, it will prolong the mispricing and misallocation of assets and likely
make the ultimate resolution more painful.
Also in the mix
now is the apparent start of the Bank of Japan’s tapering of its bond buying
program. The latest numbers may be just
a seasonal or technical fluke, so we really need to wait and see if this is for
real.
(4) geopolitical
risks: see above.
(5)
economic difficulties around the globe. The international data this week was mixed.
[a] April German
unemployment fell slightly; the May EU manufacturing PMI was below estimates
while the UK PMI was above,
[b] May Chinese
manufacturing PMI was in line,
[c] April
Japanese retail sales were well ahead of expectations but the May manufacturing
PMI was below.
The major news
item was the Italian political crisis and the turmoil it caused in its bond
market---which dominated the headlines for two days, then quickly retreated as
an issue of investor concern. It hasn’t
gone away as a risk, it is just that investors took a deep breath and decided that
there was a far lower risk of any disruptions.
But just to be
clear on the nature of the risk were it to become manifest---Italy’s withdrawal
from the EU or its refusal to abide by EU fiscal policies would result in a
significant decline in the prices of Italian government bonds. These securities constitute not only a substantial
portion of the country’s own banking system’s capital (i.e. solvency) but also
a big enough portion of other EU countries’ banking capital to cause problems.
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 the EU, NAFTA and China, 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.
That said, if
this week’s improvement in the economic numbers turn out to be permanent, I may
be proven wrong on the issue of tax cuts.
The question will be, will the increase in corporate spending be enduring
(secular) or transitory (cyclical).
Until otherwise
proven wrong, I continue to believe that the current level of the national debt
and budget deficit are simply too high to allow any meaningful pick up the long
term secular 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. The
degree to which these opposing forces offset each other is the $64,000 question
to which I currently have no answer.
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 fiscal in nature. There is also an effect on Fed policy (via
the increase in interest rates) which has its own problem extricating itself
from its irresponsible venture into QE.
The
Market-Disciplined Investing
Technical
The Averages
(DJIA 24635, S&P 2734) reversed themselves again and soared on Friday
though on lower volume. Still breadth
improved. The Dow finished below its
100 day moving average (now resistance).
The S&P ended back above its 100 day moving average voiding Thursday’s
break (now support). Both remained above
their 200 day moving averages (now support).
The Dow is in a short term trading range, the S&P in a short term
uptrend.
The resistance
from the 100 day moving average continues to have, at least, a short term
impact on upside momentum. Until that
barrier can be overcome by both indices, stocks are at stall speed. Longer term, the assumption is that stocks
are moving higher.
The VIX fell 12 %, finishing
below its 200 day moving average, negating Tuesday’s break (now resistance), below
its 100 day moving average (now resistance) and back below the upper boundary of
its short term downtrend---one day after resetting to a trading range. Given the downward momentum from other
indicators, I am leaving the trend as down.
The long
Treasury was down 3/4 %, ending over its 100 day moving (now support), below its
200 day moving average (now resistance).
It remained within its long term uptrend and short term downtrend.
The dollar rose,
closing above its 100 and 200 day moving averages (now support) and in short
term and very short term uptrends as well as, though it ended right on the
lower boundary of the latter’s uptrend.
GLD was down, finishing
below its 100 and 200 day moving average (now resistance) and in a short term
downtrend, though is it is nearing the upper boundary of that trend.
Bottom line: I continue to think that confusion/uncertainty
best describes the pin action since mid-May as (1) both the Averages see saw
back and forth around resistance/support levels and the 100 day moving average
acting like a magnet preventing follow through in either direction, (2) the
long bond points at either lower rates [slowing economy] or a safety trade, (3)
the dollar points at higher rates or a safety trade and (4) gold is unable to
get out of its own way, suggesting nothing.
At the moment, my focus is on the resistance
being offered by the 100 day moving averages to any price increase on the short
term. Longer term, the assumption
remains that stock prices will continue to rise.
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’.
At the moment,
the important factors bearing on corporate profitability and equity valuations
are the same as those impacting bonds, the dollar and gold:
(1)
the extent to which the economy is growing. The optimists are out there; but to date they
have questionable support, in my opinion, from the reported data. Clearly this week’s stats help their cause. But unless the numbers remain upbeat, the
burden of proof is on those in the positive camp,
(2)
the rate at which the Fed unwinds QE. The optimists believe that it will tighten
only to the extent as to not disrupt the Markets. However, I believe that at some point the
Markets will force the Fed to tighten whether it wants to or not. And when that occurs, so does the unwind of
asset mispricing and misallocation.
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---though as I noted above I could be proven wrong on the impact of the
tax cut. 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 6/30/18 13600
1677
Close this week 24635
2734
* 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