The Closing Bell
6/23/18
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 13350-29555
Long Term Uptrend 6410-29847
2018 Year End Fair Value
13800-14000
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Uptrend 2548-3319
Intermediate
Term Uptrend 1285-3100
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 mixed: above estimates: weekly mortgage and purchase
applications, month to date retail chain store sales, weekly jobless claims, first
quarter trade deficit; below estimates: the June housing market index, May
existing home sales, the June Philly Fed index, May leading economic indicators;
in line with estimates: May housing starts/building permits, the June flash
composite, manufacturing and services PMI’s.
However, the
primary indicators were negative: May housing starts/permits (0), May existing
home sales (-) and May leading economic indicators (-). Based on that, I rate this week negative. Score:
in the last 141 weeks, forty-eight were positive, sixty-six negative and
twenty-seven neutral.
The data
continues to provide both positive and negative signals; the last couple of
weeks being a perfect example. It is something
to be expected in an economy that is growing but is laboring to do so.
There is no
question that the overall second quarter numbers have shown a pick up from
first quarter; and if that trend continues well into the third quarter then I
will likely raise our 2018 growth forecast.
Holding me back
from doing that right now is (1) we don’t know how enduring the improvement in
the second quarter stats are. They were
almost certainly impacted by the tax cuts but not overwhelming, (2) in the background
is the current high and rising level debt in all economic sectors. I am not sure how long the recent growth spurt
can last with this overhanging burden and (3) the outcome of trade negotiations
could have a significant effect on growth.
The uncertainty around this issue is currently higher than it should be;
but it is there nonetheless.
Trade remains
front and center on the economic stage.
The lead headlines this week were tariff threats---lots of them. As you know, I agree with Trump’s objective
which is a fairer trade regime though his style could be less bellicose. Indeed, my fear is that latter could hamper
or negate the former. So at the moment,
the risk is some sort of trade war---which would be a detriment to economic
growth. On the other hand, a positive result would be a plus for the long term
secular growth rate of the US.
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. Unfortunately, the reverse would also be
true. In addition, 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 second quarter numbers are going to be better than the first, though
there is insufficient evidence at this moment to indicate a strong follow
through. So my current assumption
remains intact---an economy struggling to grow.
The
negatives:
(1)
a vulnerable global banking system. Deutschebank did it again. This time announcing a heretofore undisclosed
major loss in its trading operations.
This illustrates perfectly my objection to the rules applying to the
major bank’s prop trading desks. As long
as the traders have big upside [bonuses] and no downside
[shareholders/taxpayers eat the losses], this situation is not going to
improve. Somebody has to be fined
severely or go to jail or both before this risk to bank balance sheets
[solvency] is removed.
(2)
fiscal/regulatory policy.
Trade
issues consumed this week’s headlines.
It included lots of fiery rhetoric but some hopeful signs that our
trading partners may be willing to negotiate.
I can’t add anything to what I have already said. But I will repeat my bottom line: I believe
that Trump is attempting to reset the post WWII political/trading regime which
has grown increasingly disadvantageous to the US; and I think that he is right
to do so. Though he is woefully short on
style points. If successful, it will be
a plus for the long term secular growth of the US economy. If a trade war
results, there will be pain.
Unfortunately,
this says nothing about an equally big problem to which Trump has contributed:
too much national debt and too large a budget deficit which will usurp
investment dollars that would otherwise be used for increased productivity.
(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.
This week the
Bank of England followed up the four central bank meetings last week. It left rates unchanged. However, its narrative was more hawkish than
expected. As a result, the odds of an
August rate hike increased. It left its
bond buying program intact.
So the demise
of global QE took another baby step toward a well-deserved end. My thesis remains that {i} QE did little to
assist the economic recovery following the financial crisis; so it is unlikely
to be a major negative as it winds down. But {ii} it created a massive
mispricing and misallocation of assets; and its unwinding will not be Market
friendly.
(4) geopolitical
risks: North Korea, Iran and Italy; but
little news on any this week.
(5)
economic difficulties around the globe. Not a lot of stats released this week. But what we got was upbeat; and it was from
the EU which has been the source of much of the negative dataflow over the last
couple of months: the June flash EU composite PMI was 54.8 versus estimates of
53.9; manufacturing was 55.0, in line; and services was 55.0 versus 53.7.
Other
developments included:
Growing political turmoil within the
eurozone (medium):
OPEC raises its production limits by 600 thousand
B/D (medium):
Bottom
line: the US long term secular economic growth
rate could improve based on increasing deregulation. In addition, if trade negotiations with China,
NAFTA and the EU prove successful 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. (must read):
On the other
hand on a cyclical basis, growth in the second quarter will be above that of
the first quarter, helped along by the tax cuts. The issue for me is the strength of follow
through. Until more evidence proves otherwise,
my thesis remains 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.
The
Market-Disciplined Investing
Technical
The Averages
(DJIA 24580, S&P 2754) recovered a bit on Friday---not really surprising given
their dramatically oversold condition.
Volume rose; breadth improved. The
Dow finished below its 100 day moving average for a third day, reverting to
resistance while the S&P remained above (now support). Both ended 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 VIX declined 6 ½ %, closing
below its 100 day moving average (now resistance), back below its 200 day
moving average (voiding Thursday break) and within a short term trading
range. It looks like it bottomed in
early June.
The long
Treasury fell pennies, closing above its 100 day moving average and the lower boundary
of its long term uptrend but below its 200 day moving average and remained in a
short term downtrend. It seems trapped
in the range defined by those indicators.
The dollar was down
fractionally, but still ended well above both moving averages and in short term
and very short term uptrends.
Yes Virginia,
gold can go up, but still finished below its 100 and 200 day moving averages and
in a short term downtrend.
Bottom line: we
got a bit of cognitive dissonance on Friday as the Dow’s 100 day moving average
reverted to resistance while both it as well as the S&P’s 100 day moving
average are rolling over and heading for a cross of their 200 day moving
averages. If that occurs, it would also
be a negative technical signal. However,
the longer term momentum remains to the upside; so it is too soon to become
negative much less alter my assumption that long term stocks are going up.
On the other
hand, bonds and the dollar again traded at odds with each other; and gold is declining
no matter what the news or the pin action in other indicators. In short, we are
getting no directional information from these indices.
Friday in the charts
(medium):
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’ is being positively
impacted based on a new set of regulatory policies which should 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:
(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. To be sure, the second quarter numbers will
look better than the first. But follow
through is important. Until the stats
show more consistency to the upside, the burden of proof remains on those in
the positive camp. My thesis remains that the financing burden now posed by the
massive US deficit and debt has and will continue to constrain economic as well
as profitability growth,
(2)
the success of current trade negotiations. If Trump is able to create a fairer trade
regime, it would almost certainly be a positive for secular earnings growth. However, the reverse is also true; and at the
moment, the outcome is becoming increasing uncertain as tariff threats fill the
air,
(3)
the rate at which the global central banks unwind
QE. The optimists believe that they will
tighten only to the extent as to not disrupt the Markets. Of course, the Markets haven’t been disturbed
yet. But with the global funding needs
growing [more supply] and the US, ECB and China central banks tightening [less
demand], it may not be that long before that occurs. The question is, when it does, will it be too
late to stop the repricing of risk.
Bottom line: a
new regulatory regime plus an improvement in our trade policies should have a
positive impact on secular growth and, hence, equity valuations. 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. (must read):
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 24580
2754
* 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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