The Closing Bell
6/9//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 13307-29512
Long Term Uptrend 6410-29847
2018 Year End Fair Value
13800-14000
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Uptrend 2531-3302
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 meager and slightly positive: above estimates: weekly mortgage
and purchase applications, weekly jobless claims, wholesale inventories/sales, May
services PMI, May ISM nonmanufacturing index; below estimates: month to date
retail chain store sales, April consumer credit, April factory orders, first
quarter nonfarm productivity and unit labor costs; in line with estimates: none.
However, both primary
indicators were negative: April factory orders (-) and first quarter
productivity and unit labor costs (-). I
rate this week negative. Score: in the last 139 weeks, forty-seven were
positive, sixty-five negative and twenty-seven neutral.
So there was
really no follow through to last week’s extremely upbeat data series although
that could simply be a function of lack thereof. Therefore my conclusion hasn’t changed. ‘While
it is too soon to be considering a revision in our forecast, it (last week’s
data) could be signaling an improvement
in the growth rate of the economy.’
Overseas, the stats
were negative, which is basically in line with the dataflow for the last couple
of months. Certainly nothing to provide
much hope that the ‘global synchronized growth’ scenario is resurrecting
How the trade
negotiations with the EU, NAFTA and China conclude is probably the most
important economic unknown at the moment---because of its potential impact on
the long term secular growth rate of the economy. The rhetoric has certainly not been positive;
but that is all part of the negotiating process, especially where the Donald is
concerned. That said, China appears to
be trying to reach an accommodation with the US; and we will know more about any
progress with the EU and NAFTA by the end of the G7 meeting. I stand
by my bottom line that it is far too soon to be talking trade war. For the moment, all we can do is observe.
The
international political news was mixed.
The US/North Korea summit is on for next week (at least for the moment)
and Trump continues to play hard ball with Iran. I have no idea how the latter is going play
out; but I can think of more negative than positive outcomes.
Meanwhile, the Trump/Mueller/Stormy
Daniels/Russia brouhaha just keeps getting more convoluted as now the Hillary
email scandal is back in the mix. ‘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 notion that the economy is losing steam might have been called into
question two weeks ago. However, there
was little back up evidence this week; though as I noted, there wasn’t a lot of
data to confirm or disprove it. So my
current assumption remains intact---an economy struggling to grow. (must read):
The
negatives:
(1)
a vulnerable global banking system. Nothing new this week as long as you don’t
count the damage that [a] would be done to the EU banking system by a crisis in
Italy and [b] is now apparently being done to some emerging market economies by
a dollar funding shortage,
I thought I would include this gem
on bank regulators (medium):
(2)
fiscal/regulatory policy.
Senate
leader McConnell surprised us all and stated that the senate would remain in
session through the end of summer in order to address ‘the peoples’ business’. Leaving aside the political motivation for
this move, it would be positive if a large number of Trump judicial nominees
could be approved. On the other hand,
there is a number spending measures on the GOP agenda; and, in my opinion, that
last thing the country needs right now is more spending.
As I noted
above, while China appears to be trying to compromise, the trade discussions with
NAFTA and the EU got very acrimonious heading into the G7 meeting on Friday. Though as I also noted, given Trump’s ‘art of
the deal’ style of negotiating, I am not taking the rhetoric at face value. Further, I also believe that Trump has a
point that some provisions of the current agreements need to be changed to fit
the current reality. So I don’t see this
process as a negative, though I am not giving the Donald a lot of style
points. The bottom line is that a trade
war would be a huge negative but a restructured trade regime that is fairer to
the US would be a plus for the long term secular growth rate of the country.
While a
trade war would be a significant negative for the economy, the more immediate problem
is too much national debt and too large a budget deficit which could potentially
be made all the worse if the GOP senate pushes though additional spending
measures this summer.
(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.
Two
developments this week:
[a] the EU
central bankers confirmed that the ECB will be discussing ending its massive bond
buying program at its upcoming meeting.
I don’t view that as being particularly meaningful since {i} discussing
is not acting and {ii} these guys have a worse history of transitioning from
easy to tight money than the Fed. So I doubt
that anything really newsworthy will come out of this meeting.
Speaking of
which, our group meets this coming week and expectations are for another rate
hike. However, the important thing
coming out of that meeting will the narrative in the subsequent statement and
the press conference with Powell. Here
is a preview:
And speaking of
the Fed narrative, here is another example of how it assumes that it knows more
than the Markets (medium):
[b] far more
important, the central banks of India and Indonesia pleaded with the Fed to
halt its tightening process because of its impact on their economies {since (1)
much of the emerging markets economic growth is dependent on exports and (2)
their international trade is conducted in dollars, the growing shortage of
dollars resulting from the Fed tightening as well as the increased level of
Treasury requirements to fund the US deficit is having an adverse effect on
trade and its financial system}.
And:
Finally, the
risks of a potential trade war, the dollar funding problems in emerging markets
and the political unrest in Italy and Spain pose a threat to functioning of the
global financial system, in general, and the solvency of the EU banking system,
in particular.
Adverse
developments in either the emerging markets or the EU would likely slow, halt
or even reverse the current Fed tightening policy. I continue to doubt the effectiveness of QE
in stimulating US growth so any suspension of QT, in my opinion, will have
little economic impact. On the other
hand, if the Fed continues to tighten it could lead to big problems in the emerging
market economies.
(4) geopolitical
risks:
[a] the North
Korea/US summit is on for the moment. An
agreement that would dismantle the North Korean nuclear program would be a big
plus. The questions are {i} what do they
want in exchange? and {ii} will they adhere to any agreement given their history
of abrogating every treaty that they ever signed? Stay tuned but don’t get jiggy,
[b] more
important is the standoff between Iran and the US since it involves the entire Middle
East geopolitical sphere as well as the ongoing trade talks with the EU. I have no clue where this thing goes; but
like Woody Hayes once said, ‘I have three choices and two of them are bad’,
[c] the change
in the Italian government has the potential to cause problems for the country,
its banking system, the EU banking system and the viability of the political
structure of the EU. Not that any of
these things will occur. But we have to
be aware of them as threats to the global economy.
(5)
economic difficulties around the globe. The international data this week was negative.
[a] first quarter EU economic growth and April
retail sales were well below expectations; May EU composite PMI was in line
while the UK service PMI was better than anticipated; April German factor
orders and industrial production were disappointing,
[b] May Chinese
composite and services PMI’s were in line while its trade balance fell,
[c] May
Japanese composite PMI was below estimates and first quarter GDP declined.
In short, the
much heralded global synchronized expansion is yesterday’s story; its
importance being the lack of any positive contribution to US growth.
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.
The hope posed
by last week’s dataflow was dampened by this week’s unremarkable numbers. While it still could be a sign that the
corporate tax cut is starting to impact economic growth, the burden of proof
remains on the optimists.
So until
otherwise proven wrong, 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.
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. Part
of that problem is the growing dollar funding issue in the emerging markets
which could lead to further damage to global growth as well as the
international financial system.
The
Market-Disciplined Investing
Technical
The Averages
(DJIA 25316, S&P 2779) traded higher yesterday. Volume declined; breadth improved but is
moving into overbought territory. The
Dow finished above its 100 day moving average for a third day, reverting to
support. The S&P ended above its 100
day moving average (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
offered by the 100 day moving average now appears to be in the rear view
mirror, clearing the way for a challenge of the indices former highs. Longer term, the assumption is that stocks
are moving higher.
The VIX rose fractionally,
but still finished below its 100 and 200 day moving averages (now resistance) and
below the upper boundary of its short term downtrend. This continues to point to higher stock
prices; though it is at a level at which institutions start buying it as
portfolio insurance.
The long
Treasury was off slightly. While it
remains above its 100 day moving average and the lower boundary of it long term
uptrend, it has lost the upward momentum from mid-May and is within a point of
challenging both support levels. A break
of the latter would end a twenty year plus bull market and indicate that higher
interest rates are in our future.
The dollar was
up fractionally. Though it has voided
its very short term uptrend, it still has plenty of upside momentum, being well
above both moving averages and it is in a short term uptrend.
GLD was up
slightly but remained below its 100 and 200 day moving averages. However, it closed above the upper boundary
of its short term downtrend by virtue of having traded flat for the last three weeks
as the downtrend continued. If it
remains there through the close next Tuesday, it will reset to a trading range.
Bottom
line: the pull of the indices’ 100 day moving
averages is now yesterday’s story. The
next resistance level is their all-time highs (26656/2874) which I am assuming
that they will at least challenge. Both TLT
and UUP are pointing at an improving economy and higher interest rates. GLD isn’t really telling us much.
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 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:
(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---save for the
previous week’s stats. However, in my
opinion, the financing burden now posed by the massive US deficit and debt has
and will continue to constrain growth.
Until the numbers show some consistency to the upside, the burden of
proof remains on those in the positive camp,
(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 growth,
(3)
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. That assumption may be about to be tested as
dollar funding issues in the international economy are starting to bite. If this situation worsens, the Fed will be
faced with the alternatives of either easing to help the emerging markets and
risk rising inflation or keep tightening and trash the emerging markets’
economies.
I have
maintained all along that given the Fed’s overly aggressive pursuit of QE, it
would sooner or later be presented with a Hobson’s choice. Now it is stuck with the need to reduce the
massive liquidity injection it made into the US/global financial system as the
first visible negative consequence of tightening is becoming manifest. I continue to believe that at some point the
Fed will have no good alternative to tightening 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. 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 25316
2779
* 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