The Closing Bell
12/8/18
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%
2019
Real
Growth in Gross Domestic Product 1.5-2.5%
Inflation +1.5-2.5%
Corporate
Profits 5-6%
Current Market Forecast
Dow
Jones Industrial Average
Current Trend (revised):
Short
Term Trading Range 21691-26646
Intermediate Term Uptrend 13824-30031
Long Term Uptrend
6410-29847
2018 Year End Fair Value
13800-14000
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Trading Range 2536-2942
Intermediate
Term Uptrend 1323-3138 Long Term Uptrend 905-3065
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 a neutral for equity valuations. The
data flow this week was just slightly positive: above estimates: weekly
mortgage and purchase applications, November light vehicle sales, the November
ADP private payroll report, third quarter unit labor costs, December consumer
sentiment, November ISM manufacturing and nonmanufacturing indices, the November
services PMI; below estimates: weekly jobless claims, November nonfarm payrolls,
month to date retail chain store sales, October construction spending, October
factory orders, October wholesale inventories/sales, the October trade deficit;
in line with estimates: the November manufacturing PMI, third quarter
productivity.
However, the primary
indicators were all negative: October construction spending (-), October
factory orders (-) and November nonfarm payrolls (-). I am giving this week a minus rating. Score: in the last 165 weeks, fifty-three
were positive, seventy-four negative and thirty-eight neutral.
Update on big
four economic indicators.
The data from
overseas was actually pretty good though a bit parse. However, I can’t see this as trend setting
given the ongoing turmoil over Brexit, the riots in France, the Chinese/US trade
relations and Italy’s budget dispute with the EU.
My forecast:
A number of
Trump policy changes should have a positive impact on what is now a below
average long term secular economic growth rate.
These include less government regulation with possible minor help from
the recent agreements with Mexico/Canada/South Korea. There is the potential
that Trump’s trade negotiations with Japan, the EU and China could prove to be
another bonus; but unfortunately, the Donald’s negotiating skills are starting
to remind me of George Costanza’s---sound tough and settle for less. Possible spending cuts could also lead to a
further improvement in our long term secular growth rate.
However, the
explosion in deficit spending, especially at a time when the government should
be running a surplus, is a secular negative.
My thesis on this issue is that at the current high level of national
debt, the cost of servicing the debt more than offsets (1) any stimulative
benefit of tax cuts and (2) the secular positives of less government regulation
and fairer trade [at least on the agreements that have been renegotiated].
On a cyclical
basis, while the second quarter numbers were definitely better than the first,
third quarter stats showed slower growth and current expectations for the
fourth quarter are even lower. Perhaps
more concerning is the forward sales/earnings guidance from leaders in major
sectors of the economy suggesting a further slowdown in growth that is more
pronounced than current consensus.
So my current
assumption remains intact---an economy growing slowly though the risk of
recession may be mitigated somewhat by a less hawkish Fed.
The
negatives:
(1)
a vulnerable global banking [financial] system.
Banks are changing their business model to offset the
decline in liquidity resulting from the shrinkage in central bank balance
sheets.
(2)
fiscal/regulatory policy.
Trade remains the
most immediate issue. The results of
last weekend’s Trump/Xi are still a matter of debate. The Donald said that it was the greatest
thing since sliced bread; his advisors walked that back a bit; and Chinese
balked then said that they would buy more US products. Not coincidentally I am sure, the time for
the purchases to begin is after the ninety day deadline that Trump imposed for
reaching a deal. That whole dialogue
seemed something north of nothing burger.
However, on
Thursday the CFO of a leading Chinese tech company was arrested on charges of
violating US sanctions against Iran. Clearly,
that can’t have made happy; though there has been no reaction to date. Still, I think this has to be stirred in to Trump’s
big pot of Chinese/US love stew.
My reaction was a big ‘atta boy’ for the
Donald. As you know I am about to give
up on anything substantive coming from his stated policy of revamping the
global trade regime---NAFTA 2.0 was joke and, at least to date, the supposed ‘come
to Jesus’ meeting with Xi at the G20 seems likely to have the same impact as
wart on goat’s ass.
So I am now in
a ‘wait and see’ mode. I have growing doubts
that Trump is really willing to do what is right regarding China’s egregious
policies [theft of intellectual property] because to do so will cause pain; and
given the Donald’s Market based personal rating system, he has yet to show that
he willing to take that pain for a greater good.
Chinese
imports from US down 25%.
Another issue
is the funding of the border wall which Trump has tied to a partial government
funding measure that needs to be enacted shortly. Trump wants $5 billion and says that he will
shut down the government if he doesn’t get it.
The dems say that all he gets is $1.6 billion. So here we are in another one of those
showdowns in which the Donald either blinks or shuts down the government---an
action that has never proved a plus for the economy.
My bottom line, aside from my usual rant about the
weakening effects of an outsized federal debt/deficit on the economy, is that I
am losing confidence that Trump will achieve a reformed trade policy, and,
hence, have a positive impact on the long term secular growth rate of this
country.
(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 asset bubbles in the stock market as well as
in the auto, student and mortgage loan markets.
Nothing really
new on this front this week. The Fed did
release its latest Beige Book which I don’t think added anything to the current
debate of just how hawkish or dovish Powell/the Fed really is.
I did get some
feedback that the nothing has changed regarding the unwinding of the Fed’s balance
sheet---which as you know, I consider a lot more important than what the Fed
does with interest rates; that is, lower interest rates might help the economy
and unwinding of QE will have little effect---though it reverse the gross
mispricing and misallocation of assets.
And speaking of
the mispricing of assets, look what is going on in the leveraged loan market.
(4) geopolitical
risks:
Brexit, civil unrest in France, the EU/Italy
standoff; and now Russia and Ukraine are threatening each other. They all could be much to do about nothing;
or any one could cause serious negative financial consequences. I have no clue
on any potential outcome; but they can’t be ignored.
(5)
economic difficulties around the globe. The stats this week were positive: third quarter EU GDP was up, in line; the
November EU and UK manufacturing PMI’s were above estimates as were October
German factory orders; though October German industrial production was poor.
There was more
good news out of OPEC---it agreed to larger than expected production cuts [***warning,
these guys lie a lot].
Bottom
line: on a secular basis, the US economy
is growing at an historically below average secular rate although I assume decreased
regulation, the likely successful completion of the NAFTA 2.0 agreement and
Trump’s spending cuts (assuming implementation) will improve that rate somewhat.
However,
these potential long term positives are being offset by a totally irresponsible
fiscal policy. To be sure, the Trump
mandated spending cuts would be a great start to correcting this problem. Further, political gridlock could shut down
any new tax cut/spending increase measures.
For that, we should all be thankful.
But until evidence proves otherwise, my thesis is that cost of servicing
the current level of the national debt and budget deficit is simply too high to
allow any meaningful pick up in long term secular economic growth derived from
deregulation or the current somewhat improved trade regime.
Cyclically,
growth in the second quarter sped up, helped along by the tax cuts. Plus (1) removing the uncertainty of no NAFTA
treaty should help return economic conditions within the three countries to what
they were before and (2) a slowdown in the rise of short term interest rates
will likely improve economic sentiment.
On the other hand, trade fears [China] and a weakening global economy
point to slower growth if not outright recession. As I noted above, that is not my forecast at
the moment.
The Market-Disciplined
Investing
Technical
The Averages
(DJIA 24388, S&P 2633) had another rough day. They finished below both moving averages; and
having set a second lower high last Friday, they made a new lower low. In short, the indices’ charts continued to
deteriorate. However, they are getting
very oversold, so some rally is to be expected.
Volume rose and
breadth was negative. But again neither
had any of the characteristics of a selling climax.
The VIX was up another
9 ½ %, so its chart remains positive (bad for stocks) and actually got more
upbeat as its 100 DMA is crossing above its 200 DMA.
The long bond rose
again, finishing above its 100 DMA for a third day, reverting to support, and
above its 200 DMA for a third day (now resistance; if it remains there through
the close next Monday, it will revert to support). In sum,
its chart is being turned on its head.
Follow through is still needed to confirm the aforementioned
challenges. But clearly, bond investors are
embracing the flattening yield curve scenario (recession) enthusiastically…...
The dollar was down,
ending below the lower boundary of its very short term up trend (if it remains
there through the close on Monday, the trend will be voided), but remains in a short
term uptrend as well as above both MA’s. So the chart continues to be
technically strong.
GLD traded up almost
a point, continuing to improve technically.
It remains above its 100 DMA and is developing a very short term
uptrend. This is not unusual given the
carnage in stocks and a move lower in interest rates. In fact, I am surprised that gold has not
done better.
Bottom line: the Averages’ charts continue
to deteriorate technically, making any meaningful Santa Claus rally ever more
difficult. That said, given that they
keep getting more and more oversold, some kind of rebound seems
inevitable.
The
pin action in the long bond continues to point to lower rates. While that may be good news with respect to
Fed policy, it also suggests bad news for the economy (i.e. weaker). Both the dollar and gold look to be
supporting that view.
Friday
in the charts.
Fundamental-A Dividend Growth
Investment Strategy
The DJIA and the
S&P are well above ‘Fair Value’ (as calculated by our Valuation Model), the
improved regulatory environment and the potential pluses from trade and
spending cuts notwithstanding. At the
moment, the important factors bearing on Fair Value (corporate profitability
and the rate at which it is discounted) are:
(1)
the extent to which the economy is growing. Economic activity in the third quarter slowed
and everyone pretty much agrees that it will do so again in the fourth quarter. This is all borne out in the dataflow.
Also,
lest we forget, the growth rate in rest of the global economy has slowed and appears
to be slowing even further as fears of a prolonged US/China trade war impact
corporate investment/spending plans. That can’t be good for our own prospects. It is certainly possible, even probable, that
the US can continue to grow as the rest of the world slows. But the rate of growth will likely be
declining nonetheless.
Further,
while I don’t profess to know the exact reasoning for the Fed to turn dovish
[data dependent], an obvious motivation would be a perceived slowdown in the
economy.
My
thesis is that, a trade war aside, the financing burden now posed by the
massive [and growing] US deficit and debt is offsetting the positive effects of
deregulation and fairer trade and will continue to constrain economic as well
as profitability growth.
In
short, the economy is not a negative [yet] but it is not a positive at current
valuation levels.
(2)
the success of current trade negotiations. If Trump is able to create a fairer political/trade
regime, it would almost surely be a plus for secular earnings growth. That said, as I noted above, it is beginning to
look to me that the Donald’s bombast is just so much fluff. In other words, the odds of success seem to
me to be declining and, as a result, its potential positive impact on the long
term secular growth rate of the country.
(3)
the rate at which the global central banks unwind
QE. The Fed appears to be pulling back
from its move to hike the Fed Funds rate.
However, that is less important to QT than the run off of its balance
sheet---and, at the moment, it appears that it will continue unabated. In
addition, the ECB appears on schedule to halt its bond purchase program.
On the
other hand, the BOJ remains entrenched in its version of QE and the Chinese are
using every policy tool available, including monetary easing, to stem the
negative effects of the trade dispute with the US. I have no clue how this dance of conflicting
monetary policy will play.
I remain
convinced that [a] QE has done and will continue to do harm in terms of the
mispricing and misallocation of assets, [b] sooner or later that mispricing/misallocation
will be reversed and [c] given the fact that the Markets were the prime
beneficiaries of QE, they will be the ones that take the pain of its demise.
(4)
finally, valuations remain at record highs [at least as
calculated by my Valuation Model] based on the current generally accepted economic/corporate
profit scenario.
Whether
or not I am right about overall valuation levels, investors seem to be balking
at raising valuations any further. That doesn’t mean that a crash is imminent
but it does suggest that, at a minimum, further upward progress may be limited.
Bottom line: a
new regulatory regime plus an improvement in our trade policies along with
proposed spending cuts should have a positive impact on secular growth and,
hence, equity valuations. On the other
hand, I believe that overall fiscal policy (growing deficits/debt) will have an
opposite effect. 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.
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 12/31/18 13860
1711
Close this week 24338
2633
* 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 economy not the near term cyclical influences. The model is now accounting for somewhat
below average secular growth for the next 3 to 5 years.
The Portfolios and Buy Lists are
up to date.
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