The Closing Bell
1/26/19
I am off to the beach. Back on 2/11.
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 13994-30206
Long Term Uptrend
6585-29947
2018 Year End Fair Value
13800-14000
2019 Year End Fair Value
14500-14700
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Trading Range 2349-2942
Intermediate
Term Uptrend 1338-3148 Long Term Uptrend 913-3073
2018
Year End Fair Value 1700-1720
2019
Year End Fair Value 1790-1810
Percentage Cash in Our
Portfolios
Dividend Growth
Portfolio 56%
High
Yield Portfolio 55%
Aggressive
Growth Portfolio 56%
Economics/Politics
The Trump
economy is a neutral for equity valuations. The
data flow this week was positive: above estimates: month to date retail chain
store sales, weekly jobless claims, the January flash composite and manufacturing
PMI’s, January Richmond and Kansas City manufacturing indices; below estimates:
December existing home sales, weekly mortgage and purchase applications; in
line with estimates: December leading economic indicators, the January flash
services PMI.
There were two primary
indicators reported this week: December existing home sales (-) and December
leading economic indicator (0). And
there were two not reported: December durable goods orders and December new home
sales. I am going to give this week’s data
a tentative plus rating even though: (1) the trend in the secondary indicators suggest
that the durable goods number would miss its mark (2) the housing stats have
been almost universally poor of late, not the least of which was this week’s existing
home sales. Score: in the last 172
weeks, fifty-six positive, seventy-six negative and forty neutral.
There was plenty
of data from overseas this week and most of it was negative. Certainly, some portion of those poor results
stem from the effects of the US/China trade dispute and economic/political
turmoil in the UK, France and Italy. However,
at the risk of stating the obvious, if those problems can’t be resolved, then
they are going to keep impacting the global economy.
My forecast:
Less government
regulation, Trump mandated spending cuts, (hopefully) getting out of the Middle
East quagmire and possible help from a fairer trade regime are pluses for the long-term
US secular economic 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, the economic growth rate is slowing as the effects of the tax cut wear
off, the global economy decelerates and credit expansion slows with the unwind
of the Fed’s balance sheet (now in question).
There appears to be an increasing risk that the economy may not be as
strong as even my forecast has portrayed it.
The
negatives:
(1)
a vulnerable global banking [financial] system.
This problem just won’t go away.
(2) fiscal/regulatory
policy.
The two most
important near-term issues are:
[a] the
shutdown. There was, at least, a
temporary resolution to wall/shutdown political standoff. I have said repeatedly in these notes that
the ruling class watches the polls closely and that when it became obvious which
side was losing, a solution would be forthcoming. Trump was losing, so he cut his losses---which
in my opinion, was a great decision. You
don’t play out a losing hand if you want to stay in the game.
[b] the
US/China trade talks. It looks like
progress is being made. The head of
China’s negotiating team will be in the US for meetings next week. The statements out of the administration remain
contradictory {Ross (-) versus Kudlow (+)} though Kudlow has always been a
positive spinmeister even when he wasn’t in the White House.
That said,
Trump is likely looking for a win, after shutdown resolution. So, my concern is that he folds on, what I consider
to be the most important aspect of establishing a new political/trade regime
with China, the Chinese theft of US intellectual property. Still sitting down and talking is better than
doing nothing.
I will spare you my usual rant about the weakening effects
of an outsized federal debt/deficit on the economy, except to say that those
effects may be becoming more pronounced [and visible].
(2)
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.
This week,
China made changes in bank reserve accounting which has the effect of providing
more liquidity to its financial system.
That left the
US as the sole central bank pursuing QT---maybe. Because on Friday, the Fed announced that it is
considering ceasing the runoff of its balance sheet. I could write a treatise on how f**ked up a
decision like that would be---if it happens. But the two most important are: in
conjunction with global QE [a] it would allow the financial system to get even
more leveraged up and have an even smaller equity cushion when things go wrong---which
inevitably they will and [b] it will continue to exacerbate the social tensions
in this country as the rich get richer {asset prices rise} and the less advantaged
don’t---because stopping QT will do almost nothing for the economy and those
who benefit from one that grows.
You know my
bottom line on this issue: QE does little to support the economy but feeds
liquidity into the financial system resulting in the mispricing and
misallocation of assets. QT has the
opposite effect. All other things being
equal, if the central banks are indeed back to expanding their balance sheet,
then I expect little impact on the economy but higher asset prices.
(3) geopolitical
risks:
Europe is a
mess with Brexit, riots in France and fiscal policy discord in Italy; and it continues
to be reflected in a negative way in the economic stats.
Trump is now
backtracking on his promise to get out of the Middle East which will likely
push the threat meter higher as the rest of the players just try to figure out
what US policy is.
Plus, you never
know how the situation in Venezuela plays out.
(4)
economic difficulties around the globe. The stats this week were again negative,
continuing to point to a global economic slowdown:
[a] the January EU flash composite, manufacturing and
services PMIs were all below estimates; the January EU consumer confidence
index was lower than anticipated,
[b] fourth quarter Chinese GDP was less than expected,
December fixed asset investments and industrial production were in line and retail
sales were ahead of forecasts,
[c] the Bank of
Japan lowered its estimate for 2018 GDP growth; while it raised the numbers for
2019 and 2020, it also lowered its inflation outlook which is something of an
offset; the January flash manufacturing index was below December’s reading.
Bottom
line: on a secular basis, the US economy
is growing at an historically below average rate. Although some recent policy changes are plus
for secular growth, they are being offset by a totally irresponsible fiscal
policy. 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 the US’s long-term
secular economic growth even with improvement from deregulation or the current
trade regime (a caveat being if China does change its industrial policy).
Cyclically, the
US economy is once again slowing as evidenced by the data from both here and
abroad. As a result, my initial US 2019 economic growth rate assumption is at risk
of being too optimistic.
Finally, any move to a more dovish
stance by the Fed is not likely to have an impact, cyclical or secular, on the
economy. QE II, III, and Operation Twist
didn’t, and QE IV probably won’t either.
Meaning that if the Fed thinks backing off QT will help support economic
growth, in my opinion, it will be disappointed.
The Market-Disciplined
Investing
Technical
The Averages
(DJIA 24737, S&P 2664) had a great day.
Both Averages remain below both MA’s, are in short term trading ranges
and seem to have launched themselves off the support that they had been
building at the former 61.8% Fibonacci retracement level.
Volume was up;
breadth improved and moved further into overbought territory.
The VIX fell again,
finishing below its 100 DMA for a second day (now support, if it remains there
through the close on Monday, it will revert to resistance). Still it ended above its 200 DMA and in a
short term uptrend.
The long bond was
down, but remained above both MA’s, in short and intermediate-term trading
ranges, in a very short-term uptrend and above its last prior higher low.
The dollar also
declined. Nevertheless, it closed above
both MA’s, in a short-term uptrend and within that mid-November to present
consolidation phase.
GLD spiked on
volume, ending well above both MA’s, within a very short-term uptrend and
within a short-term trading range---a healthy chart.
Bottom line: the Averages appear to be
headed for another leg higher. Though they are so overbought right now, it may
be a short one before some backing and filling occurs. On the
other hand, supporting the notion of another leg higher, the VIX is about to a successful
challenge its 100 DMA.
The pin action continues to suggest that the December 24 low was a bottom.
If so, then I would feel more confident putting money to work in any
dip---assuming a stock moves into its Buy Range. The flip side of this is that stocks as
measured by the Averages remain way overvalued.
So, I will also be looking to take money off the table if a stock moves
into its Self-Half Range.
The dollar and gold traded in line with
an easier money scenario; but the long bond didn’t---a little confusing.
Friday
in the charts
Fundamental-A Dividend Growth Investment
Strategy
The DJIA and the
S&P are still 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. We are still missing a lot of primary
indicator data, but with the evidence at hand, it would seem that US economic
activity is slowing. There is almost no question that the global economy is
slowing; and that is not going to help our own cause. Still, it is certainly possible that the US
can continue to grow as the rest of the world slows. But declining global growth is likely going
to the rate of US growth as well as any improvement in earnings.
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. The current trade talks with China clearly
hold promise. Unfortunately, thus far,
we have gotten little more than platitudes and rumors regarding what has been
discussed. Though the fact that another
round of negotiations is occurring next week which involve higher level trade
officials must be looked at as a plus.
(3) the
rate at which the global central banks unwind QE. The most significant development is the
recent data on global central banks’ balance sheets showing that a huge
injection of liquidity began in the past month.
I noted that at least a part of this expansion is due to seasonal
factors in China. However, this week, the
Bank of China instituted measures with positive longer term member bank liquidity
implications.
And
then, there is the Fed which this week said that it was studying the
possibility of delaying/ceasing QT. I
don’t know if this is a reaction to December’s Market decline or a rising
concern about the health of the economy [or both]---though the proximity to the
former may be indicative. Whatever the
reason, if the Fed ceases QT, it will be a short term plus for the Markets. Over the last decade, we have seen all the
evidence we need concerning the impact on asset pricing and allocation of easy
monetary policy in an economy whose growth is constrained by secular forces. The bad news [for the Market] is that, at
least for the moment, QT policy is just being studied.
(4)
current valuations. the Averages have recouped roughly
one half of their October to December loss and appear on their way to recouping
even more. Since they were grossly
overvalued [as determined by my Valuation Model] in October, they are now just
slightly less grossly overvalued. That
said, if the latest central bank liquidity surge continues valuations will remain
irrelevant.
On the
other hand, there were buying opportunities created in late December which I
took advantage of. Unfortunately, they
are no longer there. To be sure, many
stocks are still well off their highs; but my measure is not how far they have
fallen but have they fallen enough to trade into their Buy Range. So I am back on the sidelines being patient. If
there is another correction that sends some stocks back into they Buy Range, I
will again step in.
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. In addition, a
global central bank ‘put’ has returned that is also likely to be a plus for stock
prices. On the other hand, I believe
that overall fiscal policy (growing deficits/debt) will hamper economic and
profit growth, restraining the E in P/E.
The recent
10-11% rally brought most stocks off their lows and some out of their Buy Ranges
(at least as determined by our Valuation Model). Hence,
I am back sitting on my hands
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 2019 Year End Fair Value*
14600 1800
Fair Value as of 1/31/19 13958
1717
Close this week 24737
2664
* 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.
