The Closing Bell
1/12/19
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 Downtrend 2387-2621
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 almost nonexistent and what there was, was mixed: above
estimates: weekly mortgage and purchase applications, weekly jobless claims, the
December small business optimism index; below estimates: month to date retail
chain store sales, November consumer credit, the December ISM nonmanufacturing
index; in line with estimates: December CPI.
There was only one
primary indicator: November factory orders and it wasn’t released due to the government
shutdown. I am again going to give a tentative rating; this time neutral. Score: in the last 170 weeks, fifty-five were
positive, seventy-five negative and forty neutral.
The data from
overseas remains weak. China is suffering
from the effects of the US/China trade dispute.
EU growth is being inhibited by economic/political turmoil in the UK, France
and Italy.
There were two
big developments this week---one fiscal, one monetary. First, the US and China completed three days
of negotiations attempting to resolve trade issues. So far, all we have gotten was happy talk out
of the US (what’s new?) and vagueness from the Chinese. Hopefully, some meat will be put on these
bones and it will be positive.
Second, the
latest FOMC minutes confirmed chairman Powell’s (more dovish) policy reversal
delivered at a forum last Friday. The initial
consensus conclusion was that the Fed ‘put’ had been reinstated. Then two days later, Powell said the Fed
would continue to unwind its balance sheet while remaining ‘flexible’.
I am not sure
how to interpret this series of flip flops.
The most obvious explanation is that, as a newcomer to the job, Powell
simply hasn’t learned how to convey Fed policy with any consistency. Which clearly raises the question, what is
Fed policy? I think that there several alternative
interpretations: (1) the Fed has finally realized that the economy is weaker
than it has been and is saying and needs to stop tightening without admitting
it has been wrong on the economy, (2) it still believes that the economy is
strong and [a] is simply waiting for an improvement in Market psychology to
resume tightening {the Fed call} or [b] will halt rate increases near term but
will continue unwinding its balance sheet.
I have no clue what the answer is.
Though, as you know, I have never believed the economy was as healthy as
the Fed has portrayed it.
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 the unwind (?) of the Fed’s balance
sheet limits credit expansion. There
appears to be an increasing risk that the economy may not be as strong as even
my weak forecast has portrayed it.
The
negatives:
(1)
a vulnerable global banking [financial] system.
Two
developments both of which I covered in out Morning Calls: [a] the ECB administrative
takeover of an Italian bank has generated pushback from Italy and [b] the
collapse of PG&E debt in the wake of major credit downgrades and the impact
that will have of its other credit obligations.
(2)
fiscal/regulatory policy.
Trade remains the
most important near-term issue. As I noted
above, the US and China wrapped up their latest effort at resolving their trade
issues. While the meeting all by itself
is a plus, the facts that [a] the leading Chinese trade official made an appearance
at the talks and [b] the negotiations were extended an additional day, gives me
hope that some substantive changes in China industrial policy [IP theft] will
occur. That said, subsequent comments
from both parties were woefully short of specifics. So, I think that this is a time to hope but
not get jiggy.
The other issue
is the government shutdown over funding of the border. This week, our ruling class got nowhere near
a resolution. Both sides are firmly
entrenched; both sides seem to believe that they have the high moral ground. So, the shutdown may go on for a while. Trump has threatened to declare a national
emergency and appropriate the funds to build ‘the wall’. But even traditionally conservative legal
experts question the constitutionality of such an action. Meaning that if Trump does take that route,
the impeachment sh*t storm in the house is likely to go from a Category 1 to a
Category 3 or 4.
All that said,
so far there has been little economic impact from the shutdown and what there
is, is falling on the public employees not receiving their [already bloated and
economically unjustifiable] paychecks [cry me a river]. I am sure that if this goes on for an
extended period of time, more serious consequences will develop. But as I noted last week, our political class watches the polls
devotedly; so, my guess is that when it becomes clear who the masses are
blaming for the shutdown, a compromise will be sought.
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].
(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.
The main
development this was the release of the latest FOMC minutes which echoed Powell’s
dovish statements from the earlier week.
That notion was reinforced in subsequent speeches by several hawkish
FOMC members which sounded the ‘flexible’ policy theme of Powell’s. However, two days later, Powell again
reversed himself on the unwind of the Fed’s balance sheet---which in my opinion,
is the single most important aspect of current policy.
You know my
bottom line on this issue: as long as the Fed continues a QT policy, liquidity
shrinks creating credit funding problems and putting downward pressure on asset
prices. But if Fed policy has returned
to being a hostage of the Market, then the December plunge in stock prices is
probably the worst asset price adjustment over the intermediate term. I continue to believe that whether the Fed is
blowing bubbles or not, QT will not be impactful on the economy.
Another must
read from Jeffery Snider.
(4) geopolitical
risks:
Europe is a
mess with Brexit, riots in France and fiscal policy discord in Italy; and it is
beginning to show up in a negative way in the economic stats.
Italy.
France.
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.
Who’s on first.
(5)
economic difficulties around the globe. The stats this week were again negative, continuing
to point to a global economic slowdown:
[a] November EU retail sales were better than anticipated
as was its unemployment rate, November German factor orders and industrial production
declined substantially,
[b] November Chinese PPI was well under forecasts,
[c] the December Japanese services and composite PMI’s
were below estimates.
[d] World Bank sees global growth slowing in 2019.
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. Though (1) removing the uncertainty of no
NAFTA treaty will help return economic conditions within the three countries to
what they were before, (2) increase in Chinese purchases of soybeans and oil
and the lower tariffs on autos and (3) a slowdown in the rise of short-term
interest rates will help keep the slowdown under control.
As a result of
these factors, my guess is that my initial US 2019 economic growth rate
assumption will likely change---with the risk now being that my estimates may
be 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
Averages (DJIA 23995,
S&P 2596) sold off fractionally on Friday after another volatile day. Both indices finished below both moving
averages (the 100 DMA’s are close to crossing below the 200 DMA’s---an
historically negative technical signal).
The Dow finished in a very short-term downtrend and a short-term trading
range. The S&P is in a short-term downtrend but is building a very short-term
uptrend (the only bright spot in this otherwise dismal picture). In addition, they have been struggling to
challenge several overhead resistance levels. So, there remains a lot of work
to be done to re-establish an uptrend. For
instance, the S&P would have to successfully challenge the upper boundary
of its short-term downtrend (~2621) before it makes any sense to start thinking
that the worst is over.
Volume declined;
breadth was flat.
The VIX fell another
6 ¾ %, this time starting to do some technical damage to its chart. It closed below the lower boundary of its
very short-term uptrend (if it, remains there through the close on Monday, it
will void the trend) and its 100 DMA (now support; if it remains there through
the close on Tuesday, it will revert to resistance). It was certainly a much greater fall than
would be normal for a slightly down day; but recall that it has not dropped as
much as would be expected on several big down days. Perhaps, this is just catch up. On the other hand, it still ended above its
200 DMA and in a short-term uptrend. Nevertheless,
cracks are clearly appearing in this chart which would suggest the potential
for higher stock prices.
The long bond
was up 3/8%, finishing above both MA’s, in short and intermediate-term trading
ranges and in a very short-term uptrend. Friday’s bounce was also off of a low that
was higher than the previous higher low (in other words another higher low),
reflecting continue price strength (lower interest rates).
The
dollar rose two cents. It ended above
both MA’s and in a short-term uptrend; though it has not regained the lower
boundary of that mid-November to present consolidation phase. With gold and the long bond both in firm uptrends,
normally that would suggest a weaker dollar---unless, of course, it is being
bought as a safety trade.
GLD was up, but closed
above both MA’s, within a very short-term uptrend and within a short-term
trading range. It remains a healthy
chart.
Bottom line: the ‘buy the dip’ crowd
has held in there despite some unfavorable economic news and has fought off
several big intraday declines. That
said, breadth is fading and the S&P is struggling near a couple of overhead
resistance levels. I remain a bit
confused by the pin action. So, I am just
watching the technical levels for a sign about what the Market is thinking. On the upside, that is the upper boundary of
the S&P short term downtrend (~2621) and on the downside, the December 26th
low (2349) or, at least, the last higher low (2446).
TLT, UUP and GLD all act like the global economy
is weakening and the US may be the least dirty shirt in the laundry.
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. US economic activity is slowing, the Fed’s
Alice in Wonderland interpretation notwithstanding. The evidence is all around that there are
disruptions occurring; I don’t know how they can be ignored. Further, the rest of the globe is slowing
even faster than I, and most others, expected.
It is
certainly possible, even probable, that the US can continue to grow as the rest
of the world slows. But declining global
growth will still act as a drag on 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---and that is showing up in the numbers.
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 regarding what has been discussed. Though the fact that another round of
negotiations involving 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 aspect of that currently
is the unwind of the Fed’s balance sheet.
Unfortunately, the recent reversal of policy and then the seeming
reversal of the reversal leaves the outcome very much in question. The key will be the Fed’s action. So, I will be watching the monthly status on
its balance sheet.
If the
Fed delays QT, then some liquidity pressures will be relieved. That likely means an upward bias to equity
prices [remember, I think the balance sheet unwind will have little impact on
the economy]. If it doesn’t delay QT,
then I expect a continuation of the liquidity problems that we have witnessed
over the last month and that will not likely be good for the Markets.
(4)
current valuations. The recent sell off begun to
rationalize valuations in some Market sectors, offering buying opportunities. However, the 10% Market advance in the last
two weeks has eliminated some of those bargains. That leaves equity prices as defined by the
major Averages overvalued.
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. Plus, if the Fed
‘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 out of their Buy Range (at
least as determined by our Valuation Model).
Hence, I am back sitting on my
hands. If equites are in a rally in a longer-term
downtrend, then buying opportunities will almost surely offer themselves
again. If the worst is over, then I will
be back watching for stocks that trade in the Sell Half Range and will act
accordingly.
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 23995
2596
* 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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