The Closing Bell
1/19/19
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 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 slightly negative: above estimates: weekly jobless
claims, weekly mortgage and purchase applications, the January housing index,
the January Philly Fed manufacturing index; below estimates: month to date
retail chain store sales, preliminary January consumer sentiment, the January
NY Fed manufacturing index, December PPI, December import/export prices; in
line with estimates: December CPI, December industrial production.
There was only one
primary indicator reported this week: December industrial production (0),
though two other indicators were not recorded due to the government shutdown: December retail sales and December housing
starts. I am going to give this week’s data a tentative rating of negative for
two reasons (1) the aggregate reported indicators were negative and (2) even
though December industrial production was flat, the November number was revised
down: Score: in the last 171 weeks,
fifty-five were positive, seventy-six negative and forty neutral.
The data from
overseas remains weak. This week’s numbers
included trade figures which showed declines in both imports and exports from
both China and the EU. 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. The good news is that (1) if you believe the
administration [and you do so at your own risk], the former may soon be resolved
and (2) Draghi assured us all that the EU will not go into a recession---and if
you believe that, I have a bridge for sale.
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 forecast
has portrayed it.
The
negatives:
(1)
a vulnerable global banking [financial] system.
Nothing new this week. https://www.realclearmarkets.com/articles/2019/01/18/the_global_economy_is_set_to_find_out_what_comes_after_sadness_103587.html
(2) fiscal/regulatory
policy.
The two most
important near-term issues are [a] the US/China trade talks and [b] the
government shutdown. However, there was little
news this week except that [a] a continuous stream of rumors that a trade deal
was close and then not and [b] both sides of the ‘wall’ funding/government
shutdown remain firmly entrenched with no end in sight.
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.
A couple of
developments this week;
[a] the leading
Fed hawk emphasized the need to be ‘flexible’ with regard to monetary
tightening---‘flexible’ being the new Fed mantra. However, as I keep pointing out most of the
Fed discussion is on delaying the rise in interest rates with little attention
given to the balance sheet unwind. And,
as I pointed out in Friday’s Morning Call, that continues apace.
As you know, I think
QE had little effect on economic growth; I don’t think that raising or not
raising interest rates now will have much impact on the economy; but I also
believe that QE had enormous consequences for the Market {mispricing and
misallocation of assets} and, as a result, so will QT {as it reverses the mispricing
and misallocation of assets}.
[b] the Bank of
China made a huge liquidity infusion into the Chinese financial system. At least partially as a result, the latest
data on central bank balance sheets showed them dramatically expanding in the
last month. Some pundits contend that the principal reason for China’s action is
the increased liquidity needs related to an upcoming major holiday. If so, we will know soon enough since that extra
liquidity will be withdrawn following the festivities. Otherwise, it would clearly be an offset to
the recent shrinkage of the Fed’s balance sheet as well as the termination of
ECB QE.
Friday, I expressed
my uncertainty over the net results from the seeming incongruity of the global
versus the US QE/QT: I am not sure how to
balance the two reports. Unquestionably,
increasing global liquidity will have a positive impact on asset prices. On the other hand, because so many global trade
and security transactions are dollar denominated, if the Fed is maintaining QT (shrinking
the supply of dollars) then that will have an outsized effect on global liquidity. All I can do is watch the data.
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. The caveat is that I am uncertain about whether
or how the Fed’s QT [if it continues] will influence global QE,
(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.
Trump
and Un to meet again.
(4)
economic difficulties around the globe. The stats this week were again negative,
continuing to point to a global economic slowdown:
[a] November EU industrial production was less than
forecast; November EU imports and exports were below estimates; 2018 German GDP
growth was lower than that of 2017, December UK retail sales were down more
than anticipated,
[b] December Chinese imports and exports were well
below expectations,
[c] December Japanese CPI fell.
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 24706, S&P 2670) remain in a moonshot. The S&P finished above the upper boundary
of its short term downtrend for the third day, resetting to a trading range. Further, both indices blew through their
61.8% Fibonacci retracement level. If they hold there through the close on Wednesday,
my assumption will be that December 24 was a bottom and more upside is to be
expected.
Even if that
proves to be the case, the current rate of upward momentum can’t be
sustained. And there is some probability
that the December low could be challenged.
Volume rose and breadth
improved.
The VIX was down
less than a point---remarkable for a 300+ point up day in the Dow. It did remain below its 100 DMA for a second
day (now support; if it remains there through the close on Tuesday, it will
revert to resistance). However, it finished
above its 200 DMA and in a short-term uptrend.
The long bond fell
½%, ending above both MA’s, in short and intermediate-term trading ranges and
in a very short-term uptrend. However,
it failed to make a new higher low, suggesting that, at least short term, TLT
has lost upper momentum.
The dollar was up
again---it had a very good week---closing above both MA’s, in a short-term
uptrend and is pushing towards the upper boundary of that mid-November to
present consolidation phase.
GLD declined almost
a point, but still ended well above both MA’s, within a very short-term uptrend
and within a short-term trading range---a healthy chart.
Bottom line: the S&P has reset its
short term trend to a trading range; and both Averages spiked through their
61.8% Fibonacci retracement level; and if they remain there through the close
on Wednesday then the question as to whether this rally was off a bottom or
simply a countertrend move in a longer term down market will likely have been
answered---a bottom has been made.
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 overvalue. So, I will also be looking to take money off
the table if a stock moves into its Self-Half Range.
UUP, TLT and GLD
all traded on big volume and all pointed to a rise in rates.
Friday
in the charts.
https://www.zerohedge.com/news/2019-01-18/small-caps-soar-best-start-1987-china-adds-record-liquidty
The
latest on margin debt.
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 global
economy is slowing. 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 contain 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 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 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. Nonetheless, it
appears central bankers reacted to the global equity markets’ selloff in December
by again allowing investor sentiment to influence monetary policy. https://www.zerohedge.com/news/2019-01-18/gift-keeps-giving-trader-warns-market-gains-just-too-easy
That
said, the Fed continues to unwind its own balance sheet. While the recent reversal of policy and then
the seeming reversal of the reversal confuses the issue, the latest data on the
Fed’s balance sheet shows that it is continuing to run off both Treasuries and
MBS’s.
Nonetheless,
the Fed maintaining QT notwithstanding, the current rapid expansion in global
central banks’ balance sheets seems to be working its magic on equity markets
and, as long as it continues, that likely means an upward bias to equity prices
[remember, I think the balance sheet unwind will have little impact on the
economy].
(4)
current valuations. the Averages have recouped roughly
one half of their October to December loss.
Since they were grossly overvalued [as determined by my Valuation Model]
in October, they are now just slightly less grossly overvalued.
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.
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 out of their Buy Ranges (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 24706
2670
* 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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