The Closing Bell
3/2/19
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 14093-30294
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 1343-3153 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 quite negative: above estimates: weekly mortgage and
purchase applications, January pending home sales, December personal income, February
consumer confidence, the February Chicago PMI, the February Dallas and Richmond
Fed manufacturing indices, preliminary Q4 GDP; below estimates: January
personal income, December personal spending, month to date retail chain store sales,
final February consumer sentiment, December factory orders, the January Chicago
Fed national activity index, December wholesale inventories/sales, the February
manufacturing PMI, the February ISM manufacturing index, the February Kansas
City Fed manufacturing index, the December trade deficit, the December PCE
price index; in line with estimates: weekly jobless claims, December housing starts/building
permits, the December Case Shiller home price index.
The primary indicators
were also negative: preliminary Q4 GDP (+), December personal income (+), December
housing starts/building permits (0), January personal income (-), December personal
spending (-), December factory orders (-), This week is an easy call: negative. Score: in the last 177 weeks, fifty-seven positive,
eighty negative and forty neutral.
Two notes:
(1)
I scored the Case Shiller home price index as a neutral
because it can be interpreted positively or negatively depending on your economic
outlook,
(2)
while the December/January datapoints have been mostly
negative, the February numbers are a bit more balanced---suggesting that the economic
growth may have stabilized. ‘May have’
being the operative words. That said, as
I point out below, the bond, dollar and gold markets are strongly suggesting that
the economy has stabilized and will likely be improving. While I pay a great deal of attention to the
message of the bond market, it still is too soon to be altering my outlook. But it is something that bears watching.
The data from
overseas this week was mixed. It was
somewhat better out of the EU but worse from Japan. Nonetheless, the global economy remains an
impediment to our own economy’s struggle to sustain growth. Certainly, a positive result from the
US/China trade talks will help.
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 and the global economy decelerates though early February data may be
indicating some stabilization in the process. However, even if cyclically the economy were
to improve, it will still be unable to overcome the secular negative of too
much debt to service.
The
negatives:
(1)
a vulnerable global banking [financial] system.
The ECB refinancing dilemma.
The Chinese shadow banking problem.
(2) fiscal/regulatory
policy.
Trade remains
front and center.
[a] the
US/China trade talks. If you believe
Mnuchin and Kudlow, trade talks are going fabulously. If you believe Lighthizer, not so much. The
Goldilocks outcome is, of course, for China to alter its industrial policy and
IP theft, the US to lift tariffs and we all sing kumbaya and go home. Lighthizer’s comments suggest that isn’t
going to happen. So, for me, the good
news scenario is for the US to delay the imposition of new tariffs in exchange
for increased Chinese purchases of US goods, but to retain the current tariffs
until meaningful progress is made on Chinese policy. The bad news scenario is for Trump to lift
all tariffs as a quid pro quo for increased Chinese purchases of US goods and
agree to ‘consult further’ on Chinese industrial policy.
Hopefully, the
conclusion of the US/North Korea is a sign that Trump won’t let himself get
played just for the sake of a deal.
Bottom line:
whatever the positive impact that might to come from a US/China trade deal,
irresponsible deficit spending will restrain US economic growth.
Crony
capitalism (must read):
(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.
Powell gave his
Humphrey Hawkins testimony before congress this week and remained very much in
tune with the recent narrative, i.e. ‘patience’ is the new watchword meaning a
delay/stoppage of rate increases and an end of QT by year end.
As you know, I could
care less about any moves or lack thereof in interest rates. But I continue to believe that QE did little to
help the economy, so QT would do little to hurt.
However, QE led
to the gross mispricing and misallocation of assets. Absent QT that condition will remain, so, [a]
if inflation accelerates, the Fed will ultimately be compelled to tightening
policy irrespective of Market reaction or [b] if economic growth continues to
decelerate, any additional QE will prove ineffective in halting the slowdown;
and Markets don’t like recessions.
(3) geopolitical
risks:
Europe is a
mess with Brexit [though some progress may be occurring], riots in France and
fiscal policy discord in Italy; and it continues to be reflected in a negative
way in the economic stats.
You never know
how the situation in Venezuela plays out.
Add the
India/Pakistan [both have nuclear arsenals] conflict to that list.
US and North
Korea were unable to reach an agreement on Korean denuclearization/US lifting
sanctions. I have always thought that
the North Koreans were all bark and no bite, so I am not particularly concerned
about this outcome. The good news is
that Trump didn’t fold just to get a deal.
(4)
economic difficulties around the globe. The stats this week were again negative,
continuing to point to a global economic slowdown:
[a] February EU manufacturing PMI and economic sentiment
were higher than anticipated while unemployment was lower,
https://www.zerohedge.com/news/2019-02-28/margins-not-revenue-have-been-main-driver-eps-growth-cycle
[b] the February Chinese manufacturing PMI came in below
consensus while the Caixin {small business} manufacturing PMI was above; but
both were in contraction territory,
[c] January Japanese industrial production, manufacturing
PMI and retail sales were reported below estimates while February unemployment
was above.
Bottom
line: on a secular basis, the US economy
is growing at an historically below average rate. Although some recent policy changes are a plus
for secular growth, they are being offset by a totally irresponsible fiscal
policy.
Cyclically, the
US economy is slowing as evidenced by the data from both here and abroad. However, there are hints that this may be
coming to an end.
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.
As
a final note, I think that it would be a mistake to tie the recent change in
Fed policy to a possibly improving economy because (1) historically, there have
always been time lags between policy implementation and their cyclical effects
and (2) as I said above, on a secular basis, QE II, QEIII and Operation Twist
had little to no impact on long term economic growth. In my opinion, if the economy is rallying is
due more to the hard work, productivity and innovation of American business and
labor than to Fed policy. Indeed, as I have
stated before, the economy is growing in spite of not due to irresponsible monetary
policy.
The Market-Disciplined
Investing
Technical
The Averages
(DJIA 26026, S&P 2803) had a volatile day but closed to the upside. Importantly, the S&P finished above the
critical 2800 level, though not by much.
Still, it is a positive sign. We
just need some follow through to confirm that the bulls have once again
prevailed.
Volume rose;
breadth improved.
The VIX dropped
8 ½%, getting ever more negative (a plus for stocks). It ended right on its prior low---a break of
which would re-establish a very short term downtrend.
The long bond plunged
1+% on heavy volume. It closed below an
important support level (119), is about to establish a very short term downtrend
and is approaching both MA’s. That would
seem to confirm a triple top. The
important question is, why? Given the positive move in stocks, a sharply lower gold
price and an improved pin action in the dollar, it suggests a strengthening
economy.
The dollar was
up strong. It ended just below its prior
lower high; a move above that level would remove the only negative in this chart.
GLD was slammed
down 1 ¾ % on big volume, breaking below a minor support level and below the
lower boundary of its very short term uptrend (if it remains there through the
close on Monday, that trend will be voided).
Bottom line: the
Averages ended up on the day, with the S&P finishing above the 2800 resistance
level. While it was only by three
points, it is still a positive sign.
Follow through would point to a resumption of upward momentum and a
victory for the bulls.
The decline in gold and TLT
accompanied by an improving dollar are suggesting that their investors are
becoming convinced that the economy is stabilizing---the dataflow notwithstanding.
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---which the
trend in the dataflow suggests is meager.
The risk is that it may not be that good; though as I noted above, the
initial February data as well as the performance of TLT, UUP and GLD could be
pointing to a stabilization of growth.
Even if
that turns out to be the case, my thesis is that the long term economic impact
on secular growth of 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 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. Though on Wednesday, Lighthizer
threw cold water on the hopes of a comprehensive deal.
My
concern is not that we get no deal or a small deal but that the Chinese out maneuver
Trump and he gives away the need for progress on industrial policy and IP theft
just to get a deal.
(3) the
resumption of QE by the global central banks.
If QEII, QEIII and Operation Twist are any guide, they should be a big
plus for the Markets, at least in the short term.
(4)
current valuations. the Averages have recouped much of their
October to December loss and appear on their way to regaining 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.
As
prices continue to rise, I will again be focusing on those stocks that trade
into their Sell Half Range and act accordingly.
Bottom line: while
fiscal policy is negatively impacting the E in P/E, a new regulatory regime,
any improvement in our trade regime with China along with proposed spending cuts
should have a positive impact on secular growth and, hence, equity valuations. More important, a global central bank ‘put’ appears
to be returning and, if history is any guide, will almost assuredly be a plus
for stock prices.
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 3/31/19 14074
1731
Close this week 26026
2803
* 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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