Saturday, April 13, 2019

The Closing Bell

The Closing Bell


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%


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                     14303-30494
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                         1359-3169                                                          Long Term Uptrend                                     913-3191
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%

The Trump economy is a neutral for equity valuations.   The data flow this week was mixed: above estimates: month to date retail chain store sales, weekly jobless claims, the March small business optimism index, the March budget deficit; below estimates: April consumer sentiment, the February job openings report, March PPI, March export/import prices; in line with estimates: February factory orders, weekly mortgage/purchase applications, March CPI.
There was one primary indicator---February factory orders (0).  So, I rate the week a neutral.  Score: in the last 183 weeks, fifty-nine positive, eighty-three negative and forty-one neutral.

The data from overseas this week was upbeat.  That is the second week in a row of better than expected results, although it is not a trend yet.  China continues to report not just better but dramatically better numbers. Last week, I discussed this seeming incongruent resurgence in the Chinese economy while the rest of the world struggles for growth.  So, I won’t be repetitious except to say that if the numbers are real, then it is clearly a plus for the global economy---‘if’ being the operative word.

The surging Chinese economy notwithstanding, a number of major organizations are shifting their global growth forecasts downward.

            Including the IMF.

My forecast (for the moment):

Less government regulation, (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, exemplified by Trump’s new budget proposal, 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.  However, there are some initial signs that global economic growth could be bottoming.  If they presage improvement, then clearly the near term outlook for economic and corporate profit growth will be enhanced.  Nonetheless even if the economy were to improve cyclically, it will still be unable to return to its prior secular rate of growth as a result of too much debt to service.

The economy is weak because the economy is weak (must read).

           The negatives:

(1)   a vulnerable global banking [financial] system.

(2) fiscal/regulatory policy. 

[a] US and China negotiators continue to put on a happy face regarding the progress of trade talks.  In this week’s narrative, it appears that systems are being put in place to monitor compliance with the terms of any agreement regarding Chinese industrial policy and IP theft. 

The good news is that the Chinese are finally admitting to unfair trade practices. 

The bad news is that we still don’t know how closely their feet will be held to the fire in correcting those abuses.  As I noted on Friday, the 2025 deadline for Chinese compliance apparently remains part of the deal---and if that is the case, then there really is no deal. 

However, we don’t know the particulars.  So, hope for the best, prepare for the worst.

Just to keep a bright shiny face on the trade talks, the US and China have now resolved the currency manipulation issue.

[b] There was a ruling by the World Trade Organization that the EU had been unfairly subsidizing Airbus.   That set off a Trump tweet fest threatening further tariffs on EU products if the situation isn’t rectified which EU officials countered with their own warning of more tariff increases.

Given the uncertain global economic outlook, the last thing the US/global economies need right now is a two front confrontation between three of the world’s largest trading blocks. 

To be sure, it is, in my opinion, necessary.  {i} The Chinese have been cheating for years.  {ii} The US created an economic umbrella over Europe following WWII which disadvantaged the US in trade terms but helped assure a recovery in Europe.  That is no longer needed; but the trade regime remains unfair to the US. 

So, while I am in favor of both situations being rectified, correcting them may lead to additional downward pressure on commerce. In which case, the outlook for global growth will diminish.

EU prepares new list of retaliatory tariffs.

[c] On the other hand, a day later the EU/China announced a trade agreement that sounds good on the surface and certainly suggests that the Chinese can be flexible.  That said, given the globalist, ‘we are the world’, ‘let’s all hold hands and sing kumbaya’ mindset of the European bureaucracy, it isn’t farfetched for me to imagine them being easily outmaneuvered by Chinese.

Bottom line: whatever the impact that might come from a US/China/EU trade quarrels, irresponsible deficit spending will restrain US secular economic growth.
(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.  

The Fed released the minutes of its last FOMC meeting.  The bottom line is that the narrative was just a tad more hawkish than I had anticipated.  However, I think that Powell has made it crystal clear that he is scared sh*tless of the Market.  So, I don’t believe that the Fed will be tightening anytime soon.

That said, Powell’s temerity plays second fiddle to the ECB/Draghi’s comments this week. 

Finally, as I recorded in Friday’s Morning Call, China increased credit [‘social lending’] at a record rate in March.

In short, the misallocation and mispricing of assets will continue until some straw breaks the camel’s back.

(3)   geopolitical risks: 

Europe is a mess with Brexit [which has apparently been given a stay of execution], riots in France and fiscal policy discord in Italy; and it continues to be reflected in a negative way in the economic stats.

Kim Jung Un is back to his old tricks, threatening his enemies with whatever he imagines that he has as leverage.  I don’t see this as particularly disturbing.  But it is still something the world must contend with.

You never know how the situations in Venezuela, Israel and Kashmir will play out.
(4)   economic difficulties around the globe.  The stats this week were upbeat with the positive dataflow out of China again making a big contribution.  As I noted both this week and last, the remarkably powerful turnaround in the Chinese economy seems a bit out of sync with the rest of the world.  For the moment, I have to accept the data as credible; but I do so with prejudice.

[a] February German exports/imports were well below consensus, March CPI was in line; February UK GDP, construction spending and industrial production were better than expected; February EU industrial production declined less than forecast,

[b] March Chinese CPI was down more than forecast while PPI was in line, its trade balance as well as credit expansion soared, auto sales were down big,
[c] March Japanese consumer confidence was below estimates, as was February machinery orders; on the other hand, March PPI ran a bit hotter than anticipated.

            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 totally irresponsible fiscal and monetary policies. 
Cyclically, the US economy is slowing as evidenced by the data from both here and abroad (?). 

          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 or lowering the Fed Funds rate will help support economic growth, in my opinion, it will be disappointed.

The Market-Disciplined Investing

The Averages (DJIA 26412, S&P 2907) roared again yesterday.  They will almost surely hold their momentum long enough to challenge their all-time highs.  The S&P’s pin action has been almost perfect.  The Dow slightly less so.  But, there are two potential negatives that could affect whether that challenge is successful or not:

(1)   both indices made a second gap up open on Friday.  Meaning they now have two gap up opens exerting restrain on the upside.  I know that I have been talking this point for the last two weeks and nothing has happened.  However, remember those gap opens in UUP, TLT and GLD, which I have also been yakking about have now been closed,

(2)   while the recent drawdown in the VIX would normally be a plus for stocks, it has now reached a level that puts it near an all-time low.  Historically, this has been a signal that stock prices are getting stretched.

Volume was up fractionally; and breadth was again mixed.

The long bond was down another ¾ % and, in doing so, closed that gap open of four Friday’s ago.  Meanwhile, it remains in a very short term uptrend and above MA’s. 

The dollar declined ¼ %.  It remains in a solid uptrend.  The only thing I can see wrong with this chart is that it needs to trade meaningfully above its prior high.

GLD was off fractionally.  While the longer term trends remain positive (above both MA’s and in a short term uptrend), the very short term is looking a bit hairy (in a very short term downtrend and it continues to develop a head and shoulders pattern).  At the moment, it seems caught in a range marked by the upper boundary of its very short term downtrend on the upside and its 100 DMA/triple bottom on the downside.

Bottom line: the upward momentum in the indices continues which I believe will take them to their prior all-time highs.  Though I am not sure that they can mount a successful challenge until those gaps are closed and the optimism reflected in the VIX dissipates some. 

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 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, ex China, suggests is meager.  That said, the Street forecast has been for very slow first quarter economic growth with a pick up through the rest of the year.  That may be what happens, though it is clearly way too soon to know; and the stats out of China, if real, could be the catalyst that drives the pick up in growth. 

To be clear, my forecast has always been for sluggish growth in 2019 restrained by irresponsible fiscal and monetary policies, not recession.  At the moment, there is little reason to doubt that scenario.

In short, the economy is not a negative [yet] but it is not a plus at current valuation levels.
(2)   the success of current trade negotiations.  If Trump can create a fairer political/trade regime, it would almost surely be constructive for secular earnings growth.  To that end, there was more happy talk this week on the US/China trade negotiations and much of it sounded upbeat. Unfortunately, the entire narrative on this issue has been so muddied by the obvious political/Market oriented nature of the administration’s comments that I, for one, have no idea about the true state of the current trade talks with China. 

As you know, I have been somewhat skeptical that a comprehensive agreement on Chinese industrial policy and IP theft could be reached in the short term.   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.

Unfortunately, this week, Trump opened a second front in his drive to reform the current global trade regime---this time with the EU.  Both sides swapped threats.  Again, this could turn out to be a big plus for the US economy. 

However, I remind you that the revised NAFTA agreement resulted only in improvements at the margin, Trump’s characterizations notwithstanding.

(3)   the resumption of QE by the global central banks.  If QEII, QEIII and Operation Twist are any guide, the latest Fed, ECB and Bank of China steps should be a big plus for the Markets, at least in the short term.

Goldman says no more rate hiked until after 2020 elections (thank you, Stephen Mnuchin).

(4)   current valuations. the Averages have recouped almost all their October to December loss and appear on their way to regaining the rest.  Since they were grossly overvalued [as determined by my Valuation Model] in October, they are now just slightly less grossly overvalued. 

However, helping valuations: judging by the initial week of earnings reports, it seems that the Wall Street analyst community went a bit overboard in downgrading first quarter profit expectations.  Many stocks are beating estimates and beating them by a decent margin.  If this turns out to be the rule, the year end earnings forecasts will likely rise and that should help valuations---or at least help investors feel less bad about buying stretched valuations.

That said, if the latest central bank liquidity surge continues and Trump keeps pushing a narrative that is Market driven, 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: fiscal policy is negatively impacting the E in P/E, although a new regulatory environment is a plus.  Any improvement in our trade regime with China should have a positive impact on secular growth and, hence, equity valuations---if it occurs.  More important, a global central bank ‘put’ has returned 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 4/30/19                                 14132            1738
Close this week                                               26412            2907

* 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.

No comments:

Post a Comment