Saturday, May 25, 2019

The Closing Bell


The Closing Bell

5/25/19

I am off to the beach.  Back 6/3.  Have a great holiday.

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                     14389-30580
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                         1365-3175                                                          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%

Economics/Politics
           
The Trump economy is a neutral for equity valuations.   The data flow this week was overwhelmingly negative: above estimates: weekly jobless claims; below estimates: April new home sales, April existing home sales, month to date retail chain store sales, April durable goods orders, the April Chicago national activity index, the May flash manufacturing, service and composite PMI’s, the May Kansas City Fed manufacturing index; in line with estimates: weekly mortgage/purchase applications.
                                       

As were the primary indicators: April hew home sales (-), April existing home sales (-) and April durable goods orders (-).  I rate the week a negative.  Score: in the last 189 weeks, sixty-two positive, eighty-five negative and forty-two neutral.


I noted last week that while the April stats were OK though not inspiring, the early May datapoints were positive and offered some hope that the better numbers from the first quarter were continuing.  This week’s terrible April numbers along with the May flash PMI’s as well as the May KC Fed manufacturing index clearly calls that hope into question; and it provides little incentive to mark up my economic growth forecast.

The data from overseas this week was a bit mixed, with somewhat improved stats from Europe and disappointing numbers from Japan.  So, no help but nothing really negative there for our own economy.

[a] April German PPI was higher than expected, Q1 GDP was in line; April UK CPI, PPI and budget deficit were less than forecast while retail sales were above; the May EU flash consumer confidence index declined less than anticipated while the manufacturing, services and composite PMI’s were below estimates,
   
[b] March Japanese machinery orders were above estimates while its all industry activity index was below; its April trade balance shrank dramatically and core inflation was in line; its May flash manufacturing PMI showed contraction.
           
Developments this week that impact the economy:

(1)   trade: this week again witnessed the back and forth of US/Chinese trade threats. 
[a] following Trump’s ban on doing business with Huawei, the Chinese really turned up the volume calling for a second ‘long march’ and threatening to cut off supplies of rare earth metals to the US,

[b] the largest UK cell phone company, Microsoft, Toshiba and several Japanese companies joined the ban on Huawei products,

[c] Trump then delayed his blacklisting of Huawei for three months, giving the Chinese {and the Market} a brief reprieve,

[d] later, Trump proposed blacklisting other Chinese high tech companies.

      ***overnight.

Two observations:

[a] with numerous other countries joining the blacklisting of Huawei, {i} Trump’s leadership appears to be giving the rest of the world the cojones to send the same message---Chinese industrial policy and IP theft is unfair and {ii} it would seem like the Chinese would be getting the message,

[b] a reminder that it was the Chinese that trashed the US/China trade deal in the eleventh hour, not the US.  I mentioned before that it is a negotiating technique for one party to wait until the last minute and alter the terms of the deal in the belief that the other party wants the deal so much it will accept any changes.  That may be what occurred in this instance.

I will repeat my bottom line: [a] we can’t believe a thing that gets said by either party, [b] no deal is better for long term US secular economic growth than a crumby deal, but [c] short term, a crumby deal will  be better for the economy than no deal, [d] if the new tariffs are going up, economic and corporate profit expectations will likely start to be reduced with the concomitant impact on equity valuations and [e] hoping for a deal, won’t make it so.
                    
                   More estimates about the cost of tariffs to the average American.

(2)   the Fed released the minutes from its latest FOMC meeting.  ‘Patience’ remains the watch word.  In this case, the Fed indicated that it believes that inflation will move higher as a result of improving economic activity but that it would likely take no policy actions for six to nine months even if inflation rising.  It also said that at the end of the six to nine  month period, if inflation hasn’t increased, it will consider cutting rates. No mention of policy moves prompted by Mr. Market---which we know is the only thing that counts.

We also know that the Fed has always and forever been wrong which likely means that the economy is slowing, inflation is dead and it may have to lower rates before the end of the six to nine month ‘patient’ period.
                    
      The dollar funding problem is contributing to deflation impulse.

(3)   following a [brief] meeting with Pelosi and Schumer, the Donald said no infrastructure spending unless the investigations stop---which likely means no infrastructure spending.  And that is good news, since the last thing our economy needs is another $2 trillion in debt to service.  You know my bottom line: too much debt  inhibits economic growth and the US already has too much debt even if it is increased through investment on productive assets.

(4)   the increasing tensions with Iran.  The hot air seems to be coming out of this balloon which is clearly good news. 

(5)   I mention the solvency risks in the global financial system occasionally.  This week China had to bail out the first bank in 30 years.

                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 (running monstrous deficits at full employment adding to too much debt) and monetary (pushing liquidity into the financial system that has done little to help the economy but has led to the gross mispricing and misallocation of assets) policies. 
           
Cyclically, the better than expected Q1 GDP number and first quarter earnings along with the initial stats from April and May indicated that the US economy might be starting to re-accelerate which would clearly be good news.  However, this week’s really  poor April data and change of trend in the May numbers from upbeat to downbeat suggests that it is too soon to be revising my economic growth forecast.  Even if the data were to begin improving again, I don’t see how that they could move markedly higher while the rest of the world languishes, trade wars inhibit commerce and the US continues to pursue an extremely irresponsible expansive fiscal policy.
    
The Market-Disciplined Investing
           
  Technical

The Averages (25585, 2826) rallied yesterday on very light (pre-holiday) volume and improving breadth.  The Dow finished above both MA’s, negating Thursday break of its 200 DMA.  The S&P finished above both its DMA’s.  Both have now made higher lows to go along with the lower highs marked earlier in the week.  Both have gap down opens which now need to be filled.  In short, a slight improvement in the technical picture.  But the indices are now in a range bordered by lower highs and higher lows.  How they break out of that range should provide some directional information.

The VIX fell 6 ¼ %, but remained above its 100 DMA for a second day (now resistance; it if remains there through the close next Tuesday, it will revert to support) and its 200 DMA (now resistance). 

The long bond was up again, finishing above both MA’s, in a very short term uptrend and at another two year high.  The next resistance level is its all-time high.

             The dollar declined 3/8 %, continuing to fall away from its ten year high.    Technically speaking, it is understandable given (1) the strong resistance posed by a ten year high and (2) the magnetic draw of those two unfilled gap up opens below current price levels.  That said, the chart remains quite strong.
           
            GLD was up.  Its chart remains broken---its 100 DMA remains resistance; plus, it still hasn’t fulfilled the downside objective set by that recent head and shoulders formation.
                       
Bottom line: investors appear undecided on direction, illustrated by the recently set lower highs and higher lows.  If they ultimately make a higher high, then the odds increase of a challenge of their all-time highs.  If a lower low is made, the probability of a double top will go up.

Thursday and Friday’s pin action in UUP, TLT and GLD points to a weaker economy.

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.  The [a] surprisingly upbeat Q1 GDP report and [b] the markedly better first quarter earnings season point to an improving economy.  However, the April data has gone from neutral to negative and the new stats from May have gone from positive to neutral at best.  In addition, a prolonged and nasty trade war with China could put a damper on both consumer sales and business investments.    So, I am hesitant to make any upward revision in my economic growth outlook until there is a bit more clarity. 

It is important to remember that my current outlook is for sluggish growth, not recession.  And that is predicated on the restrictive impact of too large a deficit and national debt.  That is only getting worse; though, clearly, if the $2 trillion infrastructure gets deep sixed, that would make this factor less negative. 

In short, the economy is a slight plus but subject to change. 
                 
(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.  

The Donald’s established pattern in any of his ‘art of the deal’ negotiations has been to bloviate on the unfairness of a current state of affairs, make all kinds of threats then settle for a slight improvement.  So far the US/Chinese talks have mostly fit the prior model.   However, to date, he has shown little inclination to settle for slight improvement and every intent of going to the mat in order to achieve a fairer trade regime with China.  In this case, going to the mat could be a long, drawn out affair given the past intransigence of the Chinese. 

Of course, Trump has been able to keep the rhetoric hot because the Market has been giving him the leeway to do so. But the question that I ask almost every day, is given Trump’s preoccupation with the level of stock prices, if the Market starts to plunge, how large a decline will he tolerate before folding [the Trump ‘put’]? 

And it seems like the Market has begun to struggle with just that question, that is, [a] it is questioning whether the US/Chinese trade war will be a brief affair and  [b] hence, it starting to assess the economic impact of a prolonged trade war which would force a marked lowering in economic growth and corporate profit estimates. 

If so, then the answer to the question {is the Trump ‘put’ still in place?} clearly has Market implications.  However,  I have added a second question, if it is, will it still work?  The answers to those two question could have a short term impact on equity prices. 

(3)   the resumption of QE by the global central banks. Of course, there is more than one ‘put’ out there.  The other is from the Fed; and it is much more potent.  As we know, the Fed claims that its policy is determined by economic developments; but it has proven time and again that what really matters is the Market.  So, even if the Trump ‘put’ fails, my assumption is that the Fed will have the Market’s back. 

If QEII, QEIII and Operation Twist are any guide, this should be a plus for the equity prices.  The question here, is when will investors realize that a Fed run by academics with an inflated view of their ability to control the economy has been a disaster?  I have no clue for the answer; but until it occurs, the assumption has to be that the Market has limited downside.  That said, history says that nothing goes on forever.

(4)   current valuations. I believe that Averages are grossly overvalued [as determined by my Valuation Model]. 

As long as the global central banks and our president continue to measure their success by the performance of the stock Market and act accordingly, valuations will likely remain irrelevant.

As prices continue to rise, I will be primarily focused on those stocks that trade into their Sell Half Range and act accordingly. However, there are certain segments of the economy/Market that have been punished severely (e.g. health care) with the stocks of the companies serving those industries down 30-70%.  I am compiling a list of potential Buy candidates that can be bought on any correction in the Market; even a minor one.

Bottom line: fiscal policy is negatively impacting the E in P/E, although the Q1 GDP number suggests that it may not be as negative as I have been assuming.  On the other hand, 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.








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