The Closing Bell
I am off again to the beach for the July 4th holiday. Back on 7/8. Have a great holiday.
Current Economic Forecast
2018 estimates (revised)
Real Growth in Gross Domestic Product 1.5-2.5%
Corporate Profits 10-15%
Real Growth in Gross Domestic Product 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 14468-30657
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 1373-3183 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 was overwhelmingly negative this week: above estimates: May pending home sales, May personal income, June consumer sentiment, finalQ1 corporate profits; below estimates: the April Case Shiller home price index, May new home sales, June consumer confidence, month to date retail chain store sales, the June Chicago Fed national activity index, the June Chicago PMI, the June Dallas, Richmond and Kansas City Feds’ manufacturing indices, May wholesale inventories/sales, the May trade deficit, the final Q1 PCE and core PCE prices; in line with estimates: weekly mortgage/purchase applications, May personal spending, May durable goods/ex transportation orders, final Q1 GDP growth, May PCE price index.
On the other hand, the primary indicators were slightly positive: May new home sales (-), May durable goods/ex transportation orders (0), final Q1 GDP growth (0), May personal spending (0) and May personal income (+), final Q1 corporate profits (+). The overwhelming amount of negative data outweighs a slightly better showing in the primary indicators. I rate the week a negative. Score: in the last 194 weeks, sixty-three positive, eighty-eight negative and forty-three neutral.
As you know, the recent trend in the numbers has been increasingly downbeat. While I am not changing my forecast, I am starting the yellow light flashing. Another three to four weeks of poor stats and a recalibration will be likely.
The overseas data was slightly negative though the numbers out of Japan improved---still, not that helpful for our own economy.
[a] June EU business confidence, economic sentiment, industrial sentiment and core CPI were disappointing, while consumer confidence and CPI were in line; June German consumer confidence was below consensus; Q1 UK GDP growth was in line while business investment was below expectations,
[b] YoY Chinese industrial profits fell less than anticipated,
[c] the April Japanese leading economic indicators, May CPI, May industrial production and June retail sales were above estimates; core CPI was in line; and May construction orders and housing starts were below projections.
Developments this week that impact the economy:
the US/China trade narrative this week was
confusing with US sounding somewhat upbeat while the Chinese continued to rail
against tariffs and adding preconditions for resuming trade talks. Of course, nobody has a clue as to what will
happen, including me---but I am sticking with my thesis that the Chinese have
no incentive to negotiate until, at least, after the 2020 elections---which
leaves Trump with two short term options, fold or hang tough. The former would likely be a short term
economic/Market plus; the latter not so much,
***overnight, Trump/Xi agreed to a ceasefire. That doesn’t mean things will improve; they just won’t get worse.
(2) monetary policy: both Bullard and Powell made speeches this week, both sounding more hawkish than was Street consensus---citing less concern about the economy [and the US/China truce should help]. To be clear, they say that they are worried, just not as much.
That said, the Fed officials economic narrative is more hope than fact anyway. As I document on a continuation basis, the economy is not as healthy as they allege. It never has been. But it needs to appear to be in order to rationalize their misdirected, ineffective monetary policy of the last ten years which did little to boost the economy.
Of course, the above is all nonsense because what the Fed is really focused on is the Market; and since stock prices are up, the need for a decline in rates has diminished. And as long as that paradigm exists, the mispricing and misallocation of assets will only get worse as will the ultimate resolution of this problem.
(3) tensions in the Middle East remain at a slow boil. The good news is that this week, the US/Iran standoff was just a war of words. The bad news is that the threat of violence remains which if it occurs could lead to severe economic consequences in a worst case scenario. Remember a large percentage of global oil supplies transits the Straits of Hormuz, which is bordered on one side by Iran. Any military action that would choke off those supplies would be a negative for the global economy.
Trump appears ready to take on the EU if they violate Iranian sanctions.
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 stronger than expected Q1 GDP dataflow seems to have faded which is not surprising given the lethargic global economy and the continuing threat of trade wars. Indeed, the recent dataflow has been negative enough that I have started the yellow light flashing for a possible downgrade in my forecast.
The Market-Disciplined Investing
The Averages (26599, 2941) rallied yesterday, as they continued to work off their overbought condition without any kind of major correction---at least, so far. They remained below their all-time highs, but, as you know, I have suspended a directional call on the short term trend. They are above both moving averages and in intermediate and long term uptrends.
At the moment, I am waiting for the indices to fill last Tuesday’s gap up opens and then, see how they trade following that. My current assumption is that the momentum is to the upside, that those gaps will be filled and the upward trajectory will be resumed. However, I am bothered by the lack of volume (though it was up big on Friday, spawned by the end of quarter institutional window dressing), uninspiring breadth and the failure of other major indices to make new highs.
VIX fell 4 3/8%, ending right on between its 100 DMA (now support), the lower bound of the narrowing gap between it on the downside and the upper boundary of its very short term downtrend on the upside. A break of one of these levels should provide directional information.
TLT was down nine cents, but still closed above both MA’s (now support), in a very short term uptrend and very close to its twenty year high. As I noted previously, that high represents major resistance; so, I expect more backing and filling before another attempt is made to break above it---if indeed there is such an attempt.
The dollar declined two cents, finishing below its 100 DMA (now resistance) but in a short term uptrend, above its 200 DMA (now support) and still needs to close last Thursday’s gap down open.
GLD rose ¼%, finishing in short and intermediate term uptrends and above both MA’s (now support). However, there is a major gap up open lower down---which needs to be filled.
Bottom line: the Averages continued to consolidate after the big run that started in early June. In the process, they got very overbought, so the current pin action isn’t surprising. In fact, it is a plus that the recent backing and filling has been so tame. Still more is needed to close those gap up opens lower down. Nonetheless, I continue to believe that momentum remains to the upside; though clearly, that call is less certain now.
It is remains disconcerting that volume is low (versus high volume in bonds, the dollar and gold which are pointing to recession/or the need for a safety trade), breadth is weakening, other indices have failed to confirm Monday’s breakout of the Dow/S&P and the VIX has been acting unconventionally for the last couple of weeks.
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. After an upbeat start to the year, the economy has settled back into the doldrums and it isn’t being helped by a slowing global economy, the fallout from the US/China trade skirmish and the burden of the carrying costs of too large a deficit and national debt.
The big question is how the slowing economy will impact second quarter earnings which will begin being reported soon.
My sluggish growth forecast is a neutral but that could change if the stats continue to deteriorate and/or the upcoming earnings season proves disappointing.
(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.
At the moment, the elephant in the room is China. While investors have been cautiously optimistic [and they were correct for having done so], I believe that the Chinese are just buying time and that ultimately, they will not even consider making any compromise before the 2020 elections, if ever. If true, then Trump faces more than a year of potential bad news on Chinese trade. And given that he measures his success by the level of the Market, the question is, will he fold if the Market declines in a meaningful way?
That may be a moot point right now, but it is a long way to November 2020 and much can happen.
If the Donald were to fold, the best scenario would be for US/China trade to return to prior levels for the short term and the continued cheating by the Chinese for the long term. In other words, nothing that would happen to improve corporate profitability or lift the valuation of equities from their already lofty levels.
(3) the resumption of QE by the global central banks. Fed officials suggested this week that because the economy appeared a bit stronger than they had previously thought, they were further from easing than they had indicated earlier. That, of course, is bulls**t. Economics have nothing to do with it. They are as close to easing as the Market will tell them to be. At the moment, I don’t see anything that is going to change this paradigm of central market/stock market co-dependency.
That makes no sense to me but that is what we are stuck with. Unfortunately, I have no clue when this model changes; but Herb Stein once said, something that can’t go on forever, won’t.
The Fed ‘put’ paradox.
(4) current valuations. I believe that Averages are grossly overvalued [as determined by my Valuation Model].
At the moment, [a] the US economic numbers are not that great, the global stats are worse and, absent a US/China trade deal, are not apt to get better---all of which augurs poorly for corporate profits, [b] long term interest rates are plunging and the yield curve is flattening, both suggesting that a weaker economy, and perhaps even recession, is in our future, and yet [c] equity prices are at their all-time highs. The only explanation that I have for this is in the context that the global central banks measure their success by the performance of the stock Market and act accordingly. As long as that is the paradigm, fundamental economics and 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. This week, I added AbbVie to the Dividend Growth and High Yield Buy Lists.
Bottom line: fiscal policy is negatively impacting the E in P/E. 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.