Saturday, June 8, 2019

The Closing Bell


The Closing Bell

6/8//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                     14439-30630
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                         1368-3178                                                          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  negative: above estimates: month to date retail chain store sales, May light vehicle sales, the May ISM nonmanufacturing index; below estimates: weekly jobless claims, May nonfarm payrolls, May ADP private payroll report, April construction spending, the May ISM manufacturing and nonmanufacturing  indices, April wholesale inventories/sales, the April trade deficit; in line with estimates: weekly mortgage/purchase applications,  the May composite and services PMI’s, March/April factory orders, Q1 nonfarm productivity/unit labor costs.
                                       
            As were the primary indicators: April construction spending (-), May nonfarm payrolls (-), March/April factory orders (0) and Q1 nonfarm productivity/unit labor costs (0).  I rate the week a negative.  Score: in the last 191 weeks, sixty-three positive, eighty-six negative and forty-two neutral.


Given the recent string of disappointing data, it appears that the promising Q1 beginning of the year has now fizzled to a halt---leaving my forecast intact.

Update on big four economic indicators.

The data from overseas this week was a bit mixed though two global measures showed a slowing of economic growth worldwide.  So, a neutral for our own economy.

[a] the May EU manufacturing, services and composite PMI’s were above forecasts, unemployment down ticked slightly while April retail sales were in line; the EU May CPI and PPI were below consensus; Q1 EU employment and GDP growth were in line; the May UK manufacturing PMI was well below estimates as was the May construction PMI; the April German trade balance was less than anticipated while industrial production was terrible; May German factory orders were stronger than forecast while the construction PMI was disappointing,

[b] the May Chinese Caixin manufacturing PMI was better than anticipated while the services and composite PMI’s were less,
   
[c] April Japanese household spending was less than anticipated while income was higher; the April leading economic indicators were below estimates; the May manufacturing PMI was better than expected but the services PMI was less,
           
                             [d] other global economic indicators:

                                    {i} ECB downgraded its EU economic growth forecast,

                                    {ii} JP Morgan’s May global manufacturing PMI fell.
           
Developments this week that impact the economy:

(1)   trade: the main headline was Trump’s Mexican standoff.

[a] short term, it worked as {overnight} Mexican officials agreed to increase efforts to block migration to our southern border

[b] even so, I have to question if  

{i} it is the correct strategy to be fighting trade wars on multiple fronts.  The Mexican victory aside, it almost certainly will put business planning on hold,

{ii} using trade weapons (tariffs) to address nontrade issues (immigration) isn’t a mistake that will work against the US in future trade negotiations.  I have already ranted over this several times this week; so, I will end it there,

[c] all that said, I continue to believe that the Donald’s objectives {controlling immigration; resetting the post WWII trade/political regime} are worthy.  It is some of his tactics that concern me.

Further, China continued its stream of threats, fining Ford for antitrust violations, warning soybean farmers that they be totally cut out of the Chinese market, threatening to embargo rare earth shipments to the US and suggesting the depreciation of the yuan was a possibility.

(2)   the FTC and DOJ have started investigations of Alphabet, Amazon, Facebook and Apple for potential antitrust actions.  I have no idea of their guilt or innocence.  But I do know that these companies are among US’s crown jewels in the global technology race.  A race which I remind you is one main reasons why the US is duking out with China.  I am mystified.
           
(3)   the Fed:  the highlight of the week was Powell basically making a Draghi-esque statement, saying that the Fed would do whatever is necessary to keep the economy [wink, wink, the Market] growing.  He also suggested that the Fed continues to believe that it can ever expand what it considers its ‘tool kit’ to exercise control over the economy despite the fact that its old ‘tool kit’ [QE] produced only marginal results. 

But don’t forget, two weeks ago, in the minutes from its latest FOMC , 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 were 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.

What could account for another quick about face in policy?   Drum roll, please---a decline in stock prices, of course; which we know is the only thing that matters.  In other words, anything that Powell/the Fed says about policy reacting to economic conditions is meaningless drivel. 

                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. 

                     And (must read).


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.  So, I see no need to alter my forecast.   
    
The Market-Disciplined Investing
           
  Technical

The Averages (25983, 2873) had yet another gangbusters’  day yet on an ever so slight increase in volume.  At least breadth improved, finally. 

The Dow ended above its 100 DMA for a second day (now resistance; if remains there through the close Monday, it will revert to support) and above its 200 DMA for a third day (now resistance); if it remains there through the close next Monday, it will revert to support.  The S&P closed above its 200 DMA (now support) and above its 100 DMA for a third day, reverting to support.

So far, so good.  The indices are pushing their way through testing multiple resistance levels; and if Monday is an up day, all challenges will have been successful.  There remains only one minor resistance level overhead; and if that falls, then it will be on to the all-time highs---which if history is any guide, will become  former all-time highs.

 VIX was actually up 2 ½ %---unusual on such a big up day in equity prices.  That leaves it in a very short term uptrend and above its 100 DMA (now support).  Importantly, it challenged both of those levels intraday and then bounced.  This pin action suggests way too much complacency.  It is still below its 200 DMA for a third day (now support; if it remains there through the close on Monday, it will revert to resistance). 

TLT was up 7/8% on big volume, finishing above both MA’s (now support) and in a very short term uptrend.  It is now 17 cents away from a twenty plus year high.  If it takes out that high, the long term trend will reset to up.

The dollar declined another ½ %, but remained in a short term uptrend and above both moving  averages (now support).  Notably, it filled the second lower gap up open intraday, eliminating the magnetic pull of that gap.

GLD rose another ½ %, closing within a short term uptrend, above both MA’s (now support) and is now nearing the upper boundary of its intermediate term trading range. 

Bottom line:  the indices are almost through successfully challenging the numerous resistance levels formed during the decline off the May double top.  If Monday is an up day all challenges will be complete; and only one minor resistance level will stand between them and their all time highs.  That is the good news.  The bad news is this has all been done on very low volume, weak breadth, a VIX that is signalling extreme complacency and bond, dollar and gold markets that are behaving like safety trades. 

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 upbeat start to the year offered the promise of some acceleration in sluggish US economic growth rate.  Unfortunately, that promise is fading as the world economy slows, trade wars threaten to make matters worse and the US economy is burdened with the carrying costs of too large a deficit and national debt. 

My sluggish growth forecast is a slight plus but the odds of an improvement have declined while those of even weaker growth increased. 
                 
(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.  

However, with the Market remaining at elevated levels, the Donald appears to be getting more aggressive in pursuit of his stated goals---which to be sure are worthy objectives.  But in the case of China, I am not yet convinced that he will go to the mat if stock prices are falling. I can’t imagine the Chinese even considering making any compromise before the 2020 elections.  If true, then Trump faces more than a year of potential bad news on Chinese trade.  So, the question remains will he fold if the Market declines in a meaningful way?---which, of course, is a moot point right now.

Further, I don’t see anything of near term positive economic significance whatever the outcome had been of Trump’s Mexican standoff.  If tariffs had been imposed, how would that have been good?  Slower growth?  Increasing distrust of any trade agreement made with Trump? Additional uncertainty in corporate suites about making investment decisions?  And where are the pluses in victory?  Trade levels, economic and corporate profit growth will remain basically the same as before this dust up.  Sure, it is solves a long term problem the results of which we may be able to measure positively sometime in the future; but how does anyone quantify that impact today for Market valuation purposes except to say that it is a psychological plus?  

(3)   the resumption of QE by the global central banks---which soared into the spotlight this week with Powell’s Draghi-esque promise to take whatever measures necessary to save the economy [the Markets].  The problem, of course, is that the Fed has been, is and forever will be wrong on the economy; and it has proven that twice in the last six months. 

So, all it has left is to react to the Markets.  And 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 a flawed model and 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. (must read)

This is a good historical review of Market performance following a first rate cut; however, I would argue with the notion that the economy is in good shape.


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

What is so mystifying to me right now is that [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, [c] as I opined above, the resolution to the Mexico immigration issue will do little to improve the economy and yet [d] equity prices are rocketing toward their all-time highs.

This makes no sense, except in the context that as long as the global central banks measure their success by the performance of the stock Market and act accordingly---in which case, 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.

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.








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