Saturday, June 22, 2019

The Closing Bell


The Closing Bell

6/22//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                     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%

Economics/Politics
           
The Trump economy is a neutral for equity valuations.   The data was overwhelmingly negative this week: above estimates: May housing starts, May existing home sales, weekly jobless claims; below estimates: the June housing market index, weekly mortgage/purchase applications,  month to date retail chain store sales, the June NY and Philly Fed manufacturing indices, the June flash composite, manufacturing and services PMI’s, May leading economic indicators, the Q1 trade deficit; in line with estimates: none.

            On the other hand, the primary indicators were slightly positive: May housing starts (+), May existing home sales (+) and May leading economic indicators (-).  I rate the week a negative.  Score: in the last 193 weeks, sixty-three positive, eighty-seven negative and forty-three neutral.

Just a note: normally, I might call this week a neutral; however, (1) the unusual tilt toward negative in the total data, (2) the consistently poor Fed manufacturing indices and the PMI’s (3) along with the fact that both positive primary indicators are interest rate related [which is not a plus for a growing economy] persuade me to deem this week a negative.


Nothing here to warrant considering a change to my forecast.

The overseas data was mixed with slightly better numbers out of Europe---not that helpful for our own economy.

[a] April EU trade balance and construction output as well as the May CPI were better than anticipated while May PPI was in line and June consumer confidence was worse; the June flash composite, manufacturing and services PMI’s were above forecasts,

The May German PPI was below consensus; the June composite and services PMI’s were ahead of projections while the manufacturing was below,

The May UK CPI was in line while the PPI was below expectations; the June EU economic sentiment index was horrible; June UK industrial orders were below estimates;,
   
[b]  the April Japanese all industry activity index was better than anticipated as was the May trade deficit; the May CPI and CPI, ex autos were below expectations; also the June flash manufacturing PMI.
           
Developments this week that impact the economy:

(1)   trade: Trump exercised his ‘put’ again, saying that he had a great conversation with Xi, that they would meet at the upcoming G20 summit.  I repeat my opinion: 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,

(2)   monetary policy: the ECB and the Fed vowed to ease monetary policy should anything go awry in their economies.  Of course, what they really meant was if equities markets told them to. 

At the risk of beating a dead horse, I believe that save QE1, global monetary policy did little to advance economic growth over the last decade---all you have to do is look at the numbers. Despite cutting rates drastically and pumping a gargantuan amount of liquidity into the global banking system, growth has been sluggish. 

Part of the reason was the central banks didn’t allow the market to rid itself of the inefficient deadwood that accumulates during an economic expansion.  The result was that part of the economy kept absorbing capital but providing little in return (must read). 

Secondly, a great deal of that liquidity flowed into the financial markets instead of being used by the corporate sector to fund investments [i.e. the misallocation of assets].  That led to the mispricing of assets [historically high valuations] and the inequitable accumulation of wealth by the financial market participants at the expense of everyone else (also a must read).

As long as this co-dependent relationship between the central markets and the stock markets exists, none of the above is going to change. 

Which is a long way of saying that the central banks can drive down interest rates further and pump all the liquidity into the system they want, it will do little for the global economy because all those aforementioned inefficiencies still exist and will act as a drag on growth.  But the financial markets will continue to love it,

(3)   violence in the Middle East remains at a slow boil. Thursday, Iran shot down a US drone. Trump threatened a response but called it off---hopefully because through back door communications, Iranians promised to play nicer.  ‘Hopefully’ being the operative word.  Still this remains a flash point which 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.

The latest.

                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.  So, I see no need to alter my forecast.

The Market-Disciplined Investing
           
  Technical

The Averages (26719, 2950) rested yesterday, but remained above the upper boundaries of their short term trading ranges (all-time highs) for a second day (if they remain there through the close on Monday, the trends will reset to up).  Both are very overbought; so, some pause is not unusual.  They also have to fill those gap up opens made  on Tuesday.  Volume spiked; but that was due to quad witching.
           
 VIX was up 4 ½ %, making yesterday another of the many schizophrenic sessions of late, i.e. it rose a lot more than would be normal on a modest down day.  However, this pin action likely reflects investors scrambling for cheap protection in a soaring Market.  It finished back above its 100 DMA, negating Wednesday’s break but is still in a very short term downtrend.

After touching a twenty year high, TLT retreated on big volume---not surprising given the resistance offered by such a long trend and the fact that bonds are overbought.  Nonetheless, it closed above both MA’s (now support), in a very short term uptrend and remains near its twenty year high. 
           

The dollar fell another ½ %, also on volume.  But it ended in a short term uptrend, above both moving  averages (now support) and still needs to close Thursday’s gap down open.

GLD was up another 3/8 %, also on big volume, finishing in a short term uptrend, above both MA’s (now support) and right on the upper boundary of its intermediate term trading range.  However, in the process, it created a major gap up open---which needs to be filled.

Bottom line:  the Averages are in the process of challenging their all-time highs which are also the upper boundaries of their short term trading ranges.  If they remain there though the close on Monday, then the trends will reset to up.

That said, on a very short term basis, they still need to close Tuesday’s gap up opens.  Longer term, 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), relatively weak breadth and a VIX that 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. 

My sluggish growth forecast is a neutral and 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.  

At the moment, the elephant in the room is China.  While it appears that some sort of truce has been made in the war of rhetoric, it remains to be seen if anything substantive will come out of it.  As you know,  I don’t believe that the Chinese will 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---including a nothing burger or worse from the side meeting at the upcoming G20 summit. 

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.  While global central bank easing had little effect on economic growth [except for QE1] and almost nothing to do with Fair Value, it has been the single biggest factor in equity prices for the last decade.  At the moment, I don’t see anything that is going to change that paradigm of central market/stock market co-dependency. 

But it makes no sense to me that a struggling economy with stunted corporate profit growth should be valued at ever higher levels.  My question is, when will investors realize that a Fed [a] run by academics with a flawed model, [b] an inflated view of their ability to control the economy and [c] whose major accomplishment  over the last decade has been the mispricing and misallocation of assets, has been a disaster?  I have no clue for the answer; but Herb Stein once said, something that can’t go on forever, won’t.

All banks pass latest Fed stress test.

(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] the resolution to the Mexico immigration issue will do little to improve the economy and yet [d] equity prices are at their all-time highs.

This makes no sense, except in the context that 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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