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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