Saturday, August 10, 2019

The Closing Bell

The Closing Bell


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%


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 Uptrend                                 23490-33730
Intermediate Term Uptrend                     14513-30732 (?)
Long Term Uptrend                                  6849-30311(?)
2018     Year End Fair Value                                   13800-14000

                        2019     Year End Fair Value                                   14500-14700

            Standard & Poor’s 500

                                    Current Trend (revised):
                                    Short Term Uptrend                                     2561-3460
                                    Intermediate Term Uptrend                         1383-3193 (?)                                                    Long Term Uptrend                                     937-3217 (?)
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.   Not much data this week and what there was, was slightly positive: above estimates: weekly jobless claims, the June JOLTS report, month to date retail chain store sales, June consumer credit, the July Markit service and composite PMI’s; below estimates: light vehicle sales, the July ISM nonmanufacturing index, August wholesale inventories/sales, July PPI; in line with estimates: weekly mortgage/purchase applications.

            There were no primary indicators reported.  I am rating this week a positive.  Score:  in the last 199 weeks, sixty-five positive, ninety negative and forty-four neutral. 

            Despite this week’s positive tilt, it was just barely so.  Hardly a reason to question my forecast.  The yellow light is still flashing.

Overseas, the stats were pretty dismal, especially out of the EU---not that helpful for our own economy.

[a]  June German factory orders were above estimates but its construction PMI, industrial production and its trade balance were below; the July German services and composite PMI were lower than expected; the July EU services PMI was also lower while the composite PMI was in line; June UK construction output, manufacturing output and business investment were below projections while industrial output was above; July UK services PMI was better, however, July auto sales were disappointing; Q2 GDP was below consensus,

[b]  the July Chinese Caixin services PMI was below forecasts, the composite PMI above; the July trade balance was larger than anticipated; July CPI ran hotter than estimates but PPI was down,

[c]  June Japanese household spending and cash income were ahead of estimates while the leading economic indicators were below forecast.
Developments this week that impact the economy:

(1)   trade: lots of activity this week

[a]  Trump threatened to increase tariffs on the all the Chinese imports not already subject to them.  Now they won’t go into effect until the first of September; so, there is time for enough progress to be made in trade talks to avoid this happening.  But….

[b] the Chinese allowed the yuan to depreciate {a low yuan = cheaper Chinese goods} which would, at least partially, offset the impact that higher tariffs have on imported Chinese goods.  While the government set the yuan value higher the next day, the message was there---increase tariffs and we will devalue our currency.

Trump immediately labelled China a ‘currency manipulator’ which implies the potential for some sort of adverse action against the Chinese; but it really is not that big a deal.

The bottom line is that the US and China appear to be locked into a standoff from which little positive can come.  Unfortunately, I don’t believe the Chinese will even try to resolve this dispute before November 2020 and they may be willing to go to mat longer term to avoid revising their unreasonable, unfair and one-sided  industrial and IP policies.  In short, the odds of a positive resolution to this standoff anytime soon seem low and as a result, its negative impact on the global economy will continue and likely get worse.
Counterpoint (must read):

[c] regrettably, others nations are starting to get into the act with {i} Japan and South Korea removing each other from their ‘preferred’ trading list (think higher tariffs) and {ii} the central banks of New Zealand, India and Thailand lowered the official interest rates---which has the ancillary effect of devaluing their currency.

All in all, this week, trade had a negative impact on global economic growth prospects.

(2)   monetary policy: little of substance this week.  Though there appears to be a growing belief that the central banks have lost their control of interest rates to the Markets.  The risk of this becoming generally accepted is that the notion that the central banks/Fed have the Markets’ back becomes null and void.  While that may have little impact on economic growth [which I have maintained that they never had in the first place], it will almost surely affect the current central bank/Fed/Market co-dependency.

(3)   tensions in the Middle East remain at a slow boil. The hostility remains contained but the buildup of military hardware in the Persian Gulf is not a plus.  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.

Unfortunately, the number of global trouble spots is growing:

[a] the unrest in Hong Kong; while ostensively a battle over Hong Kong government’s right to deport troublemakers to the Chinese mainland, it has become intermeshed with the US/China trade skirmish in that the Chinese are accusing the US of interference.  I have no idea how this situation plays out; but it has the potential for negative consequences,

[b] Italy is again on the verge of political/economic collapse.  By itself, I don’t consider that a big problem; but the extent that it would cause disruption in the EU, especially in the banking system, it could precipitate a much larger problem.  And that says nothing about the extra pressure a hard ‘Brexit’ could put on the EU financial system,

[c] North Korea keeps firing off rockets.  Like Hong Kong, this is likely tied into the US/China standoff {China encourages Kim to make trouble} makes the whole China trade, Hong Kong riots, North Korean missile testing just a big pot of love stew.

                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 US economy continues to limp along 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 (26287, 2918) drifted lower yesterday on still lower volume and weak breadth.  The Dow closed right on its 100 DMA (now support) and the S&P ended above its 100 DMA for a second day after reverting to resistance.  If it remains there through the close on Monday, it will return it to support. Both indices remained above their 200 DMA’s.

The VIX rose 6 %, finishing above both MA’s (now support) and is building a short term uptrend.  That is a bit of negative for stocks.

The long bond was off ¼%, but remained above both MA’s and in uptrends across all timeframes.  However, it still has that gap up open on Monday which needs to be closed.

The dollar was off fractionally, ending in short and long term uptrends and above both MA’s.  It still has a gap down open which needs to be filled.  However, it did close below the upper boundary of its former long term trading range for a fifth day---which is a bit worrisome as it raises the odds that last Friday’s breakout could prove false. 

Gold declined 3/8 %, resting in the midst of a very strong uptrend.  It ended within very short term and short term uptrends and above both MA’s.  However, it still has last Friday’s gap up open which needs to be closed.

            Bottom line: the Averages are in uptrends across all timeframes; but after closing Monday’s gap down opens, retreated on the day.  That raises the odds that the recent rally was just the necessary consolidation to close those gap downs, opening the way for another leg down in the indices.   That notion is reinforced by the pin action in the long bond, the dollar and gold which are all pointing at the need for a safety trade.

                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 economy continues to struggle on though there are few signs of recession, at least domestically.  Indeed, second quarter earnings came stronger than expected which bolsters the hope that the US can skate through the current global malaise without a downturn.

On the other hand, if the US/China trade dispute continues to deteriorate [which it is now doing] that would add a further burden on the US economy.  Add in a mounting deficit that has to be financed and you can see why I have the yellow light flashing.

My sluggish growth forecast is a neutral but that could change if the stats deteriorate further.
(2)   the [lack of] 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, that ain’t happenin’,  Indeed, the US/China trade dispute has gotten worse as both parties increase their penalties on the other.  This is not good for the  US economy but it is even worse for the rest of the world---and that suggests little improvement in the economic picture until the crisis is resolved. 

As you know, I believe that the Chinese will not even consider making any compromise before the 2020 elections, if ever.  So, the magnitude of this quarrel will likely be determined by Trump’s actions.  If he wants to get more contentious, it will and vice versa.  To be clear, I still believe that what he is doing is the right course for the economic long term.  But short term, pain is the word.  The only question is how much.

(3)   the resumption of QE by the global central banks.  That is now occurring worldwide.  This week, the central banks of New Zealand, India and Thailand lowered their official bank interest rate---which has the side effect of lowering the value of their currency, increasing the turmoil in international trade environment.

I have maintained for some time that the key to the Market is monetary policy, more specifically, the total capitulation of the Fed to the whims of the equity market.  But this week, investors appeared to begin to question their faith in the central banks’ ability to navigate the global economy through what is now a very trying economic climate.  While I am not suggesting a change the paradigm of central bank/stock market co-dependency, the risk is heightening that this could occur.

The Fed continues to make policy mistakes.

(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; though to be fair, Q2 earnings season was better than expected, [b] long term interest rates are falling, suggesting that a weaker economy, and perhaps even recession may be 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.  As you know, I recently 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.

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