Saturday, September 7, 2019

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                                 23560-33800
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                                     2578-3478
                                    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.   This week’s data was slightly negative: above estimates: month to date retail chain store sales, the ADP private payroll report, August light vehicle sales, the August final manufacturing PMI, the August ISM nonmanufacturing index, the July trade deficit; below estimates: weekly jobless claims, August nonfarm payrolls, July construction spending, the August ISM manufacturing index, the August services and composite PMI’s; in line with estimates: weekly mortgage/purchase applications, Q2 nonfarm productivity/unit labor costs, July factory orders/ex transportation.

            The primary indicators were also negative: July construction spending (-), August nonfarm payrolls (-), Q2 nonfarm productivity/unit labor costs (0) and July factory orders/ex transportation (0).  The call is negative.  Score:  in the last 203 weeks, sixty-six were positive, ninety-one negative and forty-six neutral.

            This leaves the yellow warning light flashing.

The Fed released its latest Beige Book, which didn’t read that much different from recent surveys: the economy is growing modestly, labor is tight and manufacturing is struggling in some industries impacted by trade.

In addition to the Atlanta Fed lowering its Q3 GDP now forecast this week, Goldman and Merrill also posted their estimates.

This is a great nine minute interview with a former Fed economist.

Overseas, the stats were mixed, providing no reason to alter my opinion that the global economy is a drag on our own.

[a]  the July EU PPI and retail sales were in line while July German factory orders and industrial production were lower than anticipated; the August German and UK manufacturing PMI’s and the August German construction PMI were below estimates; the August EU manufacturing PMI and Q2 GDP growth were in line; the August German and EU services and composite PMI’s plus August UK car sales above forecasts,

[b]  the July Japanese cash earnings was less than consensus; household spending was also down but less than expected,

[c] the August Chinese Caixin manufacturing, services and composite PMI’s were better than anticipated.

Developments this week that impact the economy:

(1)   trade: the d├ętente in the US/China trade talks was resurrected with low level negotiations beginning in September and a formal meeting in October.  Clearly, a positive outcome would be an economic plus.  But at the risk of being too cynical:

[a] the Chinese communist party has its 70th anniversary in October.  This is a major celebration for them and they undoubtedly want it free of any controversial headlines.  Hence, backing off in Hong Kong.  Hence, the resumption of trade talks.  I could be totally wrong; but until the Chinese show any inclination on compromising on unfair industrial policy and IP theft, my take is this latest round of talks is all for show,

[b]  Trump has more to lose on a short term basis than China, i.e. he has a 2020 election to worry about and Xi doesn’t.  Not only that but the harsher the confrontation becomes, the more US voters are negatively impacted and that just ups the pressure on Trump.  The point being that Chinese can afford to string Trump along until, at least the 2020 elections and I continue to believe that they will do just that.

(2)   fiscal policy:  N/A.

(3)   monetary policy: as noted above, the Fed released its latest Beige Book which was a nothing burger.  In addition,  in a Q&A in Zurich, Powell stayed with the party line---a rate cut in September.

Further, the Bank of China lowered reserve requirements [infusing money into the banking system] this week.

And last but certainly not leased, Draghi has virtually guaranteed that rates will be lowered at the next [and his last] ECB meeting.  If that isn’t bad enough, his position will be filled not by an economist but by a politician [Lagarde] whose latest claim to fame was pouring billions and billions into the Argentine economy only to watch it disappear.

The bright spot was that several prominent EU bankers criticized the ECB’s monetary policy as being harmful to the EU economy which [a] makes me wonder why they are just now figuring that out, but more importantly [b] it hopefully starts a discussion among those who count of just how detrimental QE has been to the economies of those countries on which it has been imposed.  One can only hope that this will have an impact.  Otherwise we are doomed to the further destruction of the pricing of risk [misallocation and mispricing of assets].

(4)   global hotspots. the Middle East hostility continues to simmer, though Trump has put out feelers for a pow wow with the Iranians. 

[a] the turmoil in Hong Kong is subsiding as a result of concession by the government.  As I noted above, this could be just a ploy to calm the waters until the Chinese anniversary bash is over. 

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

[c] Japan and South Korea escalated their dispute again this week.

[d] the Brits can’t figure out which way is up.  That leaves Brexit very much in limbo where developments could go either way.  In any case, the economic turmoil it is causing is negatively impacting the data out of the EU.

                Bottom line:  on a secular basis, the US economy is growing at an historically below average rate and I see little reason for any improvement.  The principal cause of the restraint being 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 trade wars.  Indeed, this progress is a miracle given all the aforementioned fiscal and monetary headwinds.  That said, the yellow warning light is still flashing.

The Market-Disciplined Investing

The Averages (26790, 2978) rested yesterday after a big Thursday, closing above their 100 DMA’s for the third day (reverting to support) and the upper boundaries of their August 5th trading ranges for a second day, voiding that trading range.  They also finished above their 200 DMA’s and in uptrends across all timeframes.  Volume was down; and breadth improved slightly.   The only negative is that both of the indices made gap up opens on Thursday---which will have to be closed.

                The VIX fell another 8 %, ending below its 200 DMA for a second day (now support; if it remains there through the close next Tuesday, it will revert to resistance).  It also closed below its 100 DMA (now support; if it stays there through the close next Tuesday, it will revert to resistance) and below the lower boundary of its August 5th trading range (inversely related to the August 5th trading range for the Averages); if it remains there through the close on Monday, that trend will be voided.

            The long bond was rose ¾ %, but not enough to close Thursday’s gap down open---which needs to be filled.  It finished above both MA’s and in uptrends across all time frames.   So, the chart remains strong and the trend toward lower rates remains intact.

            The dollar was up fractionally but not enough to fill Wednesday’s gap down open---which needs to be closed.  It ended above both MA’s and in short and long term uptrends. 
 Another strong chart,  pointing towards a higher dollar.      

            GLD was down another 7/8 %.  Nonetheless, it closed above both MA’s and in very short term and short term uptrends.  There  is also Thursday’s gap down open---which needs to be filled.
            Bottom line: long term, the Averages are in uptrends across all timeframes; so, the assumption is that they will continue to advance.  Short term, they have resolved their August 5th trading range to the upside, pointing to the return of upward momentum.  The next resistance levels are their July all-time highs (27398, 3027).  The only negative is that both indices plus TLT, UUP and GLD all experienced gap opens last week, which, in my opinion, just multiples the odds of price reversals that will close those gaps.

            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 forward against multiple headwinds.  The very recent data has become less bad---but that it no reason to stop yellow warning light flashing.  Not helping matters is the recent surge in bond, dollar and gold prices [Thursday’s pin action notwithstanding]; all of which point to a flight to safety [fear of recession].

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.  

The dispute with China drew a positive headline this week.  However, as I made clear above, I think the Chinese motive for resuming talks has nothing to do with wanting to compromise.  So, I don’t expect any give on their part.  They may be hoping that Trump will fold during the negotiations anyway just to get a deal ahead of the 2020 elections.  And  if he does, I consider it a long term negative.  Either way, in my opinion, pain is in our future.  The only question is how much.
(3)   the resumption of QE by the global central banks.  That is now occurring worldwide.  [a] the ECB  made it clear that it is strongly considering another big dose of QE,  [b] this week China lowered bank reserve requirements and [c] the US bond market continues to price in multiple cuts in the Fed Funds rate this year and this week, Powell all but guaranteed a September rate cut.

I have maintained for some time that the key to the Market is monetary policy, more specifically, its co-dependency with the Fed.  Investors recently began to question their faith in its ability to navigate the US economy through an increasingly trying economic climate.  But so far not enough to suggest a change the paradigm of central bank/stock market co-dependency.  However, the risk is heightening that this could occur.

Another ear burner from Jeffrey Snider (must read):

(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 still showing little sign of challenging their long term upward momentum. 

The only explanation that I have for this is in the context that the global central banks are all in on their support of equity markets. For the last decade, they have measured their success by the performance of the stock Market, acted accordingly and been victorious.  As long as that is the paradigm, fundamental economics and valuations will likely remain irrelevant.  But as I noted over the last two weeks, that may be changing. 

As prices continue to rise, I will be primarily focused on those stocks that trade into their Sell Half Range and act accordingly. Despite the Averages being near all-time highs, 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.

Looking for value.

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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