Saturday, October 5, 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                                 23814-34114
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                                     2611-3511
                                    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 were negative: above estimates: weekly mortgage and purchase applications, month to date retail chain store sales, September light vehicle sales, the Dallas Fed manufacturing index, the September manufacturing PMI; below estimates: weekly jobless claims, the September ADP private payroll report, September nonfarm payrolls, August construction spending, the September Chicago PMI, the September ISM manufacturing and nonmanufacturing indices, the September NY Fed ISM index, the August trade deficit; in line with estimates: August factory orders/ex transportation, the September Markit services and composite PMI’s.
                  Air cargo rates continue to fall.

            The primary indicators were also negative: August construction spending (-), September nonfarm payrolls (-) and August factory orders/ex transportation (0). The call is negative.   Score: in the last 207 weeks, sixty-seven were positive, ninety-two negative and forty-eight neutral. 

                Update on big four economic indicators.

            As I noted several times, the numbers were the primary news event of the week.  More specifically, their horribleness. Not only were they abysmal here but so was the global data.  That said, this is one week’s stats (how many times have I said that?).  I still see the data pattern as erratic; but investors apparently woke up (at least for a day) to the fact that everything is not coming up roses.  In the end, I am not changing my forecast on one week’s numbers.

Overseas, the stats were negative, providing little reason to alter my opinion that the global economy is a drag on our own.

[a]  August EU unemployment was better than expected, its September manufacturing, services and composite PMI’s was abysmal, while August retail sales and September core CPI was in line;  August German retail sales, the September services and composite PMI’s and September CPI were below estimates while the September manufacturing and construction PMI’s were above; Q2 UK business investment and September new car sales were above forecasts, Q2 GDP growth was in line, September UK housing prices and the construction PMI were disappointing,

[b]  August Japanese housing starts and construction orders were awful; September consumer confidence, its Q3 August all industry capex and small manufacturers index were below estimates; August Japanese unemployment, the Q3 large manufacturers and nonmanufacturers indices were above; September services and composite PMI’s were in line; finally, the government has raised the national sales tax---not a boost to growth,

[c] the September Chinese Caixin manufacturing and composite PMI were better than anticipated while the service PMI was worse.

Developments this week that impact the economy:

(1)   trade: the only trade related headline this week was Trump imposition of $7.5 billion in tariffs on EU goods.  While that certainly doesn’t help global economic growth, $7.5 billion is a wart on a goat’s ass in the scheme of things.

There was the usual amount of happy talk on the upcoming US/China trade talks.  Those start next Thursday.  So, expect some major headlines.

(2)   fiscal policy: no news this week.

(3)   monetary policy: a couple of points:

[a] an FOMC meeting is coming up next week.  Given the recent string of poor economic data both here and abroad, I think the odds are quite high of another rate cut,

[b] last week, the Bank of Japan declined to raise its key interest rates.  Then this week, it indicated that it was moving toward tighter monetary policy, suggesting that the only thing that its QE had accomplished was to wreck its financial system.  Duh.  That has been obvious for the last five years.  What we need now is for the light to go on at the Fed and the ECB, moving them in the same direction.  Alas, don’t count on it.

What is the ECB doing?

Which leaves my bottom line unchanged: the lion’s share of central bank policy moves over the last ten years has been a negative [asset mispricing and misallocation] for global growth and will remain so as long as they pursue their irresponsible QE.  The only beneficiaries of this policy have been the securities market which are now grossly overvalued,

[c] the current dollar liquidity problem may be another manifestation of the failed global QE Infinity policy.  So far, the Fed has kept the problem under control.  But when, as and if, the Markets lose faith in the central banks’ ability to manage monetary policy, trouble is a heartbeat away.

Weakening the dollar is the global economy’s last hope (must read).

And the beat goes on.

(4)   global hotspots. The biggest headline this week was on the looming Brexit at the end of this month.  The politics of this situation is very confusing.  My bottom line is that a ‘no deal’ Brexit would be a negative for global growth, at least in the short term. 

In addition, the US and North Korea resume nuclear talks today; although the significance is marginal.

(5)   impeachment: I am adding this to the list of concerns.  I will continue to avoid political commentary.  Though I believe that more intense the situation becomes, the more it will negatively affect businesses and consumers willingness to invest/spend.

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. 
The Market-Disciplined Investing

The Averages (26573, 2952) rallied hard on Friday, closing the 10/2 gap down open and negating Wednesday’s break below their 100 DMA’s.  Plus, breadth looked good.  On the other hand, volume was down, the VIX remained above both MA’s and in a very short term uptrend and the long bond, gold and the dollar are all back acting as safety trades.

I still think the pin action supports the assumption that momentum remains to the upside.  But there is enough cognitive dissonance coming from multiple sources that if the indices can’t make a new high, that assumption comes into question.

Too much optimism?

Meanwhile, as I noted above, the long bond, gold and the dollar are moving higher which doesn’t usually occur when stocks are moving higher.

            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, not the least of which are the weakness in the international stats and the fallout from the US/China trade dispute.  This week’s data was quite negative; though I think this has to be viewed in the context of the erratic dataflow of the last five years. 

I was surprised when investors reacted negatively to economic bad news on Wednesday.  But that didn’t last long.  On Thursday and Friday, stocks were up on bad economic news---because, you know, the Fed will ease.  So, apparently bad economic news continues to be good Fed news.

(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.  

While the major headline in trade this week was the imposition of tariffs on EU goods, it wasn’t all that big a deal.  $7.5 billion in tariffs is minor when compared to the US/China war.

Speaking of which, top negotiators from both countries meet this week.  Whatever the outcome, it is apt to have an impact on stock prices.

As you know, I don’t believe that the Chinese have any incentive to negotiate on their industrial policy and IP theft, at least until after the 2020 elections and maybe not even then. Clearly, I could be dead wrong.  If I am and Trump gets the changes he wants, then the outlook for increased trade and a stronger economy improves markedly.  If Trump gets out maneuvered, then while the short term prospects for growth will rise, the US will be still stuck with the longer term burden on unfair Chinese industrial policies and IP theft.
(3)   the resumption of QE by the global central banks.  This week the Japanese appeared to be moving toward a tighter monetary regime.  The reason given was that years and years of QE had wrecked their banking system; hence a different approach made sense.  And speaking of sense, that is the first sign that someone out there in central banker land may be figuring out what an abomination QE has been and the damage it has done to the pricing of risk.

Of course, there are few signs that any other central bank is considering such a move.  Indeed, the poor US stats this week are pointing to a further cut in rates by the FOMC this month.  That should keep US investors happy as little has happened that would suggest an unwinding of the Market/Fed codependency.

                  Powell spoke on Friday.  It was a nothing burger.

(4)   impeachment. as I noted above, the more vicious this battle becomes the more likely it is to have a negative effect on stock prices.

(5)   current valuations. I believe that Averages are grossly overvalued [as determined by my Valuation Model].  The economy [whether US or global] isn’t improving. There could be a trade deal that would brighten the outlook.  But there has been so many ups and downs in the negotiations, I think that a healthy dose of skepticism on a positive outcome is warranted.

Of course, as usual, I have to conclude that all of the above are irrelevant as long as investors believe the central banks have their back.  While I still believe that the monetary policies of the last decade have stymied not aided economic growth, that they have created valuation bubbles through the mispricing and misallocation of assets and that they have led to a pronounced inequality in the distribution of wealth, I am clearly in the minority.  Nonetheless, I also believe that investors will ultimately awake to the damage the monetary regime of the last decade has done and the unwinding of these effects will not end well for them. 

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.

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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