Saturday, October 19, 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                                 23910-34210
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                                     2623-3523
                                    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 mixed: above estimates: the October housing index, weekly jobless claims, August business inventories/sales, the October NY Fed manufacturing index; below estimates: month to date retail chain store sales, September retail sales, September industrial production/capacity utilization, the October Philly Fed manufacturing index, September leading economic indicators; in line with estimates: weekly mortgage/purchase applications, September housing starts/building permits.
            However, the primary indicators were negative: September retail sales (-), September industrial production (-), September leading economic indicators (-), September housing starts/building permits (0). The call is negative.   Score: in the last 209 weeks, sixty-seven were positive, ninety-four negative and forty-eight neutral. 

Overall, the stats have been trending negative the last couple of weeks.   But it will take a good deal more to persuade me that this isn’t just part of the erratic data pattern of the last decade.

The IMF has thrown in the towel on global recovery (must read).

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 industrial production, September German PPI, October EU and German economic sentiment and September UK retail sales, ex fuel were better than expected;  July UK employment and average earnings, the August EU trade balance, September UK CPI and PPI, and August EU construction output were worse; September UK retail sales were in line,

[b]  August Japanese industrial production was in line; August capacity utilization and September CPI were below estimates,

[c] the September Chinese trade surplus, industrial production and loan growth were larger than anticipated; September vehicle sales and CPI were disappointing; Q3 GDP and September retail sales were in line.

Developments this week that impact the economy:

(1)   trade: Trump said that the US and China have reached ‘phase one’ of a trade deal.  However, the agreement was verbal; nothing on paper yet.  And the Chinese started walking back the talking points almost immediately.  That doesn’t mean that there won’t be a deal.  It just means that nothing is certain.

(2)   fiscal policy: no news this week.

(3)   monetary policy: the Fed released its latest Beige Book; and the narrative  was less optimistic than prior Beige Book releases or the minutes of the last FOMC meeting.  This sets the Fed up for another rate cut in October---if it wants.

Meanwhile, NotQE is in full operation mode; but it is still having trouble satisfying the liquidity needs of the overnight repo market.  So far, this has not been a problem; and it may never be.  The concerning aspect is that, no one, including the Fed, has been able to provide a valid reason for this liquidity freeze up---which suggests that there could be a major issue in the global financial market that isn’t obvious yet.  ‘Could be’ being the operative words.
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,

(4)   global hotspots.

[a] Turkey/Syria/the Kurds.  A five day truce has been implemented, giving the Kurds in the Turkish ‘safety zone’ time to evacuate.  That seems fair---Turkey pushes the Kurds who have been fighting Turkey for decades out of a so called twenty mile ‘safety zone’ and the Kurds get US protection in the process.  What happens next is anyone’s guess.  As you know, Trump’s initial actions which  seemingly abandoned the Kurds caused a good deal of domestic turmoil that only exacerbated the already contentious domestic political environment.  That said, having our political class gnawing on each others ankle bones keeps them from doing much damage to the electorate.

[b] Brexit.  Johnson and the EU have a deal.  The question is, can he sell it to Parliament.  The vote is today.  No news as of this writing.

(5)   impeachment:  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 (26770, 2986) were off yesterday on lower volume, poor breadth and a rising VIX.  Still, they ended solidly above both MA’s and in uptrends across all timeframes.  Two other somewhat worrisome details are (1) longer term, the indices have now made their fifth unsuccessful try to mount a challenge of their all-time; plus, they have made  succession of lower highs and (2) short term, the October 11th gap up opens need to be closed.  While my assumption remains that momentum is to the upside and that the all-time highs (27398, 3027) will be challenged, my conviction is starting to weaken. 

            Gold was down fractionally, but still ended above the lower boundary of its pennant formation, leaving that technical pattern intact.  TLT was unchanged, remaining close to challenging its 100 DMA but finishing in uptrends across all time frames. 

The dollar’s chart bears the most comment.  UUP was down another 3/8% on Friday, finishing right on its 100 DMA and the lower boundary of its short term uptrend---clearly posing a threat to the upside momentum.  So, this chart has gone from the strongest of those I follow to potentially breaking down.  I said yesterday that this doesn’t make any sense to me in the midst of a dollar funding shortage.  Though traders tell me it is due to strong pound and euro reacting to the increased odds of a negotiated Brexit.  I am not entirely convinced by that explanation and worry that something more untoward may be happening.

                Friday in the charts.

            Stock buybacks expected to decline in 2020.

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 negative; though I think this has to be viewed in the context of the erratic dataflow of the last ten years. 

Of course, if we get a China deal, any deal, it will likely prove beneficial to economic growth over the short term.  But as I have repeated ad nauseum, an agreement that doesn’t adequately address the issues of Chinese industrial policy and IP theft will be  Pyrrhic victory.

                  US policy uncertainty soars.

(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.  And, of course, we now have a ‘deal’ however tenuous it may be at this point.  Whether that it proves to be a positive, in my opinion, remains a question.  I tried this week to present as many views of this deal as I could; and most engendered skepticism.  That doesn’t mean that there won’t be a deal; it means investors should control their level of jigginess.
(3)   the resumption of QE by the global central banks.  This week, the Fed restarted QE [Not QE].  But [a] investors were apparently focused on other issues and [b] it has not solved the liquidity issue in the overnight repo market---a problem that few are giving much import.  Perhaps they are right; but until this problem goes away, it is still a problem that could potentially get worse.

The other event this week was the release of the latest Fed Beige Book which read like the preamble to a rate cut---which I am assuming we will get at the next FOMC meeting.

All this should have made US investors happy, but didn’t.  Another sign of  the unwinding of the Market/Fed codependency?
(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 clearly have been in the minority.  Nonetheless, I also believe that when investors ultimately awake to the damage the monetary regime of the last decade has done, the unwinding of these effects will not end well for them.  And there are signs that this could be happening.

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.

Defying reversion to the mean.

Draghi warns of overstretched valuations.

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, it should be a plus for stock prices---though there are signs of late that this interdependency is cracking. 

            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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