Saturday, October 26, 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                                 23990-34290
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                                     2634-3534
                                    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 a lot of data this week; but what there was, was negative: above estimates: the October flash manufacturing PMI, the October Richmond and Kansas City Feds manufacturing indices; below estimates: weekly mortgage/purchase applications, September existing home sales, weekly jobless claims, month to date retail chain store sales, October consumer sentiment, September durable goods orders, the October flash composite PMI, 2019 budget deficit; in line with estimates: September new home sales, the October flash services PMI.

            In addition, the primary indicators were also negative: September existing home sales  (-),  September durable goods orders (-) and September new home sales (0). The call is negative.   Score: in the last 211 weeks, sixty-seven were positive, ninety-six negative and forty-eight neutral. 

The stats continued their negative trend of the last month.   Still it will take a couple more weeks of poor numbers to persuade me that this isn’t just part of the erratic data pattern of the last decade.

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

[a]  September German PPI and the October business conditions index were higher than expected; October UK industrial orders and Q4 business optimism, October consumer confidence and both the German and EU October flash manufacturing, services and composite PMI’s, October German consumer confidence were less,

[b]  August Japanese all industry index and leading economic indicators were better than estimates; the September trade balance and the October flash manufacturing, services and composite PMI’s were worse,

Developments this week that impact the economy:

(1)   trade: aside from the usual happy talk, the one event this week that bears mentioning is an announcement by the Chinese that its soybean purchase won’t start until the second year after Phase One of the new, improved trade deal goes into effect.  In other words, any positive economic impact of a trade deal is fading into the sunset---unless Trump folds.

(2)   fiscal policy: the highlight of the week was the news that the FY2019 budget deficit was $984 billion, the largest since 2012.  And it is forecast to only get bigger, at a time when the economy is [or has already passed] peak growth and unemployment is at a historic low.  You know my thesis: the US debt/GNP has already passed the level at which added deficit spending hampers growth.

I thought this article on the impact of EU spending was enlightening.

(3)   monetary policy: NotQE is developing into a bigger injection of monetary stimulus than QE; primarily because the liquidity needs of the global financial system appear insatiable at the moment.  How long this goes on and whether or not the Fed can ultimately satisfy Market demands are major questions right now---and the answers will be critical to the health of the global economy. 

That said, I could be making a mountain out of a molehill because there are very few other observers that seem concerned.  Still I don’t think it can be ignored.

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. This situation remains quite fluid.  We are not likely to know the real consequences of the change in US policy for some time; although the neocons are howling like scalded dogs.

[b] Brexit.  the British Parliament passed the Brexit deal but voted to delay implementation.  At this moment, we are waiting to see if the EU will extend the deadline for a deal.

                  Here is a blow by blow description of where the process is 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.  My forecast remains that the US will avoid recession.
The Market-Disciplined Investing

The Averages (26988, 3022) had a good Friday.  The S&P reset its very short term uptrend (the Dow didn’t) and pushed through its prior lower high (the Dow didn’t) on improved volume and better breadth.  The VIX fell 7 ¾ %, breaking below the lower boundary of its recent trading range and is approaching its 7/25 low (the S&P high). 

The indices ended solidly above both MA’s and in uptrends across all timeframes.  Plus, as I noted, the S&P reversed two of its short term negatives (resetting its very short term uptrend and ending above its last lower high)---which clearly improves the short term technical picture.  The negatives that remain are (1) the Dow is now out of sync with the S&P and (2) the October 11th gap up opens need to be closed.  My assumption remains that momentum is to the upside and that the all-time highs (27398, 3027) will be challenged; and my conviction is improving

TLT declined ½% and is now re-approaching its 100 DMA.  While it finished above both MA’s and  in uptrends across all time frames, it is again threatening the loss of momentum. 

The dollar rose 1/8%, continuing its bounce off its 100 DMA and the lower boundary of its short term uptrend and appears to be regaining its upside push.

Gold was up ¼ %, confirming  the break above the upper boundary its pennant formation.  My assumption is now that it has made a short term bottom and its price is headed higher---although it still has several minor resistance levels that it must be overcome. 

What is a bit mystifying about the GLD, TLT, UUP pin action is that GLD is usually negatively impacted by higher interest rates and a strong dollar; and we go both on a day that GLD moved 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).  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 again.  But I want to see additional data before I think this is other than the erratic dataflow pattern of the last ten years. 

Of course, if we get a China deal, any deal, it will likely prove beneficial to economic growth and the Market 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.

(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’---supposedly.  However, the Chinese keep walking back the terms---something we should be used to by now.  The latest change being that any agricultural purchases will start only after the Phase One deal has been in effect for two years.  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.  The Fed is pushing QE [Not QE] with a vengeance, the scope of which is apparently tied to the growing liquidity problems in the global financial system.  So far, I am in the minority of those who think this a problem.  Perhaps the others are right; but until this problem goes away, it is still a predicament that could potentially get worse. 

China is having its own liquidity problems.

That said, until Friday, the Market has not been acting like the Fed is easing mightily.  Perhaps Friday’s trading was just a delayed reaction to NotQE.  We will know more by the end of next week.
(4)   impeachment. as I noted above, the more vicious this battle,  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.  Plus, the Trump impeachment process gets more divisive every day.  Ultimately, there could be a spillover effect on stock prices. 

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; and right now, the Fed is delivering a dove’s wet dream.  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.

On the inequality in the distribution of wealth (must read).

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, 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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