Saturday, November 16, 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                                 24132-34432
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                                     2653-3563
                                    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.   The dataflow this week was negative: above estimates: weekly mortgage/purchase applications, October CPI and PPI; below estimates: month to date retail chain store sales, weekly jobless claims, the October small business optimism index, October industrial production/capacity utilization, the November NY Fed manufacturing index, September business inventories, the October budget deficit; in line with estimates: October core CPI, October retail sales/ex autos.

            The primary indicators were  also negative: October retail sales/ex autos (0) and  October industrial production (-). The call is negative.   Score: in the last 214 weeks, sixty-eight were positive, ninety-eight negative and forty-eight neutral. 

No reason to alter my forecast that the economy struggling but not sliding into recession.   

After a week of upbeat stats, the overseas data once again turned ugly---providing little reason to alter my opinion that the global economy is a drag on our own.

[a]  above estimates: September EU industrial production, trade surplus and its November economic sentiment; November German economic sentiment and the flash Q3 GDP growth; weekly UK unemployment, September unemployment and preliminary Q3 productivity; below estimates; the September UK trade deficit, industrial production, construction output, consumer earnings, GDP and October retail sales, CPI and PPI, Q3 EU employment change; in line with estimates: October German CPI, the second estimate of Q3 EU GDP growth,

[b] September Japanese machinery orders, October machine tool orders and PPI and the preliminary estimate of Q3 GDP growth were below forecasts; September industrial production was above.

[c] October Chinese CPI was better than consensus while  PPI, auto sales, loan growth, fixed asset investments, industrial production and retail sales were below.

Developments this week that impact the economy:

(1)   trade: who knows.  The circle jerk continues and the news flow seems to be taking on the characteristics of white noise.  In any case, in a Tuesday speech, Trump delivered a balanced message on trade, then Wednesday morning issued a harsh statement, threatening to increase tariffs on China even further if there was no Phase One deal---which drew an equally harsh Chinese response.  Plus, there were reports that China was resisting the proposed size of ag purchases as well as provisions against technology transfers and enforcement. On Friday came a new dose of happy talk from Kudlow. As I noted Thursday, trying to figure out what is really happening is a waste of time. 

Perhaps the most potentially significant headline came from Germany where a report stated that an estimated 25% of its global businesses are relocating plants outside of China due to the difficulties associated with that country’s industrial policy.  If a large portion of the world’s major international companies were to follow suit, that could be a major influence in altering unfair Chinese industrial policy and IP theft.  ‘Could be’ are clearly the operative words.

That said, my bottom line hasn’t changed.  I don’t believe that there will be a deal that incorporates the primary issues of Chinese industrial policy and IP theft before November 2020, if at all.  Any other deal will be not be a long term positive for the US and will take place because Trump folded.  That said, any deal that removes tariffs and increases Chinese purchase of US ag products will be a minor short term economic plus.

                                  I usually ignore doomsday forecasts, but I thought this was worth review.

(2)   fiscal policy: the October budget deficit came in larger than anticipated (surprise, surprise).  Interestingly, in Powell’s testimony [see below] he noted that fiscal policy was on a ‘unsustainable course’.  As you know, I agree with that completely.  Although I would note that, ironically, keeping interest rates artificially low so that the government can deficit spend at a very low cost contributes to enabling it to do so, i.e. if rates were at normal levels, the cost of financing the national debt would be considerably higher and would likely act as a governor on profligate spending.

(3)   monetary policy: Powell testified before the Joint Congressional Economic Committee.  In it, he repeated the narrative from the last FOMC meeting---no more rate cuts in sight, but no increases either even if the economy starts running hot and most importantly, NotQE is alive and well.  In that testimony, Powell may have had his Bernanke moment: "there’s nothing that’s really booming now that would want to bust."

The latter point was bolstered on Thursday when the Fed laid out its fourth quarter NotQE schedule revealing lots of free money.

How central bankers are stealing from savers.

Here is another great piece from Ed Yardini (a bull, I might add) explaining why the Fed’s expansive monetary policy has not worked, is not a plus for the economy and is sowing the seeds of the next financial crisis.

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 beneficiary of this policy has 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.

[b] Brexit.  nothing new.

[c]  I am adding the ongoing unrest in Hong Kong to this list.  The turmoil has gone on too long with no lessening in the violence.  The risks here are that {i} the disorder could spread into China or {ii} China could intervene and the US responses by shutting down trade talks or, even worse, adding new punitive measures on US/China trade.

***and lo and behold, overnight,

(5)   impeachment:  I will continue to avoid political commentary.  Though I believe that the 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 causes 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.  Indeed, any 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 (28004, 3120) had a blockbuster day, regaining the momentum that in Friday’s Morning Call, I speculated they had lost.  Breadth was strong and the VIX was down 7 ½ % pointing to an increasingly overbought condition. Volume, as usual, was down.

My assumption remains that momentum is to the upside; but there are still some short term negatives:  (1) October 11th gap up opens need to be closed and (2) the VIX and breadth suggest equities are overbought.

The bond market rested after a strong performance earlier in the week.  The good news is that it bounced off the lower boundary of its short term uptrend on Thursday; the bad news is that it remains below its 100 DMA.  Clearly, a successful challenge to the upside would indicate an end to price weakness and the thesis that the economy is strengthening.  But that hasn’t happened yet.

The dollar was down ¼ % and is nearing the lower boundary of its short term uptrend.  Nonetheless, it remains above both MA’s and in uptrends across all timeframes.

Gold declined ¼ %, retreating off the upper boundary of its very short term uptrend and remaining below its 100 DMA. Like TLT, a successful challenge to the upside would suggest a change in momentum and question the thesis that the economy is strengthening.

The UUP, TLT and GLD’s pin action continues to support the notion that the economy is improving though they are all nearing support/resistance levels which if successfully challenged would indicate otherwise. 

                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, though I continue to believe that is not falling into a recession.  As long as the US economy grows at a subpar rate but avoids a recession, this factor will be a neutral  for the Market.

(2)   the [lack of] success of current trade negotiations.  At this moment, who knows.  I do think the odds slightly favor the Phase One agreement if the assumptions are that [a] it only includes some kind of modestly beneficial economic trade off {ag purchases versus lower tariff} and [b] it will not occur until the outcome of the 2020 elections is clearer.  That said, any deal at any time will likely be a short term positive for the Market.

But as I have repeated ad nauseum, I don’t believe an agreement will be reached that adequately addresses the issues of Chinese industrial policy and IP theft---which are why there is trade war in the first place. And that will continue to overhang the Market.

(3)   the resumption of QE by the global central banks.  This week, Powell reiterated the narrative from the last FOMC meeting and the Fed backed it up a day later, releasing its Q4 Not QE liquidity injections which continue at a high level.

My bottom line remains the same.  The Fed’s monetary policy has been a negative for the economy and will continue to be as long as it is focused on keeping the Markets happy versus following its dual mandates.  However, because it is Market friendly, stocks should continue to do well until the Fed either reverses its policy or investors figure out just how punitive that policy has been for the economy.

(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].

Currently, the economy [whether US or global] offers little reason to assume that the secular dividend growth rate will move higher in the future. On the other hand, third quarter earnings season surprised to the upside and that lessens the uncertainty of any cyclical fall corporate profits [dividends]. 

Of course, as usual, I have to conclude that NotQE makes all other factors 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. 

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 and Kroger to the Dividend Growth Buy List.

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. 

            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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