Saturday, November 9, 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                                 24095-34395
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                                     2647-35474
                                    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: month to date retail chain store sales, weekly jobless claims, the October ISM nonmanufacturing index, the October NY ISM; below estimates: weekly mortgage/purchase applications, preliminary November consumer sentiment, September consumer credit, September factory orders, September wholesales inventories/sales, the October services and composite PMI’s, preliminary Q3 nonfarm productivity and unit labor costs; in line with estimates: the September JOLTs report, the September trade deficit.

            The primary indicators were also negative: September factory orders (-) and  preliminary Q3 nonfarm productivity (-). The call is negative.   Score: in the last 213 weeks, sixty-eight were positive, ninety-seven negative and forty-eight neutral. 

The numbers were back in the negative this week.  However, I  am sticking to my forecast that the economy struggling but not sliding into recession.   

On the other hand, the Market, at the moment, seems to think that the economy is about to achieve ‘lift off’.  I see no evidence of that.  Unquestionably, a trade deal would help short term.  But remember that (1) before there were any tariffs, the economy was  growing at a subpar rate., and (2) when tariffs were imposed, many pundits forecast that they would cause a recession; and that hasn’t happened.  In short, tariffs haven’t had that big an impact on US economic growth; so, why would their elimination have an effect?  As I point out endlessly, the major sources of restraint on US economic growth has been, is and will remain irresponsible fiscal and monetary policies.

ECRI weekly leading index.

For the first time in a long time, the stats overseas were upbeat.  And universally so.  As always, one week does not a trend make.  But just having a positive data week brings some hope that conditions have ceased deteriorating.  Nonetheless, it provides little reason to alter my opinion that the global economy is a drag on our own.

[a]  above estimates: the September German trade surplus, the final October German and EU manufacturing, services and composite PMI’s, the final October UK and services construction PMI‘s, the October German construction PMI; below estimates September German industrial production; in line with estimates: September EU retail sales, the September EU PPI,

[b] September Japanese cash earnings, household spending and leading economic indicators were above forecasts;  the October Japanese services and composite PMI’s were lower than expected,

[c] the October Chinese Caixin services PMI was below consensus while the composite PMI was above; as was the October trade surplus.

Developments this week that impact the economy:

(1)   trade: who knows.  Early in the week, it looked like a Phase one deal was close to being finalized.  Then Chinese first poured cold water on that narrative, but later reversed field and supported it.  Then Friday morning, Navarro sounded negative on a deal.  As I noted Thursday, trying to figure out what is really happening is a waste of time. 

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.

(2)   fiscal policy: nothing new this week.

(3)   monetary policy: this week [a] the Bank of China, lowered interest rates, joining the other major central banks in a race to see how much liquidity can be pumped into the global financial system but [b] the Bank of England left rates unchanged {at 75 basis points}.

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.

(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.  Indeed, any progress is a miracle given all the aforementioned fiscal and monetary headwinds.  My forecast remains that the US will avoid recession.

            Jeffrey Snider thinks otherwise (must read):

The Market-Disciplined Investing

The Averages (276781, 3093) drifted higher yesterday on lower volume and but good breadth.  The latter remains in overbought territory. The VIX fell 5 1/8%---nearing its 7/25 low and putting it in sync with breadth. 

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.

TLT was down another ½ %, finishing below its 100 DMA (now resistance) and a short hair away from the lower boundary of its very short term uptrend and only a couple of points from its 200 DMA.  If these levels hold, then TLT will likely have found a bottom; if not, the next visible support level is 20 points away.

The dollar was up another ¼%, maintaining its upward momentum.  Clearly, the longer it sustains this uptrend, the more in harmony it gets with stocks.

Gold was down 5/8 %, ending below its 100 DMA for a second day (now support; if it remains there through the close on Monday, it will revert to resistance).  However, it finished well above its 200 DMA and the lower boundary of its short term uptrend; meaning it has plenty more room on the downside before meeting any significant support.

Dollar investors are almost surely of the same mind as equity investors in the belief that a stronger economy is dead ahead.  TLT and GLD investors are also moving in that direction; but nothing is confirmed yet.

One observation.  The numbers simply aren’t confirming a strengthening economic scenario.  Of course, as I noted Friday, Markets are forward looking; and they likely are assuming a trade deal will lead to a pick-up in economic growth.  As  I discussed above, I don’t buy that thesis. 

                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.  This week’s data was back in the red; though I continue to believe that this only means that the economy is struggling to grow, 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.  However, 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 [a] the Bank of China  lowered interest rates, joining the other major central banks’ liquidity dump and [b] the Bank of England left its key rate unchanged---though at a very low 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]---which is determined by the present value of future dividend growth.

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 continues to surprise to the upside and that lessens the uncertainty of any cyclical fall corporate profits. 

Corporate profits are not as good as you think (must read).

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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