Saturday, February 1, 2020

The Closing Bell


Statistical Summary

   Current Economic Forecast
2019 estimates (revised)

Real Growth in Gross Domestic Product                          1.5-2.5%
                        Inflation                                                                          +1.5-2%
                        Corporate Profits                                                                6-9%


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                                 24674-37135
Intermediate Term Uptrend                     16100-32301
Long Term Uptrend                                  6849-38067

                        2019     Year End Fair Value                                   14500-14700

                        2020     Year End Fair Value                                   15100-15300

            Standard & Poor’s 500

                                    Current Trend (revised):
                                    Short Term Uptrend                                     3076-3575
                                    Intermediate Term Uptrend                         2724-4224                                                          Long Term Uptrend                                     1320-4955
2019 Year End Fair Value                                     1790-1810

2020 Year End Fair Value                                       1870-1890         

Percentage Cash in Our Portfolios

Dividend Growth Portfolio                           56%
            High Yield Portfolio                                     55%
            Aggressive Growth Portfolio                        56%

With the signing of the US/China and USMCA trade treaties, the Trump economy is a slight positive for equity valuations.   The total dataflow this week was marginally upbeat; however, the primary indicators were negative (two neutral, two negative). The call is negative.  Score: in the last 226 weeks, seventy-four were positive, one hundred and two negative and fifty neutral. 

That is somewhat disappointing in that a three week positive trend in the stats has been broken.  Of course, as I repeatedly note, a see saw pattern of economic growth has been with us for a decade.  So, no surprises here.  That said, the new trade treaties should provide some positive bias to economic growth both short and long term; and that will hopefully insure no recession. 

On the other hand,  the coronavirus will likely act as an offset in the short run, meaning this erratic pattern of global growth may remain with us for a while.  At the moment, I continue to believe that this epidemic will have a short shelf life, economically speaking. 

Hence, the economy should keep growing in line with my forecast (sluggish but positive) with no immediate concern about recession.  Longer term, I still believe that the economy is facing fiscal and monetary policies that are impediments to higher growth.

Update on big four economic indicators.

The latest Q1 GDP nowcasts.

The overseas data had another very upbeat week with the Japanese economy showing particular strength.  I am not sure how long this positive numbers flow can last in the face of the coronavirus,  But as of the end of this week, the global economy is supportive of US economic growth.

Developments this week that impact the economy:

(1)   trade:  on the back burner for the time being.  But the positive impact of the US/China and USMCA deals should start to show up later in the quarter.

(2)   fiscal policy: the latest CBO forecasts were released  this week.  They projected a $1 trillion deficit in FY2020 and expect that number to grow every year in the foreseeable future.  I repeat Rogoff and Reinhart’s thesis [with which I agree] that when the national debt is above 90% of GDP [which it is], it acts as a restraint on growth.          

(3)   monetary policy: the FOMC held its January meeting this week, leaving rates and Not QE  unchanged.  In its post meeting narrative, it slightly downgraded the economic outlook for the US, pointing at something that we have known all along; to wit, QE has done little to stimulate economic growth. Indeed, it  has inhibited growth through the mispricing and misallocation of assets. 

Our weekly dose of Jeffrey Snider.

A distortion of QE: German banks hoarding cash.

(4)   global hotspots. the coronavirus outbreak in China remains the key variable in this category.  It continues to spread and, as a result, the economic fallout worsens.  I still believe that this is an event that has a relative short shelf life.   That is, I don’t see it effecting global growth six months from now.  So, any economic negative that results will be temporary.  On the other hand, I could be wrong and if this blows into a major crisis, then clearly, global economic growth will slow more significantly than I expect.

In addition, Brexit is now upon us.  The UK formally exited the EU last night.  It now has until 12/31 to work out terms of a new relationship the EU, especially with regards to trade.  Both sides have a lot to lose in the absence of an agreement; but never underestimate the ability of a politician to make a mess of a situation.  In any case, the headlines are likely to be volatile in the months ahead.

(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.  While the data has improved of late and the newly signed trade deals should, at the least, help the US avoid an economic downturn, more is needed before I will consider any upward revisions to my long term secular growth forecast.

The driving causes behind my below average growth outlook are 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 but may improve somewhat as a result of the trade treaties.  Offsetting the latter short term is the likely negative impact on the global economy of the coronavirus.  Longer term, any progress is a miracle given all the fiscal and monetary headwinds.  My forecast remains that the US will avoid recession.
The Market-Disciplined Investing

The Averages (28256, 3225) got hammered yesterday.  However, they still ended above both MA’s and in short, intermediate and long term uptrends.  So, there has hardly been a loss in long term momentum. 

On the other hand, really significant support doesn’t exist until the Averages reach their 100 DMA [27740/3110] and the lower boundaries of their short term uptrends [24756/3076].

Volume rose.  Breadth was terrible; indeed, some indicators are nearing oversold territory.  The VIX popped 22%.  It is now approaching a nine month price high, supporting the breadth indicators that a technical rest may be in the cards short term.

The long bond was up 1%, continuing its ongoing directional momentum change to the upside (pointing to a sluggish economy; i.e. no lift off).  Although there are two gap up opens below that need to be filled. 

The dollar was down another 3/8%.  Recall that Thursday, it touched its 200 DMA (now resistance) but fell back.  So, the retreat continues.  Plus, it remains below both MA’s, in a short term downtrend and is still the ugliest chart on the block.  While it is attempting to close that big gap down open from 12/23, my assumption remains that the dollar will continue to weaken.

Gold was up ½ %, closing within very short term and short term uptrends and above both MA’s.

            TLT, GLD and UUP continue to trade like the economy is not near any kind of ‘lift off’.  The Averages are leaning in that direction but are not quite there yet.

                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.  My forecast remains that the economy continues to struggle forward against multiple headwinds.  Though clearly the signing of the US/China and USMCA trade agreements removes one of those impediments and reinforces my conviction that the economy is not falling into a recession.  However, in an environment in which corporate earnings are dramatically overvalued, a modest improvement in profit growth expectations [due to the trade agreements] will only make overvaluation slightly less so.

On the other hand, the coronavirus epidemic will almost surely have a negative effect on short/intermediate term economic growth.  That said, exogenous events with a short shelf life rarely have an influence on long term equity valuations.  Furthermore, as long as the Fed and its fellow central banks continue to pump money into the financial system, the Market impact should be contained,

(2)   the  success of current trade negotiations.  See above.

My bottom line is that Trump’s attempt to reset the post WWII global trade paradigm is meeting success and that is a plus for US economic growth.  At the moment, I am not saying that it will provide the fuel for any ‘lift off’ in growth; but it should reduce the odds of a further stagnation in US economic growth or worse.

(3)   the resumption of QE by the global central banks.  The FOMC and Bank of England met this week.  Both appear on goal to continue their own versions of QE and, perhaps, even expand these programs.

As you know, I believe that QEInfinity has, is and will continue to create distortions in pricing of risk which, in turn, leads to the mispricing and misallocation of assets.  As such, it is a negative for the efficient growth of the economy.

Nonetheless, on a short term basis, QE, QEInfinity and NotQE have been and remain Market friendly.  Meaning 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 will continue to count for little as long as the global central banks are pumping liquidity into the financial system.

The Fed’s view of valuations may be misguided (must read).

As prices continue to rise, I will be primarily focused on those stocks that trade into their Sell Half Range or fail to meet the minimum financial quality criteria for inclusion in our Universes 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 and the improvement in our trade regime should have a positive impact on secular growth and, hence, equity valuations.  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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