Saturday, February 22, 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                                 24905-37367
Intermediate Term Uptrend                     16100-32301
Long Term Uptrend                                  6860-38078

                        2019     Year End Fair Value                                   14500-14700

                        2020     Year End Fair Value                                   15100-15300

            Standard & Poor’s 500

                                    Current Trend (revised):
                                    Short Term Uptrend                                     3102-3597
                                    Intermediate Term Uptrend                         2744-4244                                                          Long Term Uptrend                                     1329-4964
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 negative again; but the primary indicators (three) were all upbeat.  I am calling it a positive.  Score: in the last 229 weeks, seventy-six were positive, one hundred and three negative and fifty neutral. 

The erratic pattern in the numbers persists.  It seems likely that the signing of the two trade treaties would have had a positive influence of business/consumer psychology which would  in turn increase the willingness to invest and spend.  But if the result is simply that the economy continues to struggle to grow, that is probably not going to be much help when the impact of the coronavirus becomes manifest.

Of course, nobody has a clue as to the effect that the virus will have on global growth. We do know that China lowered the reported infection and death growth rates this week; but we don’t know how much of that is bulls**t.  We know that Japan and South Korea have seen a pickup in infections/deaths; but those numbers are relatively small, at least for the moment.  In short, we don’t know diddily about the ultimate economic outcome of the coronavirus.  As you know my conclusion is that this virus will have a temporary effect on global growth but that dissipate over time. For the moment, I am not altering my longer term view that the coronavirus will not impact secular economic growth; but I got there by the WAG [wild ass guess] method.

Hence, I am also not altering my long term economic outlook, which is that the economy will continue to grow at a subpar rate due to the twin burdens of egregiously irresponsible fiscal and monetary policies.

Overseas data was slightly negative.  My concern is that it will only get worse as the influence of the coronavirus works its way into the numbers.   But as of the end of this week, the global economy is supportive of US economic growth.


Bottom line:  on a secular basis, the US economy is growing at an historically below average rate. 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.  However, short term the coronavirus will almost surely have a negative impact on global economy growth.  The questions are (1) are what are the stats going to look like when the impact of the coronavirus becomes manifest?  At the minimum, it would seem reasonable to assume that there will be a period of weak numbers, and (2) how long will that effect last?  My assumption is that any decline/slowdown in economic activity will be short lived.  In other words, it will almost surely influence 2020 growth estimates but the impact will dissipate through the year.

The Market-Disciplined Investing

The Averages (28992, 3337) got whacked yesterday.  The good news was that the S&P held above its former all-time high.  The bad news is that the rest of the indicators that I follow are pointing at a need for safety. 

GLD, TLT and UUP maintained their strong move as safety trades and they all are either making or about to make new highs.  I think this is potentially ominous signal.  Though it is too soon to act.  They need to successfully challenge those boundaries; and the S&P needs to start busting through some support levels before we can be sure that this is not a head fake (i.e. that economic outlook is about to turn negative). 

                There remains an apparent dichotomy between the economic expectations of equity investors and those in GLD, TLT, and UUP.  Somebody is going to be wrong.

                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  the signing of the US/China and USMCA trade agreements reinforces my conviction that it will bolster the secular growth rate of the economy. That should keep secular corporate profit growth on a somewhat even keel which is a plus for stock prices.

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 a lasting 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 resumption of QE by the global central banks.  In an attempt to offset the economic impact of the coronavirus, the Bank of China continued to shovel liquidity into the Chinese financial system with both hands.

As long as that remains the case AND investors believe that it is a plus for the Market, stock prices should maintain their upward bias irrespective of valuations.

That said,  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.

Whether or not the changes occurring in the technical landscape are a sign of that occurring remains to be seen.  But clearly, they need to be watched closely.

Bottom line:  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.

            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.

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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