Saturday, March 14, 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                               ?
                        Inflation                                                                                  ?
                        Corporate Profits                                                                    ?

   Current Market Forecast
            Dow Jones Industrial Average

                                    Current Trend (revised):  
                                    Short Term Trading Range                       21732-29540
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 Trading Range                          2855-3303
                                    Intermediate Term Uptrend                         2765-4265                                                          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                           50%
            High Yield Portfolio                                     52%
            Aggressive Growth Portfolio                        56%

Spread of the coronavirus and concerns about its potential impact on economic activity have raised enough questions about the expected cyclical growth prospects for the US that I am suspending my 2020 economic outlook until the coronavirus’ ‘impact on economic activity’ becomes clearer.

The dataflow this week was positive (no  primary indicators).  I am calling it a positive.  Score: in the last 232 weeks, seventy-nine were positive, one hundred and three negative and fifty neutral. 

Overseas stats were mixed; but like the US numbers, they are likely irrelevant because have yet to reflect the rapid global increase in the coronavirus infection/death rate and its consequences on economic growth.  Unfortunately, at the moment, no one has a handle on the extent of the economic losses associated with combatting the virus.   Until we do, making predictions about the economy, at least over the short term, is wasted exercise.

I have suspended my short term economic forecast.

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

The Market-Disciplined Investing

The Averages  (23185, 2711) roared back yesterday from a very oversold condition aided by a huge short squeeze in the final hour of trading.  Nonetheless, the S&P remained below [a] the lower boundary of its short term trading range for a third day, resetting to a downtrend and [b] the lower boundary of its intermediate term uptrend for a third day; if it remains there through the close next Monday, it will reset to a trading range.  On the other hand, the Dow ended back above the newly reset lower boundary of its short term trading range, voiding Thursday’s break.  

TLT, GLD and UUP maintained the major reversals that began on Tuesday.  TLT  remained positive; GLD is now challenging its 100 DMA; and UUP continued its huge rally, setting it up to go from the most negative to the most positive chart. 

The question remains ‘are the reversals in TLT, GLD and UUP just a trading blip or are they starting to forecast a major change/incident in the economy as they did from late 2018 to their recent peak (low)?’ ---for instance, a Market rattling credit/liquidity event which would explain higher yields, lower gold prices and a strong dollar.

                Where has all the liquidity gone? (must read):

                Friday in the charts.

Fundamental-A Dividend Growth Investment Strategy

The recent decline notwithstanding, the DJIA and the S&P are still 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.  I am clueless about the prospects for economic growth over the next twelve months and will almost certainly remain so until we have a handle on the magnitude of the risks currently facing the economy.

[a] lower oil---the known known.  Not a plus but a known.  Low oil prices can be easily plugged into the production/GDP models, providing analysts with a decent estimate of the impact on the profitability of the oil industry as well as those segments of the economy that use oil either as a source of energy or a feedstock.  The effects are clearly not all bad.  And they can be roughly calculated and, therefore, discounted.  The point being that the net negative result of lower oil prices is likely reasonably well reflected in current prices.

That said, there is one known unknown and that is security of the debt held by many oil and gas producers.  (see [c] below)

[b] the coronavirus or more specifically the peak in infections/death rates---the known unknown.  The good news is that based on the experience in China and South Korea, we are getting a handle on how rapidly the virus spreads, the casualty rates and the timing of peak infection/death rates.  But two is a small sample and in one case {China}, the government {i} has extraordinary power to fight the virus via closing businesses and quarantining individuals, cities, provinces that other more democratic governments don’t possess and {ii} lies a lot, making their statistics suspect].  Still it is a start. 

On the other hand, the economic consequences of virus in terms of lost wages, sales and profits are still largely unknown.  And until they start to be measurable, this will be an uncertainly that is going to hang over the Market.  I have no doubt that some, perhaps all of the ultimate negative consequences are being priced into stocks.  Indeed, it is possible that they are being overly  discounted.  But the point is that we just don’t know and until we do, this factor will likely be a disrupter of valuations.

Is there a better approach?

[c] the financial distress on corporate balance sheets---the unknown unknown.  We know that the Fed has created the overleveraging of corporate America via the mispricing of risk {the cost of money}.  It has led some companies to borrow cheap money in order to {i} buy back their stocks at elevated price and other companies to avail themselves of very low interest rates to {ii} avoid bankruptcy, i.e. servicing current unrepayable debt with additional unrepayable debt. 

In my opinion, this misallocation of assets by corporate America will ultimately be unwound just as the mortgage financing debacle was in 2009.  But we don’t when or how large/painful the unwind will be.  However, I believe that the liquidity problems currently being experienced in the financial system are directly related to this issue; though I have no idea how the solution will manifest itself.  Until it does, this is a negative like the coronavirus except more unknown.

(2)   the resumption of QE by the global central banks.  The ECB joined the QEInfinity crowd this week.  The Fed also shoveled a massive amount of liquidity into the repo market.  But for a second time in a row, the Market didn’t care.  Powell et al have another chance to impress investors next week when the FOMC meets and is expected to lower rates substantially.  Their success [or not] will likely have an impact on the Market.

Investors’ worries seem to be focused on those highly leveraged corporate balance sheets mentioned above.  If this problem results in the massive downgrading of corporate credit along with bankruptcy among the marginal businesses kept alive by cheap credit, I think it likely that the credibility of the Fed and its whole QE regime may be lost.  And, in fact, that may already be happening. 

Whether it is occurring now or sometime in the future, I continue to believe that  the unwinding of the mispricing and misallocation of assets will negatively impact the Market.

Jeffery Snider takes another rip at the Fed.

Bottom line:  The current selloff notwithstanding, I still believe that the Averages and certain segments of the Market remain grossly overvalued [as determined by my Valuation Model].  As a result, I believe that the stocks in those parts of the Market will continue under pressure.

            Nonetheless, there are certain segments of the economy/Market that have been punished severely  with the stocks of the companies serving those industries down 30-70%.  It is time to start putting our cash to work in these beaten up stocks. 

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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