Saturday, June 27, 2020

The Closing Bell



6/27/20


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%

            2020

Real Growth in Gross Domestic Product                               ?
                        Inflation                                                                                  ?
                        Corporate Profits                                                                    ?


   Current Market Forecast
           
            Dow Jones Industrial Average

                                    Current Trend (revised):  
                                    Short Term Trading Range                      18210-29540
Intermediate Term Uptrend                     16100-32301
Long Term Uptrend                                  7006-38224

                        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                          2188-3398
                                    Intermediate Term Trading Range              1813-3398                                                          Long Term Uptrend                                     1352-4987
                       
2019 Year End Fair Value                                     1790-1810

2020 Year End Fair Value                                       1870-1890         
                       

Percentage Cash in Our Portfolios

Dividend Growth Portfolio                           48%
            High Yield Portfolio                                     50%
            Aggressive Growth Portfolio                        54%

Economics/Politics
           
The economic dataflow continues to come in better (less bad) than consensus, meaning that while the US is in a recession [a] the worst is probably behind us and [b] it was likely not as deep and will not be as long as originally anticipated.  That said, there are too many unknowns to make any semblance of a forecast.  In my opinion, the economy will be a question mark at best until there is some visibility to the magnitude and extent of a recovery as well as the impact that the virus/lockdown will have on American work, social and spending patterns.
               

The data (and primary indicators) this week was upbeat again while the overseas stats were overwhelmingly positive.

Short term,  the economic recovery continues though the question of progress was raised this week as the second wave of coronavirus infections appear to be upon us albeit sooner than many anticipated.  How well it is contained will almost certainly affect the shape of the recovery (V, U, W, etc.).

 Longer term, the economic growth will be influenced by how quickly virus treatments and a vaccine are discovered as well as the permanent impact this disease/government reaction will have on the spending and work habits of the nation. 

Whatever the shape of the recovery, I am not altering my belief that long term economy will grow at a historically subpar secular rate due to the twin burdens of egregiously irresponsible fiscal and monetary policies---which, by the way, are becoming even more egregiously irresponsible as a result of measures being taken by the government and the Fed in dealing with the current crisis.
                       

The Market-Disciplined Investing
           
  Technical

The Averages  (25015, 3009) got beaten like a rented mule yesterday on elevated volume and horrible breadth.  Plus (1) the S&P closed below its 200 DMA; now support.  If it remains there through the close next Wednesday, it will revert to resistance and put it back in sync with the Dow [i.e. acting as resistance], (2) both indices are in very short term downtrends and (3) they still have those ‘island tops’ weighing on them. There was one potential bright spot---the VIX’s pin action was quite subdued for such a big down day, suggesting that investors may be less alarmed than stocks indicate.

Hence, the short term the technical picture has gotten shakier.  Nonetheless, I am sticking with my assumption that the Market’s bias is to the upside---at least until/unless the Averages revert their DMA’s to resistance.

Gold jumped back to the level of Tuesday’s seven year high which was clearly a positive.  The long bond was also strong, greatly improving its short term technical picture.  The dollar was also up again, but only fractionally so.  It was unable to make a second higher high.  Higher gold and bond prices and a lower dollar suggest a weakening economy.

                 Friday in the charts.

Fundamental-A Dividend Growth Investment Strategy

The DJIA and the S&P are 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 recent data clearly shows that  a bounce off of a recessionary low is occurring---which is clearly a plus.  However, there are negatives to temper our optimism [a] the collapse in economic activity has been so pronounced that any recovery will have to be significant just to regain the prior level of economic activity, [b] a second wave of the virus appears to be up on us; the question is, how much will it impact the current rebound.  The good news is that we will know the answer reasonably soon, [c] we have no idea about either the ultimate magnitude of the economic consequences of the government/Fed’s actions to combat the virus in terms of lost wages, sales and profits or how much this whole coronavirus affair will alter Americans’ long term living/spending habits.  In short, the economy may have seen the worst but we have idea about what is to come.                    

More coronavirus data.

In my opinion, those factors will also ultimately play a key role in determining the Market’s Fair Value [as determined by my Valuation Model].  But, as I noted above, there remains so much about them that we simply do not know; so, any attempt to determine Fair Value would of necessity be by the WAG [wild ass guess] method.  In the meantime, investors are pricing many equities near the same valuations of pre-coronavirus, pre-US/Chinese trade tensions and pre-riots levels.  That seems  overly optimistic to me.

There are two other factors to consider. 

[a] short term, US relations with China remain tenuous.  The risk here, of course, is a major schism {or worse}with a huge trading partner which would certainly be a negative for the economy and potentially the Markets.,

[b] longer term, with all the spending to offset the results of a national lockdown {and it seems likely that yet another stimulus bill will be enacted}, the budget deficit/national debt has gotten out of hand.  As you know, I believe that once the national debt reaches a certain size relative to GDP {the US, the EU and Japan are already there}, the debt has a stifling effect on economic growth.  Even under the current best case {‘V’ shaped} recovery scenario, that extra debt will still be there, usurping capital from the private sector and inhibiting its growth and profitability.  I believe that the resulting stunted economic growth will ultimately work its way into equity valuations.

(2)   QEInfinity/Forever.  That was helped along this week by the FDIC loosening the restrictions of Volcker Rule, the net effect of which was to allow banks to increase the leverage on their capital---just what this asset price bubble needs.  The good news is that the Fed imposed restrictions on stock buybacks and dividends for at least the third quarter [for all the good that will do].

As you know, I believe that massive injections of liquidity by the global central banks’ QEInfinity policies have done little to spur economic growth and, indeed, have inhibited it by destroying the functionality of the pricing of risk and the efficient allocation of capital; and that there will be an ultimate price to pay both for the economy and the securities markets. 

That said, throughout the entire QEInfinity experiment, investors have shown a complete disregard for its consequences and instead have used the increased liquidity to bid up asset prices to grossly inflated valuations.  Until that changes, the bias in stock prices will remain to the upside.


Bottom line:  I believe that the Averages and most segments of the Market are overvalued [as determined by my Valuation Model].  This is not a time to be buying equities.
                       
            Nonetheless, there are certain segments of the Market that have been punished severely  with the stocks of the companies serving those industries down 30-70%.  As a result, I will be putting cash to work in these beaten up stocks on any Market decline. 
       
As a reminder, my Portfolio’s cash position did not 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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