1/5/19
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%
2019
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 Trading Range 21691-26646
Intermediate Term Uptrend 13966-30174
Long Term Uptrend
6585-29947
2018 Year End Fair Value
13800-14000
2019 Year End Fair Value
14500-14700
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Downtrend 2408-2642
Intermediate
Term Uptrend 1338-3148 Long Term Uptrend 913-3073
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%
Economics/Politics
The Trump
economy is a neutral for equity valuations. The
data flow this week was mixed: above estimates: month to date retail chain
store sales, the December ADP private payroll report, the December employment
report, the December services PMI; below estimates: weekly mortgage and
purchase applications, weekly jobless claims, the December ISM manufacturing index,
December Dallas Fed manufacturing index; in line with estimates: the December
manufacturing PMI.
Update on big
four economic indicators.
There was only one
primary indicator: the December jobs report (+). Though like last week, another important stat
wasn’t reported (November construction spending) due to the government shutdown. Even though the construction number would
likely have been negative, I am still going to give this week a tentative positive
rating. Score: in the last 169 weeks,
fifty-five were positive, seventy-five negative and thirty-nine neutral.
The data from
overseas was not good at all, much of the poor numbers being attributed to the
US/China trade dispute. Not helping is the
ongoing turmoil over Brexit and the ECB taking administrative control of an
Italian bank.
There were three
big developments on Friday (at least in stock land). First, the jobs report showed exceptionally
strong employment growth. The knee jerk
reaction apparently was to think that all is well in the economy. But it is not, and the numbers show it. Remember that employment is a lagging
indicator. So, it is entirely possible
to see good job growth as the economy loses steam.
Second, the
US/China have agreed to vice-minister level trade talks beginning this coming
Monday. Certainly, getting back to the
negotiating table is a plus. But talking
is not doing. In my opinion, there is a
long hard fight ahead of us before China gives up IP theft. Assuredly, it needs to be done and when it is,
hallelujah. But there is much to trip
between the cup and the lip.
Finally, Fed
chair Powell made some dovish comments, the most important of which reversing
his prior statement that QT was on autopilot to ‘Markets, we are listening to
you’. (Just to remind you, it is the Fed’s
balance sheet unwind that is starting to cause liquidity problems in the
Markets.) In short, he seems to have been reinstating the Greenspan/Bernanke/Yellen
Fed ‘put’. (Interestingly, he made those
comments while sitting with both Bernanke and Yellen.) Missed in what seems to have been a very
favorable equity market response to the ‘listening’ statement, was any
indication that QT was actually going to slow.
Indeed, Powell also said that ‘if’ the Fed thinks that there is a need
to slow its tightening (normalization) process, it would act---with no suggestion
that the ‘if’ circumstances were upon us.
You know my
sentiments on this issue. Sensitivity to
Market temperament is not part of the Fed mandate. Nor should it be. I don’t think that it is
clear that Powell is reestablishing the Fed ‘put’---at least, not yet. But if he is, then it will likely lead to another
leg up in the Market, but also blow an even bigger asset price bubble that
ultimately will get popped.
My forecast:
Less government
regulation, Trump mandated spending cuts, getting out of the Middle East quagmire
and possible help from a fairer trade regime are pluses for the long-term US
secular economic growth rate.
However, the
explosion in deficit spending, especially at a time when the government should
be running a surplus, is a secular negative.
My thesis on this issue is that at the current high level of national
debt, the cost of servicing the debt more than offsets (1) any stimulative
benefit of tax cuts and (2) the secular positives of less government regulation
and fairer trade [at least on the agreements that have been renegotiated].
On a cyclical
basis, the economic growth rate is slowing as the effects of the tax cut wear
off, the global economy decelerates and the unwind (?) of the Fed’s balance
sheet limits credit expansion.
The
negatives:
(1)
a vulnerable global banking [financial] system.
As
noted above, this week the ECB assumed administrative control of an Italian
bank. At the moment, this is a singular
event. However, I have persistently documented
the balance sheet weakness of the EU banks.
I am not forecasting any further contagion, but the odds of one have
almost surely increased.
(2)
fiscal/regulatory policy.
Trade remains the
most important near-term issue. The big development
this week was the announcement that US and Chinese trade officials will meet on
January 7/8. Clearly, the hope is that something meaningful
will come out of this gathering aside from the ‘everything is awesome’ commentary
that we have gotten out of the administration of late. But if Trump remains firm on his intent to
stop Chinese theft of intellectual property, I am not sure how much will be
accomplished, given that the Chinese have shown little inclination to accede to
that condition. I believe that it is too
soon to be tip toeing through the tulips.
However,
congress isn’t waiting.
The other trade
related events this week included [a] the lousy Chinese economic numbers [b] as
well as the surprise lower earnings guidance from Apple which management
attributed to China trade. This clearly doesn’t bode well for global growth
absent a fairer trade regime.
The other issue
is the government shutdown over funding of the border. To me, this is more of a political than an
economic matter. First of all, it is not
a total shutdown because much of the agency funding has already been done in
other bills. So, its economic impact will not be as significant as it would be
if the entire government were closed. Second, most of the funds not spent today
will spent anyway when the standoff is over.
So, on a longer-term basis, little economic damage will be done.
Unless you are
planning on getting that tax refund early.
Third, this
more about who has the biggest Johnson in DC than it is about budgetary concerns. The argument is over the difference between
$1.6 billion versus $5 billion funding for ‘the wall’ in a budget that is
running a trillion-dollar annual deficit.
That difference is a wart on a goat’s ass in the scheme of things. Certainly, if this goes on for an extended
time, some economic harm will occur. But
our political class watches the polls devotedly; so, my guess is that when it
becomes clear who masses are blaming for the shutdown, a compromise will be
sought.
I will spare you my usual rant about the weakening effects
of an outsized federal debt/deficit on the economy.
(3)
the potential negative impact of central bank money
printing: The key point here is that [a] the Fed has inflated bank reserves far
beyond any comparable level in history and [b] while this hasn’t been an
economic problem to date, {i} it still has to withdraw all those reserves from
the system without creating any disruptions---a task that I regularly point out
it has proven inept at in the past and {ii} it has created asset bubbles in the stock market as well as
in the auto, student and mortgage loan markets.
Two newsworthy
items this week. First, Trump began backing
off of his criticism of Powell. That likely
will have little impact on the economy but is a plus for investors
psychology. How long that lasts is
anyone’s guess.
Second,
Powell spoke at a forum at which both Yellen and Bernanke were in attendance. His comments included [a] the economy
continues to grow, [b] employment is expanding, [c] inflation is under control,
[d] Fed policy, i.e. rate hikes and QT, is data dependent and it will adjust
policy {including the unwind of its balance sheet} accordingly and [d] most
important, the Fed is ‘listening to the Markets’---apparently meaning that the ‘data
dependence’ of the Fed includes responding to an investor hissy fit.
You know my
bottom line on this issue: as long as the Fed continues a QT policy, liquidity
shrinks creating credit funding problems and putting downward pressure on asset
prices. But if Fed policy has returned
to being a hostage of the Market, then the current asset price adjustment may
be over. I continue to believe that
whether the Fed is blowing bubbles or not, QE will not be impactful on the
economy.
(4) geopolitical
risks:
While the EU/Italians
seemed to have worked a solution to Italy’s budget issue, the ECB’s assumption
of control over an Italian bank could be disruptive to the completion of an
agreement on the budget.
The Brits still
can’t figure out how to implement a Brexit and that is causing heartburn in the
UK.
US withdrawal from Syria and Afghanistan
will almost surely have some effects on Middle East politics and the fight
against terror. As you know, I think
that we should wall the whole region off and let them keep killing each other
until no one’s left or they figure out that is not a good strategy. Getting our own troops out may be the next
best thing: it will save the lives and money: [a] if the US had all the money
that it has spent in the Middle East for meager if any long-term benefit, how
much better off would our fiscal situation be and how many young men would still
be alive? [b] why are we involved in an
internecine Arab food fight? We don’t
need their oil. What else do they have
to offer us or the rest of the world?
Dates?
(5)
economic difficulties around the globe. The stats this week were quite negative:
[a] the December EU manufacturing PMI was in line, though
the composite PMI was below estimates,
[b] the December Chinese manufacturing, the Caixin and
the Taiwan PMI’s fell into contraction territory; the December Chinese services
and composite PMI’s were better than anticipated; November Chinese industrial
profits fell 1.8%,
[c] the December Japanese manufacturing PMI was above
estimates,
[d] the J.P. Morgan global manufacturing PMI hit the lowest
level since 2016.
Bottom
line: on a secular basis, the US economy
is growing at an historically below average rate although I assume decreased regulation,
the successful completion of the NAFTA 2.0 agreement and Trump’s spending cuts
(assuming implementation) will improve that rate somewhat. The long term positive potential from an
altered Chinese industrial policy would have a meaningful effect on the US long
term secular growth rate.
However,
these possible long term positives are being offset by a totally irresponsible
fiscal policy. Until evidence proves
otherwise, my thesis is that cost of servicing the current level of the
national debt and budget deficit is simply too high to allow any meaningful
pick up in the US’s long-term secular economic growth even with improvement
from deregulation or the current trade regime (a caveat being if China does
change its industrial policy).
Cyclically, the
US economy is once again slowing. Though (1) removing the uncertainty of no
NAFTA treaty helps return economic conditions within the three countries to what
they were before, (2) increase in Chinese purchases of soybeans and oil and the
lower tariffs on autos and (3) a slowdown in the rise of short-term interest
rates will help keep the slowdown under control. On the other hand, a weakening global economy
points to slower growth. As a result of
these factors, my guess is that my initial US 2019 economic growth rate
assumption will likely change as their impact becomes more apparent.
Finally, any move to a more dovish
stance by the Fed is not likely to have an impact, cyclical or secular, on the
economy. QE II, III, and Operation Twist
didn’t, and QE IV probably won’t either.
The Market-Disciplined
Investing
Technical
The Averages
(DJIA 23433, S&P 2531) staged a powerful rally on Friday on good news on
multiple front. Still both indices finished
below both moving averages. The Dow
finished in a very short-term downtrend and a short-term trading range. The S&P
is in a short-term downtrend but negated (again) its very short-term downtrend.
So longer term, there remains a lot of work to be done to re-establish an uptrend.
On the other hand, the indices failed to
challenge their December lows and managed to mark both a higher low and a
higher high. That suggests more follow
through to the upside, at least, near term.
Volume was up;
breadth positive. But neither were impressive
given the price action.
The VIX fell 16%,
but still ended above both moving averages and in very short-term and
short-term uptrends. So, its chart
remains strong which is bad on stocks.
The long bond gave
up all of Thursday’s gain but on much less volume. It closed above its 100 DMA (now support),
above its 200 DMA (now support) and in short and intermediate-term trading
ranges and in a very short-term uptrend. Nothing here to suggest rates aren’t going to continue
to fall.
And:
China’s shrinking
trade surplus will have a negative impact on global interest rates and
liquidity.
The dollar fell four
cents, but remained above both MA’s, in a short-term uptrend and within the mid-November
to present consolidation range. It was a bit usual for the dollar to be down so
little on a huge risk-on day.
GLD move down ¾ %
but still closed above both MA’s, within a very short-term uptrend and within a
short-term trading range.
Bottom line: so much for losing upside
velocity. With Friday’s monster advance,
the trend question was turned on its head---instead of watching for follow
through to the downside, we now wait to see how much follow through there is to
the upside. Further, with the indices
having made a new higher low and higher high, they are now developing a very short-term
uptrend---implying more upside, at least, in the very short term.
While equity
investors clearly got jiggy over a change in the economic outlook, others
apparently need a bit more persuading:
The long bond investors reacted as you might
expect to the very positive jobs number (stronger economy = higher rates) and
Powell’s more dovish tone (more accommodative Fed = less chance of a credit
crisis). Still the yield curve remains
bent out of shape. Like equities, watch
the follow through.
The
dollar gave up just a tad of its ‘safety trade’ status; but not enough to be convincing. The same with GLD.
Friday
in the charts.
Fundamental-A Dividend Growth
Investment Strategy
The DJIA and the
S&P are still well above ‘Fair Value’ (as calculated by our Valuation
Model), the improved regulatory environment and the potential pluses from trade
and spending cuts notwithstanding. 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. US economic activity is slowing, the strong
jobs number notwithstanding; and the rest of the globe is slowing even faster
than I, and most others, expected.
It is
certainly possible, even probable, that the US can continue to grow as the rest
of the world slows. But declining global
growth will still act as a drag on any improvement in earnings. Certainly, that was the message from Apple
this week.
My
thesis is that, a trade war aside, the financing burden now posed by the
massive [and growing] US deficit and debt is offsetting the positive effects of
deregulation and fairer trade and will continue to constrain economic as well
as profitability growth.
In
short, the economy is not a negative [yet] but it is not a positive at current
valuation levels.
(2)
the success of current trade negotiations. If Trump is able to create a fairer political/trade
regime, it would almost surely be a plus for secular earnings growth. Having whiffed on NAFTA 2.0, the prospect of a
meaningful change in the trade regime with China seems questionable. But if it happens, it would be a major
positive. We should get some kind of read
on progress following the January 7/8 trade meeting.
(3)
the rate at which the global central banks unwind
QE. The most disappointing economic news
this week was Powell’s comments that suggested that the Fed was ‘listening to
the Markets’ and would adjust policy accordingly---which is much like me saying
that I will listen to my four-year-old granddaughter’s hissy fit and adjust my
actions accordingly. This kind of groveling
before the Markets is what has been blowing financial bubbles since Greenspan
initiated the Fed ‘put’. However, ultimately,
I believe that there will be a heavy price to pay for excess levels of debt,
the financing of unproductive projects and lending to the those not creditworthy.
That
said, until that bubble is ultimately burst, the equity Markets are likely going
to prosper. If Powell has reinstated the
Fed ‘put’, it will become a significant factor in Market pricing just like it
has been for the last five to six years.
Though to be clear, I think that there was enough ambiguity in his
comments to question whether that has occurred.
I remain
convinced that [a] QE has done and will continue to do harm in terms of the
mispricing and misallocation of assets, [b] sooner or later that mispricing/misallocation
will be reversed and [c] given the fact that the Markets were the prime beneficiaries
of QE, they will be the ones that take the pain of its demise.
On final
observation, when Volcker took over the Fed, his task was to reverse the irresponsible
monetary policies of the prior regime.
Back then, the easy money had been used by participants to buy goods and
services---driving up inflation which created a hue and cry from the electorate
to which the ruling class had to respond.
In this
round of Fed mismanagement, the easy money has been used to buy
assets---leading to the mispricing and misallocation of assets. Since those economic consequences are less
visible to the electorate than inflation, QE can go on placating the Markets until
something goes wrong in the economy and the electorate again raises a hue and
cry---and the ruling class will have to respond. What might it be? Inflation, again? No clue.
But I believe that it is inevitable.
(4)
current valuations. The recent sell off has begun to
rationalize valuations in some Market sectors, offering buying
opportunities. And given the very recent
pin action, investors may have decided to taking advantage of those opportunities.
Still equity prices as defined by the major Averages remain very overvalued.
Bottom line: a
new regulatory regime plus an improvement in our trade policies along with
proposed spending cuts should have a positive impact on secular growth and,
hence, equity valuations. Plus, if the
Fed ‘put’ has returned that is likely to have a positive impact of stock prices. On the other hand, I believe that overall fiscal
policy (growing deficits/debt) will hamper economic and profit growth, restraining
the E in P/E.
The math in our
Valuation Model is getting more reasonable.
While the indices and some sectors of the Market remain overpriced,
other sectors have been beaten like a rented mule. As you know, I am focusing on that set of
companies as potential buy candidates.
Quality companies whose stocks are down 50% or more should be bought.
That said, I
believe that there is more pain to come; so, my purchases, for the moment, will
be small. Still this situation is what I
designed my Valuation Model for---to buy low after having sold high.
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.
DJIA S&P
Current 2018 Year End Fair Value*
13860 1711
Fair Value as of 12/31/18 13860
1711
Close this week 23433
2531
* Just a reminder that the Year
End Fair Value number is based on the long term secular growth of the earning
power of productive capacity of the US economy not the near term cyclical influences. The model is now accounting for somewhat
below average secular growth for the next 3 to 5 years.
The Portfolios and Buy Lists are
up to date.
