12/10/16
Statistical
Summary
Current Economic Forecast
2016 estimates
Real
Growth in Gross Domestic Product -1.25-+0.5%
Inflation
(revised) 0.5-1.5%
Corporate
Profits (revised) -15-0%
2017 estimates
Real
Growth in Gross Domestic Product +1.0-2.5%
Inflation +1.0-2.0%
Corporate
Profits +5-10%
Current Market Forecast
Dow
Jones Industrial Average
Current Trend (revised):
Short
Term Uptrend 18150-21200
Intermediate Term Uptrend 11613-24463
Long Term Uptrend 5675-20165
2016 Year End Fair Value
12600-12800
2017 Year End Fair Value
13100-13300
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Uptrend 2118-2462
Intermediate
Term Uptrend 2000-2602
Long Term Uptrend 881-2419
2016 Year End Fair Value
1560-1580
2017
Year End Fair Value 1620-1640
Percentage
Cash in Our Portfolios
Dividend Growth
Portfolio 55%
High
Yield Portfolio 54%
Aggressive
Growth Portfolio 55%
Economics/Politics
The Trump
economy will likely provide am upward bias to equity valuations. This
week’s data was neutral: above
estimates: weekly purchase applications, December consumer sentiment, October
wholesale inventories/sales, the November Markit services PMI, the November ISM
nonmanufacturing index,; below estimates: weekly mortgage applications, month
to date retail chain store sales, weekly jobless claims, revised third quarter
nonfarm productivity and unit labor costs, the October trade deficit; in line
with estimates: October factory orders.
The primary
indicators were a slight negative: third quarter nonfarm productivity and unit
labor costs (-), October factory orders (0).
One more datapoint: the growth in consumer credit slowed noticeably.
Despite
the even split in the overall stats, the productivity and consumer credit
numbers weigh to the negative. Hence, I
am scoring it a slightly downbeat week. The
score is now: in the last 62 weeks, twenty-one were positive, thirty-seven
negative and four neutral.
Overseas, the
data was mixed but other factors should have a negative impact: the problems
with bailing out Monte Paschi, the British parliament’s vote to proceed with
the Brexit, China’s ongoing battle to keep the yuan from declining and the potential
for increased global economic turmoil due to a change in US trade policy. So our global ‘muddle through’ forecast
remains intact.
Other factors
figuring into the global outlook:
(1) Russia
said that it would back the OPEC production cut; but nothing official happens
until next week. Then we will see the
whites of their eyes. That said, Putin
lies, everyone cheats and US frackers are said to be gearing up to increase
production. I don’t see a production cut having a lasting positive impact on oil
prices even if OPEC approves it,
(2) Friday’s
ECB’s announcement that it will begin tapering its bond buying program. More monetary tightening? Perhaps not.
It is wrapped in so many caveats, its implementation is questionable,
especially in light of the fact that there are still a lot of sick puppies in
the EU banking system which will likely require aid from the ECB.
(3) the
Donald’s trade policy. All we have so
far is words. But if he does what he
says that he is going to do, it could have a negative impact on global trade
which already has a problem in the form of a soaring dollar and a depreciating
yuan.
In summary, this
week’s US economic stats were slightly negative, though I think that the data
flow has less relevance at the moment than it will be when it starts to reflect
the likely coming changes in fiscal/regulatory policies---but we may not know
that for a year. Nevertheless, if the
current Market euphoria in any way anticipates a rise in consumer and business
sentiment (spending/investment), then we could see the numbers start to improve
as early as next month. For the moment,
I am revising our short term forecast but will wait until we see any concrete
changes in the Trump/GOP fiscal agenda before altering the long term secular
economic growth rate in our Models.
Our (new and
improved) forecast:
a possible pick
up in the long term secular economic growth rate based on lower taxes, less
government regulation and an increase in capital investment resulting from a
more confident business community.
However, there are still a number of potential negative unknowns
including a more restrictive trade policy, a possible dramatic increase in the
federal budget deficit, a Fed with a proven record of failure and even whether
or not the aforementioned tax and regulatory reforms can be enacted.
It is important
to note that this change in our forecast is all ‘on the come’ and hence made
with a good deal less confidence than normal.
Nonetheless, I have made an initial attempt to quantify this amended
outlook with the caveat that it will almost surely be revised.
Bottom line: the
stats over the last month or so have reflected more of a mixed picture than
purely a negative one. It is still too early to say that this reflects an improving
economy but the odds grow with each passing week. That said, the more important factors are (1)
an upturn in sentiment which itself could be a spur to growth and (2) the likely
net positive impact of the Trump fiscal/regulatory policies. Unfortunately, I have no idea how much until
we see exactly what is enacted.
The problems of
an irresponsible monetary policy and global economic weakness remain.
The
negatives:
(1)
a vulnerable global banking system. This week:
[a] Italians
voted down the constitutional referendum but too little fanfare. More importantly, the primary concern of the
‘no’ vote, a potential crisis in that country’s banking system, received a much
needed boost when the Italian government said that it would inject E2 billion
into Monte Paschi, its weakest bank. The
problem is that how that is done because many of the obvious alternatives
violate EU rules. Moreover, it has reached the point where the can can’t be
kicked down the road any longer. I think
a decision likely in the very near term; and whatever it is, there are likely
to be ripples. Meanwhile, Fitch
cut its outlook for Italian banks,
[b] the European Commission fined three major banks,
one of which is JP Morgan, E485 million for a Euribor rate price fixing scheme,
The point here is that while the US banks have
improved their balance sheets and gotten out of more risky businesses, the
global banking system in overleveraged and chocked full of nonperforming loans.
(2) fiscal/regulatory
policy. I continue to be hopeful that
this potential negative goes away, given the Donald’s campaign promises. And indeed, looking at his cabinet nominees,
policy seems to be headed in the direction of lower taxes and less
regulations. Further, one advisor said
this week that Trump was not going to tear up NAFTA. So far, so good.
Waiting for the
Trump fiscal stimulus (medium):
That said,
Trump went after Boeing this week over the price of the new Air Force One
contract. The question is, what does
this mean? On the negative side, it
suggests that deregulation may not be a broadly positive as many seem to
think. On the other hand, it may be just
a signal to all that the federal budget will be under close scrutiny for
wasteful spending. All we can do now is wait and see which Donald will stand
up. (must read):
(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 or is creating asset bubbles
in the stock market as well as in the auto, student and mortgage loan markets.
Two things to
comment on here: First, in speeches this week, several FOMC members stated that
the rate of monetary normalization would depend on fiscal policy; thus grasping
at the notion that somehow the Fed’s policies [QE, ZIRP] have made a big
difference in pulling the US out of the financial crisis. As you know, I give the Fed credit for the
work that QEI did in stabilizing the economy.
But the rest was worse than useless, doing little to benefit the economy
and serving only to create one of the greatest asset mispricing and
misallocation bubbles of my life time. The
aforementioned line of self-important thinking will likely mean that the Fed
will stay looser even longer and make the ultimate process of asset repricing and
reallocation even more painful than necessary.
This is the
best critique of the failure of QE I have ever read (a must read):
Second, this
week, the ECB announced that it would begin the tapering of its bond buying
program. As I said last week, I am a bit
surprised in that there are potential near term funding issues in both Italy
and Greece which would require ECB assistance.
To be sure, Draghi left plenty of wiggle room by including a handful of
caveats that would cause the ECB to cease and desist the tightening move. So much so that many are doubting that this
really is a tapering---the same old central bank song, bulls**t and do nothing.
(4) geopolitical
risks: Not much occurred in the Middle East this week, though Trump informed
the world that he was going to shake up foreign policy. In the campaign, he had sounded a bit dovish
in the sense that he wants the US less involved in regional conflicts. On the other hand this week, he nominated
three hard asses for national security positions and he poked his finger in
China’s eye by taking a call from the Taiwanese president [a no no in US China
policy].
Frankly, I am
not sure what this all means; but I do feel less easy about the potential for a
foreign policy crisis.
(5)
economic difficulties in Europe and around the globe. This week:
[a] November UK
industrial production was very disappointing while November German industrial orders
were excellent,
[b] November
Chinese trade figures improved, its foreign exchange reserves fell for the
fifth straight month and PPI and CPI were hotter than expected,
[c] revised
third quarter Japanese GDP was much lower than originally reported.
Other
factors bearing on that state of the global economy include:
[a] the
potential difficulties with rescuing Italy’s third largest bank and the
consequences of whatever occurs,
[b] the
likelihood of success of the OPEC production cut {slim to none},
[c] the
British parliament’s decision to proceed with Brexit {effects unknown, the
political hysteria aside}.
[d]
China continues to battle a declining yuan.
The importance is that its net impact is a tightening in the global
money supply.
Another
week of mixed stats. In addition, the
four ‘other’ factors are on balance negative.
Certainly, there is nothing to suggest anything other than a ‘muddle
through’ scenario at best.
Bottom
line: the US economic stats were slightly
disappointing this week, while the global economic numbers were once again in
no man’s land. That said, both the US
and global economies may be about to change, perhaps dramatically---which would
make the current dataflow less relevant.
If the stars align, the US will be getting an injection of fiscal
stimulus in early 2017, which offers promise of not only better data but a
normalization of Fed monetary policy (and a December rate hike). Not just that,
there has been a huge increase in sentiment as a result of the foregoing which
itself could propel a pickup in economic activity. Hence,
my new (tentative) forecast.
A
counterproductive central bank monetary policy is the biggest economic risk to
our forecast; although, it is still unclear how much fiscal stimulus will be
forthcoming.
This week’s
data:
(1)
housing: weekly mortgage applications fell while
purchase applications rose,
(2)
consumer: month to date retail chain store sales grew
much slower than in the prior week, weekly jobless claims fell less than
consensus; December consumer sentiment was well ahead of estimates,
(3)
industry: the November Markit services PMI and the
November ISM nonmanufacturing index were better than expected; October factory
orders were in line; October wholesale inventories were off, but sales rose
dramatically,
(4)
macroeconomic: revised third quarter productivity was
lower than anticipated while unit labor costs were higher; the October trade
deficit was larger than forecast.
The
Market-Disciplined Investing
Technical
The indices
(DJIA 19756, S&P 2259) continued their relentless upward momentum on huge
volume. Breadth strengthened and remains
in grossly overbought territory. The
VIX (11.8) got whacked by 7%, remaining below its 200 day moving average (now
resistance) below its 100 day moving average (now resistance) and within a
short term downtrend. It is near the
lower boundaries of its intermediate term trading range (10.3) and long term
trading range (9.8). These boundaries
were set back in 2006.
The Dow ended
[a] above on its 100 day moving average, now support, [b] above its 200 day
moving average, now support, [c] in a short term uptrend {18150-20200}, [c] in
an intermediate term uptrend {11613-24463} and [d] in a long term uptrend {5675-20165}.
The S&P
finished [a] above its 100 day moving average , now support, [b] above its 200
day moving average, now support, [c] within a short term uptrend {2118-2462},
[d] in an intermediate uptrend {2000-2602} and [e] in a long term uptrend {881-2419}.
The long
Treasury (117.5) fell another 1 1/4 %, closing below its 100 day moving average
(now resistance), below its 200 day moving average (now resistance), below a
key Fibonacci level and in a very short term downtrend. It appears that the question, ‘will it challenge
the lower boundary of its short term trading range (117.3) and the lower boundary
of its intermediate term trading range (115.3) or is it attempting to build a
base’, is at a critical point of being answered.
GLD (110) fell, ending
below its 100 day moving average (now resistance), below its 200 day moving
average (now resistance), below the lower boundary of its short term downtrend
and back below at a key Fibonacci level.
The question of its attempting to stabilize is closer to being answered
than TLT. There is almost no support
between current price levels and the lower level of its intermediate term
trading range (100).
The dollar jumped
back above the upper boundary of its short term trading range (for the third
time). If it remains there through the
close next Tuesday, it will reset to an uptrend. Given its two prior failures, it needs strong
follow through to be convincing near term.
Bottom line: the
upside momentum continues, driven by a lot of institutional investors being
underinvested and all investors being unwilling to sell until next year because
of the anticipated changes in the tax code.
The result is incredible volume and very strong breadth. Whether or not these conditions will last
long enough for the indices to challenge the upper boundaries of their long
term uptrends is the question. If they
do, I still believe that those challenges will be unsuccessful.
I had wondered
out loud earlier in the week whether TLT, GLD and the dollar were attempting to
stabilize after some big moves.
Yesterday, they appeared to regain momentum in the original direction
(down for TLT and GLD, up for UUP). If
this continues, it suggests problems for corporate profits (higher dollar,
higher interest rates) and the Market (higher interest rates)
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (19756)
finished this week about 55.5% above Fair Value (12700) while the S&P (2259)
closed 43.8% overvalued (1570). ‘Fair
Value’ will likely be changing based on a new set of fiscal/regulatory policies
which will lead to an as yet undetermined improvement in the historically low
long term secular growth rate of the economy but will still reflect the
elements of a botched Fed transition from easy to tight money and a ‘muddle
through’ scenario in Europe, Japan and China.
This week’s US economic
data was negative while the global stats were again mixed. But they are both secondary considerations as
we try to figure out what a Trump presidency/GOP sweep means for the economy
and the Markets.
Speaking of
which, you would think that as time passed, we would receive more information
and begin to develop a better sense of what the economy will look like a year
from now. We know, of course, what the
Donald/GOP promised in the campaign; most of which is a plus for the
economy. But since the election, Trump
has gotten involved with the operations of both Carrier and Boeing, suggesting
that deregulation may not be as encompassing as many assumed. In addition, while he was critical of foreign
involvements (a plus in my opinion) in the campaign, his national security
appointments and actions toward China seem a good deal more aggressive. The point here is not to criticize his
actions/statements but to point out that they don’t reflect some of his
campaign rhetoric and, therefore, rather than there being more certainty with
respect to the policies of a Trump administration, there is less.
The Market could
apparently care less about this at the moment and is ignoring the potential for
Market moving surprises in the near future. While I doubt that this willful disregard will
last, there is still the problem of quantifying the uncertainty surrounding
these elements of change---which is clearly a determinant of Fair Value. To be sure many of these shifts in policy
will have a positive impact. However, I
am less sure about what deregulation means as well as the outcome of altered
trade relations and a big increase in deficit spending. So while I wait for clarity in order to attempt
to quantify these changes, I have to settle for a qualitative statement that I
believe that the net effect will be positive.
‘That said, aside from the aforementioned
uncertain economic effects, valuation continues to be a major problem because:
(1)
at this
point, the Market is seemingly only
focused on the positive results,
(2)
while I think it reasonable to assume that the
rate of corporate profit growth could pick up, that is not a forgone conclusion
because earnings expansion will likely be hampered by the negative elements,
among which are rising interest rates, rising labor costs, adverse currency
translation costs, rising trade barriers and a slowdown in corporate buybacks,
(3)
the P/E at
which those earnings are valued will be adversely impacted by higher interest
rates,
(4)
the current
assumptions in our Valuation Model are for a better secular economic and
corporate profit growth rate than has actually occurred. So any pickup in the
‘E’ of P/E is at least partially reflected already in our Year End Fair Values,
(5)
finally, the
Market’s problem right now is the absence of real price discovery, i.e. asset
mispricing and misallocation, brought on by a totally irresponsible monetary
policy. One of the major things a stronger fiscal policy will do is allow the
Fed to normalize monetary policy, i.e. raise rates and sell the trillions of
dollars of bonds on its balance sheet. In other words, start unwinding asset
mispricing and misallocation. Plus the
unwinding of QE appears to be happening in China and Europe which could likely
speed up the whole process. Once real
price discovery returns, I believe it will not be favorable to stock prices.’
Net, net, my
biggest concern for the Market is the unwinding of the gross mispricing and
misallocation of assets caused by the Fed’s (and the rest of the world’s
central banks) wildly unsuccessful, experimental QE policy. In addition, while I am positive about the
potential changes coming in fiscal/regulatory policy, I caution investors not
to get too jiggy with any accompanying acceleration in economic growth and
corporate profitability until we have a better idea of what, when and how new
policies will be implemented.
Bottom line: the
assumptions in our Economic Model are likely changing. They may very well improve as we learn about
the new fiscal policies and their magnitude.
However, unless they lead to explosive growth, then Street models will
undoubtedly remain well ahead of our own which means that ultimately they will have
to take their consensus Fair Value down for equities.
Our Valuation
Model will also change if I raise our long term secular growth rate
assumption. This would, in turn, lift
the ‘E’ component of Valuations; but there is an equally good probability that
this could be offset by a lower discount factor brought on by higher interest
rates/inflation and/or the reversal of seven years of asset mispricing and
misallocation.
As a long term investor, I
would use the current price strength to sell a portion of your winners and all
of your losers. If I were a trader, I would
consider buying a Market ETF (VIG, VYM), using a very tight stop.
DJIA S&P
Current 2016 Year End Fair Value*
12700 1570
Fair Value as of 12/31/16 12700
1570
Close this week 19756 2259
Over Valuation vs. 12/31 Close
5% overvalued 13335 1648
10%
overvalued 13970 1727
15%
overvalued 14604 1805
20%
overvalued 15240 1884
25%
overvalued 15875 1962
30%
overvalued 16510 2041
35%
overvalued 17145 2119
40%
overvalued 17780 2198
45%
overvalued 18415 2276
50%
overvalued 19050 2355
55%overvalued 19685 2433
60%overvalued 20320 2512
Under Valuation vs. 12/31 Close
5%
undervalued 12065
1491
10%undervalued 11430 1413
15%undervalued 10795 1334
* 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.
Steve Cook received his education
in investments from Harvard, where he earned an MBA, New York University, where
he did post graduate work in economics and financial analysis and the CFA
Institute, where he earned the Chartered Financial Analysts designation in
1973. His 47 years of investment
experience includes institutional portfolio management at Scudder. Stevens and
Clark and Bear Stearns, managing a risk arbitrage hedge fund and an investment
banking boutique specializing in funding second stage private companies. Through his involvement with Strategic Stock
Investments, Steve hopes that his experience can help other investors build
their wealth while avoiding tough lessons that he learned the 74hard way.
