4/22/17
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 19410-21635
Intermediate Term Uptrend 11963-24812
Long Term Uptrend 5751-23390
2016 Year End Fair Value
12600-12800
2017 Year End Fair Value
13100-13300
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Uptrend 2269-2602
Intermediate
Term Uptrend 2092-2696
Long Term Uptrend 905-2591
2016 Year End Fair Value
1560-1580
2017
Year End Fair Value 1620-1640
Percentage
Cash in Our Portfolios
Dividend Growth
Portfolio 57%
High
Yield Portfolio 54%
Aggressive
Growth Portfolio 55%
Economics/Politics
The Trump
economy is providing an upward bias to equity valuations. This
week’s data was negative in aggregate: above estimates: month to date retail
chain store sales, March existing home sales, March industrial production,
March leading economic indicators; below estimates: March housing starts, the
April housing market index, weekly mortgage and purchase applications, weekly
jobless claims, the April NY and Philly Fed manufacturing indices and the April
Markit flash manufacturing and services PMI’s; in line with estimates: none.
However, the primary indicators were upbeat: March
industrial production (+), March leading economic indicators (+), March
existing home sales (+) and March housing starts (-). Given this latter series of stats, I am going
to score this week as a positive: in the last 81 weeks, twenty-six were
positive, forty-four negative and eleven neutral.
As you know, I bought into the post-election-euphoria-stimulated-economy
thesis and raised our short term economic growth estimate slightly. And this week’s numbers keep that notion
alive---but just barely. However, as you
also know, I have not been particularly impressed with what positive dataflow
that we have received and that after the last four weeks of mediocre to poor
stats, I have been seriously considering reversing that growth forecast. I am still holding off doing that; though it remains
under serious consideration.
On the political
side, congress was on vacation but the Donald was one busy little beaver this
week, issuing multiple executive orders, calling for the studies of H1-B visas,
the potential damage from low priced steel imports, tax regulations and Dodd
Frank. Further, advisors were out in
force assuring voters that healthcare reform, tax reform, infrastructure
spending and an increased debt limit were on the way in short order.
If all that
happens, Nirvana can’t be too far behind.
If enacted, not only would it lessen my inclination to reverse the
aforementioned increase in the short term economic growth outlook but also likely
lead to a further rise in our long term secular economic growth rate
expectation---if (and this is a big if) the fiscal programs don’t lead to a meaningful
increase in the federal debt.
The troubles
with Syria and North Korea continued in the headlines this week. I expand on this below. But my conclusion is that I can’t imagine either
situation leading to anything more serious than threatening headlines. Still, we have to be open to the chance of
either or both of these situations going beyond a war of words.
Overseas, the
data this week was much better than the prior week. Plus a solution to the Greek debt crisis
seems to be close at hand. That keeps
alive the somewhat erratic improvement in the global economy and leaves open
the possibility of an upgrading of our ‘muddle through’ scenario. Nevertheless, I remain concerned about the worsening
liquidity in Italian banking system and the growing odds of an anti-EU
president being elected in France.
Bottom line: I
rates this week’s US economic stats as positive for the first time in four
weeks. Whether this is a one off
occurrence, a pause in the fading momentum from the Trump bliss or a sign of
its rebirth, we will just have to await further evidence. If it is the latter, then it is likely to get
a boost from this week’s potential developments in the fiscal arena. However, if it is a one off, short term that
could mean that I have to reverse the recent slight increase in our 2017 economic
growth forecast.
On the other
hand, based on Trump’s deregulation efforts and his more reasoned approach to
trade, I remain confident in my recent upgrading our long term secular growth
rate by 25 to 50 basis points. Clearly, if Trump/GOP manages to effect all
that was promised this week, then that forecast will get even better.
Our (new and
improved) forecast:
An undetermined
but positive pick up in the long term secular economic growth rate based on
less government regulation. This
increase in growth could be further augmented by pro-growth fiscal policies
including repeal of Obamacare, tax reform and infrastructure spending. On the other hand, it could prove detrimental
if the result is a dramatic increase in the federal budget deficit. However, it is far too soon to speculate on
any outcome.
Short term, the economy may be losing momentum
as the post-election Trump buzz wears off.
If that is the case, then our former recession/stagnation forecast would
likely reappear brought on by the current expansion dying of old age and/or the
unwinding of the mispricing and misallocation of assets wrought by another
instance of failed Fed monetary policy. Clearly that would all change if Trump/GOP
were to achieve its promised fiscal program without running up the federal
debt.
It is important
to note that this forecast is made with a good deal less confidence than normal;
so it carries the caveat that it will almost surely be revised.
The
negatives:
(1)
a vulnerable global banking system. Nothing new.
(2)
fiscal/regulatory policy. I continue to hope that the Donald’s new
policies will prove beneficial to the economy and I can eliminate this factor
as a negative.
Certainly, the regulatory element is unfolding as well
if not better than anyone could have imagined---though I think that this week’s
executive order to study the H1-B visa program has the potential to produce a
nonoptimal solution. The issue here is
whether [a] the US is limiting entry of high tech, highly skilled workers that
are needed help businesses grow or [b] US businesses are gaming the system and
bringing in workers who will fill current jobs but at a lower wage. We can only hope that the ‘studiers’ get the
right answer.
On the other
hand, other new executive orders [a] ordering the Commerce Department to study
the impact that large amounts of steel imports have on the US industrial base
and [b] directing Treasury to lower tax regulations and revaluate parts of Dodd
Frank, will likely prove beneficial to the economy.
In addition, the Donald’s actions with respect to
trade have been much less negative than I had feared. Supporting that point, after he opined last
week that the dollar was too strong [which I consider a misjudgment], Mnuchin
said this week that Trump definitely favored a strong dollar [remember the
analysis I linked to that showed a positive long term correlation between economic
growth and a strong dollar].
On the
other hand, Trump/GOP’s fiscal program is a mess---or at least has been a mess.
As you know, Thursday was a big day for fiscal chatter, with statements from
various participants suggesting that a compromise was on the way on healthcare
reform, a tax reform package would soon be presented [with no mention of
healthcare reform being a prerequisite], the government debt limit would be
raised and an infrastructure spending plan would soon be forthcoming.
I have
no clue how to assess the certainty of any of this. But I do think that this burst of activity
could well be related to the need to show major accomplishments ahead of the
upcoming end of Trump’s first 100 days. However, clearly, if they all occur, it
would lead to a further increase in our long term secular economic growth rate
assumption.
That
said, I continue to believe that ‘(1) is
not apt to have nearly as big an impact as many of the dreamweavers would hope
and (2) could get lost in the short term if the current economic expansion dies
of old age/or is put to death by the Fed.’
The
bottom line here is that (1) deregulation is lifting our economy’s long term
growth prospects, (2) announced trade positions are not the negative that I had
feared, (3) but the Trump/GOP election victory was not the magic elixir that
many seemed to believe, (3) however, I believe that they will still achieve
some form of tax reform and infrastructure spending legislation which will also
prove beneficial to the economy’s long term secular growth but (4) the
restraint on accomplishing aggressive tax and spending programs is not GOP
harmony but math.
(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.
Several Fed
members were on the stump this week---one approving the idea of shrinking the
Fed balance sheet, another saying that three rate hikes this year was a good
idea.
As you know, I
applaud both. My concern is not the damage
ending QE might do to the economy---QE did little to help it, so I don’t
imagine that its reversal will be that disruptive. But if the Market perceives that it is
stepping up the tightening process at the exact moment the economy is starting
to falter again and investors realize that the Fed has again stimulated too
much and deferred tightening for too long, the Markets which were the prime
beneficiaries of QE will become the victims of its reversal.
In the
meantime, other central banks have bought $1 trillion in assets in the first
four months of 2017 (short):
(4) geopolitical
risks: the troubles over Syria and North Korea were again in focus this week. The saber rattling continued in North Korea
[a] which fired off another missile [b] as the US has three carrier groups
steaming toward the Korean peninsula.
China continues to help. But when
you are dealing with at least one nut case, the risk of some untoward event
occurring is higher than normal.
In Syria,
things weren’t much better. Most of the
verbiage this week centered on the accuracy of the facts in Syrian government’s
the gas attacks on civilians. In the meantime, the risk of a faceoff with
Russia remains. To that end, US fighters
had to intercept Russian bombers twice as they approached Alaska.
(5)
economic difficulties in Europe and around the globe. This week, the global data flow improved:
[a] the April
EU flash composite PMI was up versus its March reading,
[b] first
quarter Chinese GDP as well as March retail sales and factory orders were
better than expected and March housing prices rose at a slower pace than in
February {remember these guys lie a lot},
[c] the
March Japanese trade surplus shrank to 14 month low.
In
related news, Greece achieved a 2016 budget surplus well above EU/IMF
requirements; in return the IMF has said that it would provide bail out money
for a year---at which time, it is hoped that the country will qualify for the
current ECB QE related bond purchases.
Finally,
France votes this weekend in its presidential election in which two of its
candidates want to exit the EU. While
there will likely be a runoff vote later, having one or both in the final vote
may induce investor heartburn [although I would note that the Street
expectations for the Brexit and Trump votes were for heartburn and look how
they turned out].
In sum, the
global economic stats were upbeat this week; plus Greece seems to be working
its way out of its financial mess, at least temporarily. On the other hand, the Italian banking system
is a train wreck and the French elections could result in a very disruptive
conclusion. I am still considering
altering our ‘muddle through’ scenario; just not quite yet.
Bottom
line: the recent trend in the post-election
sentiment inspired economic improvement got a boost from this week’s data after
having stalled in the prior four weeks. At
the moment, I am uncertain whether or not the post-election-sentiment-driven
pickup in economic activity is fading or not.
Though as in noted above, if Trump/GOP pulls off healthcare reform, tax
reform and infrastructure spending on a reasonable timely basis, I would
suspect that sentiment driven increases in business and consumer spending would
be positively affected; and more importantly, the long term secular economic
growth rate would also certainly rise---with the caveat that it doesn’t result
in a big increase in the national debt.
For the long
term, the Donald’s drive for deregulation and improved bureaucratic efficiency
is a decided plus; and as a result, I inched up my estimate of the long term
secular growth rate of the economy. In
addition, a more reasoned approach to trade appears to be emerging which would remove
a potential negative.
This week’s
data:
(1)
housing: March housing starts and building permits were
lower than consensus while March existing home sales were higher; the April
housing market index was below forecast; weekly mortgage and purchase applications
were down,
(2)
consumer: month to date retail chain store sales growth
improved from the prior week; weekly jobless claims rose more than anticipated,
(3)
industry: March industrial production was above
expectations; the April NY and Philadelphia Fed manufacturing indices were
disappointing; the March Markit flash manufacturing and services PMI’s were
below projections,
(4)
macroeconomic: the March leading economic indicators
were better than consensus.
The
Market-Disciplined Investing
Technical
The indices
(DJIA 20547, S&P 2348) couldn’t generate any follow through to Thursday’s
Titan III shot. Volume rose, breadth
deteriorated. Both ended below the
upper boundaries of their very short term downtrends, the S&P having failed
at its second challenge of that boundary.
The VIX (14.6) was up 4 %, closing above the lower boundary of its very
short term uptrend, above its 100 day moving average (now support), above its
200 day moving average (now support) and in a short term trading range (it
closed above the upper boundary of its former short term downtrend).
The Dow closed
[a] above its 100 day moving average, now support, [b] above its 200 day moving
average, now support, [c] in a short term uptrend {19410-21635}, [c] in an
intermediate term uptrend {11963-24812} and [d] in a long term uptrend
{5751-23390}.
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 {2269-2602},
[d] in an intermediate uptrend {2092-2696} and [e] in a long term uptrend
{905-2591}.
The long
Treasury was unchanged, ending above its 100 day moving average (now support),
below its 200 day moving average (now resistance), in a very short term
downtrend and in a short term trading range.
GLD rose,
closing above its 100 day moving average (now support), above its 200 day
moving average (now support), in a very short term uptrend and right on the
upper boundary of its short term downtrend.
The dollar rose
fractionally, ending above its 100 day moving average (now support), below its
200 day moving averages (now resistance), below the upper boundary of its very
short term downtrend and in a short term uptrend.
Oil was spanked
once again.
Bottom line: the
dreamweavers couldn’t hold on to that feeling of euphoria, again. Not to try to hold on to an old thesis, but
this week’s trading pattern was similar to what was already occurring but with
the difference that instead of the price battle occurring intraday, it was
happening on sequential days, i.e. down day, then up day, then down day.
One
thing has changed; and that is that fundamentals are driving the price
action. Next week will almost surely be
the same with the completion of the first round of French elections and the
promised new and improved fiscal plans.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (20547)
finished this week about 59.5% above Fair Value (12823) while the S&P (2348)
closed 48.1% overvalued (1585). ‘Fair
Value’ will likely be changing based on a new set of fiscal/regulatory policies
which may lead to an as yet undetermined improvement in the historically low
long term secular growth rate of the economy; but it still reflects the
elements of a botched Fed transition from easy to tight money and a ‘muddle
through’ scenario in Europe, Japan and China.
I scored this
week’s US economic data as a plus. That supports my decision to raise our short
term growth forecast based on the thesis that the rise in post-election
sentiment would eventually be reflected in the hard data---which it did
initially and then faded. More recently,
the stats have been through a rocky period and I am not sure this week’s
results is anything other than a pause that refreshes. Meaning a reversal in our outlook is still on
the table---which would suggest a possible near term disappointment for the dreamweavers.
Of course, we just
got a new round of fiscal promises this week with regards to healthcare reform,
tax reform and dealing with current federal debt limit; and that accounted for at
least one day’s worth of positive pin action.
If they occur as presented, then they would almost surely revive/keep
alive the positive post-election Market sentiment and its likely constructive
impact on the economy. If not and the
numbers keep disappointing, then the probabilities remain that I will have to
reverse the recent short term increase in economic growth.
On a long term
basis, I feel like I am on firmer ground modestly raising the secular economic
growth rate in our Models based on Trump’s good work at deregulation and the move
toward a more free trade posture. In
addition, if Trump/GOP can successfully enact a fiscal program, I will likely
raise the secular growth rate assumption again; although I have no thought on
the order of magnitude.
But remember, at
least as calculated by our Valuation Model, whatever effect these new programs
have on the secular growth trends, they won’t erase the current overvaluation
of equity prices---just make it a bit less so.
All that said, I have made it clear that based on the budget math, I
seriously doubt that the final product will be anywhere near as positive as
many on the Street believe.
Of course, you know that my negative outlook
for stocks has little to do with the progress or lack thereof for the economy/corporate
profits and is directly related to the irresponsibly aggressive global central
bank monetary policy which has led to the gross misallocation and mispricing of
assets.
As you also know, my thesis all along has been that since the
economy was little helped by QE/ZIRP, then it could do just fine in the face of
a reversal of those policies (again, just for clarity’s sake, the economy
can slow down due to old age and that would have nothing to do with unwinding
QE. The point being that the ending of
QE wouldn’t make the slowdown any worse). On the other hand, since the Markets were the
primary beneficiaries of Fed largesse, it would be they who suffered when the
Fed began to tighten.
Counterpoint:
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 encouraged about the changes already made in regulatory
policy as well as a more rational approach to trade, I am cautious that this
second round of fiscal reform promises are any more likely to be enacted than
the first. Remember we are talking about
politicians.
To be sure, if
the reforms are enacted as presented (operative words) and they don’t bust the
budget, they will have a positive impact on the long term secular growth rate
of the economy and equity valuations---just not of the magnitude hoped by many
on the Street. On the other hand, if they
fail to materialize it will likely have detrimental effect on Street economic,
corporate profits and Market expectations. Finally, whatever happens, stocks
are at or near historical extremes in valuation, even if the full Trump agenda
is enacted; and there is no reason to assume that mean reversion no longer
occurs.
Bottom line: the
assumptions in our Economic Model are beginning to improve as we learn about
the new regulatory policies and their magnitude. However, this week’s renewed promises
notwithstanding, fiscal policies remain an unknown as well as their timing and
magnitude. I continue to believe that
end results will be less than the current Street narrative suggests---which
means Street models will ultimately will have to lower their consensus of the Fair
Value for equities.
Our Valuation
Model assumptions are also changing as I raise our long term secular growth
rate estimate. This will, in turn, lift
the ‘E’ component of Valuations; but there is a decent probability that short
term this could be at least partially offset by the reversal of seven years of
asset mispricing and misallocation. In
any case, even with the improvement in our growth assumption the math in our
Valuation Model still shows that equities are way overpriced.
As a long term investor, with
equity valuations at historical highs, I would use the current price strength
to sell a portion of your winners and all of your losers.
DJIA S&P
Current 2017 Year End Fair Value*
13200 1630
Fair Value as of 4/30/17 12864
1590
Close this week 20578
2355
Over Valuation vs. 4/30 Close
5% overvalued 13507 1669
10%
overvalued 14150 1749
15%
overvalued 14793 1828
20%
overvalued 15436 1908
25%
overvalued 16080 1987
30%
overvalued 16723 2067
35%
overvalued 17366 2146
40%
overvalued 18009 2226
45%
overvalued 18652 2305
50%
overvalued 19296 2385
55%overvalued 19939 2464
60%overvalued 20582 2544
65%overvalued 21225 2623
Under Valuation vs. 4/30 Close
5%
undervalued 12220
1510
10%undervalued 11577 1431
15%undervalued 10934 1351
* 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 hard way.
