3/18/17
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 19082-21321
Intermediate Term Uptrend 11839-246697
Long Term Uptrend 5751-23298
2016 Year End Fair Value
12600-12800
2017 Year End Fair Value
13100-13300
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Uptrend 2231-2565
Intermediate
Term Uptrend 2069-2673
Long Term Uptrend 881-2561
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 will likely provide an upward bias to equity valuations. This
week’s data was heavily weighed to the plus side: above estimates: weekly mortgage and purchase
applications, February housing starts, the March housing market index, month to
date retail chain store sales, weekly jobless claims, March consumer sentiment,
the March NY and Philadelphia Feds’ manufacturing indices, the February small
business optimism index and the February leading economic indicators; below
estimates: February retail sales, February industrial production, January
business inventories/sales and February PPI; in line with estimates: February
CPI.
However, the primary indicators were neutral: February
housing starts (+), the February leading economic indicators (+), February
retail sales (-) and February industrial production (-). Other factors to consider were (1) the FOMC
meeting which raised the Fed Funds rate 25 basis points but delivered a
Goldilocks narrative [the economy is improving enough not to be hampered by any
rate increases] and (2) on the same day, the Atlanta Fed lowered their first
quarter GDP growth estimate to 0.9%.
Anyone but me see the irony here?
Given the
magnitude of the positive indicators, I am scoring this week as a plus: in the
last 76 weeks, twenty-five were positive, forty-three negative and eight
neutral.
Net, net, the
recent trend in the data has been mildly upbeat. It is not as good as much of
the narrative on Street would have you believe; but it does seem to be
improving. So perhaps the thesis that economic
growth would start to mend post-election due to a pickup in sentiment is being
played out. While I have bought into
that notion, I still feel a bit uncomfortable with it.
On the political
side, Trump delivered his first budget to congress; and it contained some major
spending shifts (more defense spending, less domestic discretion spending,
mostly in the form of cuts in government agencies budget). Everyone opined that it was DOA; but that is
just politics. Certainly there will be
compromise. But if the final product
starts a transition away from funding the US bloated bureaucracy, that will be
a major accomplishment. Along those
lines, he also issued an executive order authorizing a review of all government
departments with the aim of making them more efficient.
I have to tell
you that I am pleasingly surprised at the extent to which Trump is pushing
downsizing and rationalization of the bureaucracy. So much so that I think that it will have a
bigger impact on the economy than I originally forecast. On the other hand, I continue
to question the magnitude and timing of fiscal reforms---the potential benefits
of which I believe have been way over estimated by investors. But the net of both of these factors is a
larger positive than I have been assuming.
Indeed, if the only thing the Donald achieves is a more efficient, less
costly federal government bureaucracy that alone will raise the long term
secular growth rate of the economy. I
haven’t put a number on it yet; but I soon will.
In another
development in the political sphere, the CBO issued its scoring of the new GOP
version of healthcare---and it was not a favorable one for the forces of change. Still, if it can lead to revisions to the
plan then it will have done all a service.
The point here is that the fiscal side of Trump’s agenda, in my opinion,
is going to be (1) a long drawn out affair and (2) will likely fall
considerably short of current expectations.
Of course, I am of the opinion that tax cuts and infrastructure spending
unaccompanied by offsets will be counterproductive in stimulating economic
growth anyway.
That said,
Friday afternoon, it looks like Trump/Ryan are moving towards a consensus
within the GOP house on healthcare. There
is still a ways to go; and that doesn’t account for opposition among senate
republicans. Still credit where credit
is due.
Finally, oil
prices took it in the snoot this week. Whether
this continues is a matter of debate. As
you know, I have been a skeptic about OPEC’s ability to follow through with
proposed production cuts. So from my
perspective, there are better than even odds that further price declines are in
the cards. As always there are two views
of the economic impact of weaker oil prices: (1) the unmitigated positive crowd
and (2) those who look at the facts. And
the facts are that the last time this happened, the economy slowed. The downdraft in prices to date probably isn’t
enough to influence the direction of the economy; but if this trend continues, I
believe that growth forecasts will start coming down.
Trade is the other area that Trump has spent
a lot of time and capital on; and while he has unquestionably shaken up the
establishment by criticizing NAFTA/Mexico, Germany and the euro, nothing really
concrete has been done---and that is the good news. I am not going to repeat
the endless number of reasons why actually following through with his threats
would be a negative for both our trading partners and ourselves. My hope is that they are just negotiating
bluster and the final results will be much more free trade friendly. But if he is serious, this will be a major
economic negative.
Overseas, the
data this week was almost nonexistent; so the notion that there is a decent
probability that the ‘muddle through’ scenario gets replaced by an improving
economy is still operative. While it may
be a bit too soon to make that call, another couple of weeks of solid positive
stats would likely push me to do so. That
said, there are still problems out there that could stop a recovery in its
tracks: the Monte Paschi bailout, the Brexit, currency turmoil in China, Mexico
and Turkey, the potential impact of a Trump anti- free trade agenda and
Greece’s bailout difficulties.
Bottom line: this
week’s US economic stats was positive, helping the thesis that either the
economy is improving or is about to improve based on increasing investor
sentiment. More is needed before I will
feel confident with my revised tentative short term forecast. On the other hand, I have no intention of
altering our long term secular growth rate outlook until I see concrete results
of the Trump/GOP fiscal agenda.
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 spending
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.’
The
negatives:
(1)
A vulnerable global banking system. Nothing new this
week.
(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, his efforts at deregulation are a positive. The latest example is an executive order
signed this week that called for the comprehensive reorganization of the
executive branch. This could potentially
have far reaching consequences in terms of streamlining the government and
reducing operating costs. That said,
expect a massive pushback from the entrenched bureaucracy; so it will be a lot
easier said than done. Nonetheless, it
is a big boost for the ‘deregulation’ element of Trump’s policies; and as I noted
above, it is likely meaningful enough to warrant some increase in our long
secular growth forecast.
On the other
hand, it is becoming obvious that fiscal policy changes are going to be very
difficult. The Donald has pissed off the
dems so much that I don’t think that they would vote a recommended pay raise
for themselves. That means that
virtually all the heavy lifting has to be done by the GOP led congress which,
at the moment, appears very disjointed with respect to their own set of
priorities.
Topping the
list is the repeal and replacing of Obamacare. Given the diversity of opinions
among the republicans, the timeframe for likely passage keeps getting moved
out, suggesting that nothing will be enacted until the fall, if then. Unfortunately, tax reform can’t be done until
the tax consequences of healthcare reform are known. So we will be lucky to get legislation on that
score this year; and if that doesn’t occur, then 2018 be even harder since the
house will again be running for reelection.
Infrastructure
spending comes after that because healthcare and tax reform will have to be
scored for changes in revenues/costs before anyone knows how much budget
flexibility will exist for extra spending.
Unfortunately, spending faces another hurdle, which is the federal debt
cap. Since the current debt is virtually
at that limit, a new cap will need to be enacted before any additional spending
can take place [other than any savings that might come from deregulation/reorganization
and healthcare reform and/or net new revenues from tax reform].
And this
sobering piece from David Stockman (medium and today’s must read):
In short, there
is a lot of work to do to accomplish any of the Donald’s fiscal pledges. Even assuming all this gets done, there will
of necessity likely be lots of compromises.
So all we have now are the promises of change, the hope that Trump can
corral/browbeat the GOP congress into enacting legislation that reasonably
reflects those promises and then passing enabling legislation that will pay for
it all.
‘Please understand, I don’t think Trump is
blowing smoke up our skirt about his intentions to follow through with all of
the above. But the key to getting any of
these measures enacted is, as it always has been, to achieve compromise. And compromise means getting less than you
hoped for.’
The point here
is not to piss and moan about the legislative process. It is simply to say that we have no earthly
idea how the process is going to play out; hence, trying to create an economic
forecast based on the as yet unknown particulars is probably an exercise in
futility.
Finally, Trump’s
comments on trade demonstrate the seeming lack of understanding of what free
trade has meant to global prosperity and peace.
Plus trying to talk down the dollar only generates similar responses
from our trading partners, which in the end accomplishes nothing expect
fostering ill will.
That
said, I remain open to the notion that many of Donald’s initial currency/trade
positions may just be for negotiating purposes.
So the ultimate outcome could be quite positive.
(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.
As I noted
above, the lead headline this week was the FOMC meeting. The Fed Funds rate was increased an expected
25 basis point; and while the narrative included the forecast for multiple rate
hikes this year and next, it was sugar coated---the economy is strong enough to
handle the rate increases.
But to be
clear, I don’t believe that it raised rates Wednesday because of the
collective, infinite wisdom of a bunch blue sky academics thought that it was
time. Rather, I believe that if the bond
market hadn’t pushed rates up, the Fed would have done nothing, despite its
upbeat economic outlook.
That said, I
believe that the Fed should be raising rates.
Indeed, you know that I have oft times noted that I believe that the Fed
is way behind schedule in raising rates.
And at the risk of being repetitious, I don’t believe that a tightening
Fed will side track the economy because its easy money policy [except QE1] did
little to help it.
On the other
hand, I also believe that what the Fed really fears is that rising rates will
derail the Markets because its QE/ZIRP policies were one of the main drivers of
this grossly overvalued Market. Further,
however much the Fed may believe that it can finesse a tightening in monetary
policy without disrupting the securities markets, I think that they are smoking
dope.
My bottom line
remains that when the unwinding of the global QE/ZIRP/NIRP begins in earnest, I
believe that it will have only a modest effect on the economy but a noticeable
one on the Markets.
Another stem
winder from Jeffery Snider (medium and a must read):
In addition to
the Fed, [a] the Bank of Japan met this week and left rates unchanged [b] while
the Bank of China raised key benchmark rates for the third month in a row. My
point in bringing this up is that when the major central banks’ monetary policies
are at odds, it tends to raise the volatility in the fixed income and currency
markets; and depending on just how at odds they are, it can impact trade.
(4) Geopolitical
risks: I continue to worry about Trump’s
seeming willingness to throw diplomacy aside and treat the rest of the world
like they are the press. To be clear, I
don’t have an issue with most of the principles behind his offensive comments. And
I understand that he may just be trying to set up a negotiating position.
My point here is that, in my opinion, duking
it out with foreign leaders in public increases the odds of a misstep that
could be costly in far more ways than just economically.
Saber rattling
against North Korea (medium):
(5)
Economic difficulties in Europe and around the globe. This week, the global economic numbers were
very few:
[A] February
Chinese retail sales were less than anticipated while industrial output was
greater
[b] January Japanese CPI rose for the
first time in over a year.
The
other news was that the UK parliament voted to begin Brexit talks; but the
Dutch left the anti-EU party in the minority.
Notably absent was any update of the bankruptcy problems at Italy’s
Monti Paschi and the Greek bailout.
In sum,
this week’s data was too sparse as to add to or detract from any judgement
about the trend. That said, since the
trend has been towards improvement, I have to leave it intact. However, it is scarcely a reason to alter our
‘muddle through’ forecast.
Bottom
line: the US economic stats were positive. More importantly, the Donald’s drive for
deregulation and improved bureaucratic efficiency is a decided plus. On the other hand, while the dialogue on
taxes, spending and Obamacare has picked up as a result of the introduction of
the GOP’s new healthcare bill as well as Trump’s first budget, all we are
hearing are the reasons neither will be passed.
I don’t buy that; something will be enacted. I just don’t believe that it will be nearly
as significant as many do. Net, net, at
this moment, what has been accomplished to date may only modestly alter long
term secular growth rate of the economy.
This week’s
data:
(1)
housing: February housing starts were ahead of
forecasts; the March housing market index was better than anticipated; weekly
mortgage and purchase applications were up,
(2)
consumer: February retail sales were a bit
disappointing; month to date retail chain store sales growth improved from the
prior week; weekly jobless claims fell more than estimated; the preliminary
March consumer sentiment was better than forecast,
(3)
industry: February industrial production was below
consensus; the March NY and Philadelphia Feds’ manufacturing indices were
better than projected; January business inventories rose but sales grew less; the
February small business optimism index was slightly ahead of expectations,
(4)
Macroeconomic: February PPI was up more than anticipated;
while CPI was in line; the February leading economic indicators were ahead of
estimates.
The
Market-Disciplined Investing
Technical
The indices
(DJIA 20914, S&P 2378) continued to consolidate. Volume jumped dramatically but that was
largely a function of quad witching; breadth was weaker. The VIX (11.3) was unchanged, ending below
its 100 and 200 day moving averages (now resistance) and in a short term
downtrend. It closed right on the lower boundary
of a very short term uptrend for the second day---having challenged it unsuccessfully
intraday on both days. If it holds above
that boundary, then I have to take the thesis that the period of complacency
could be ending more seriously.
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 {19082-21321}, [c] in an
intermediate term uptrend {11839-24691} and [d] in a long term uptrend
{5751-23298}.
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 {2231-2565},
[d] in an intermediate uptrend {2069-2673} and [e] in a long term uptrend
{881-2561}.
The long
Treasury was up, but ended below its 100 and 200 day moving averages, in a very
short term downtrend and near the lower boundary of its short term trading
range.
GLD rose, closing
above its 100 day moving average (now support).
Nevertheless, it ended below its 200 day moving average (now resistance)
and within a short term downtrend.
The dollar was unchanged,
ending below its 100 day moving average (now resistance), above its 200 day
moving averages (now support) and in a short term uptrend.
Bottom line: the
Averages continued their relentless move to the upside. The assumption has to be that they are headed
for the upper boundaries of their long term uptrends.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (20914)
finished this week about 63.0% above Fair Value (12823) while the S&P (2378)
closed 50.0% 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.
This week’s US economic
data was upbeat but that positive was tempered by mixed primary indicators and
a second downward revision in first quarter GDP growth estimate by the Atlanta
Fed. So while the risk of recession may
be going down, there is not a lot in the numbers to suggest a major growth spurt. That said, the Market continues to interpret
all data/news in a very positive light---which currently is that a major
turnaround in the economy is occurring based on pro Market regulatory/fiscal
policies from the new administration. I
think more information is needed to draw that conclusion.
Politics
continues to dominate the headlines. And here is where, in my opinion, we find
the most upbeat news. Trump continues
his effort to reduce regulation as well as the size of the bureaucracy---this
week issuing an executive order for a major review of all government agencies
with the purpose reducing their power over the economy as well as saving
money. This objective was obvious in his
first budget in which there were major cuts in government agency spending.
On the other
hand, given the reception of the new GOP healthcare plan and the aforementioned
budget proposal, it seems likely that any changes in Trump’s fiscal plan will
be very hard fought, longer in coming and not nearly as impactful as many
believe. Not that something positive won’t
come out of these negotiations. But is
simple too soon to be altering forecasts on the probable outcome. And the rub Market wise is that many
investors seem not to have grasped the political and mathematical reality that
big tax cuts and major infrastructure spending are not likely to occur. On the
other hand, many on the Street have already made huge changes in their forecast
based this misperception; and the risk to the Market is that those forecasts
won’t materialize. That said, at the
moment, hope is all that matters to the Market; but if I am correct, then
ultimately those models will change for the worse.
While talk of
trade and currency has been out of the headlines of late, I remain concerned
about Trump’s push towards tariffs and manipulating the dollar lower. Free trade is and always has been an agent of
economic progress and global political stability. His proposals would inhibit those
objectives. Although I have acknowledged
that his moves may be nothing more than initial negotiating positions from
which positives can be derived. Still the
evidence to date keeps this factor as a negative.
All that being said, 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 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. 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.
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 potential changes coming in regulatory
policy, I caution investors not to get too jiggy about the rate of any accompanying
acceleration in economic growth and corporate profitability flowing from any
transformation in fiscal policy until we have a better idea of what, when and
how new policies will be implemented.
Finally, whatever happens, stocks are at or near historical extremes in
valuation and there is no reason to assume that mean reversion no longer occurs.
Bottom line: the
assumptions in our Economic Model may very well improve as we learn about the
new fiscal/regulatory policies and their magnitude. However, unless they lead to explosive growth,
they do little to alter the assumptions in our Models. That suggests that Street models will
undoubtedly remain more optimistic than our own which means that ultimately
they will have to take their consensus Fair Value down for equities.
Our Valuation
Model could 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 at least partially 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. In any case,
at least according to the math in our Valuation Model, 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. If I were a trader, I would consider buying a
Market ETF (VIG, VYM), using a very tight stop.
If only I knew when
(medium):
DJIA S&P
Current 2017 Year End Fair Value*
13200 1630
Fair Value as of 3/31/17 12823
1585
Close this week 20914 2378
Over Valuation vs. 3/31 Close
5% overvalued 13464 1664
10%
overvalued 14105 1743
15%
overvalued 14746 1822
20%
overvalued 15387 1902
25%
overvalued 16028 1981
30%
overvalued 16669 2060
35%
overvalued 17311 2139
40%
overvalued 17952 2219
45%
overvalued 18593 2298
50%
overvalued 19234 2377
55%overvalued 19875 2456
60%overvalued 20516 2536
65%overvalued 21157 2615
70%overvalued 21799 2694
Under Valuation vs. 3/31 Close
5%
undervalued 12181
1505
10%undervalued 11540 1426
15%undervalued 10899 1347
* 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.
