2/23/19
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 14088-30287
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 Trading Range 2349-2942
Intermediate
Trading Range 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 positive: above estimates: the February housing market
index, weekly mortgage/purchase applications, weekly jobless claims, month to
date retail chain store sales, the February flash composite and services PMI’s;
below estimates: January existing home sales, the February flash manufacturing
PMI, the February Philly Fed manufacturing index, January leading economic
indicators; in line with estimates: December durable goods/ex transportation.
However, the primary
indicators were negative: January existing home sales (-), January leading economic
indicators (-) and December durable goods/ex transportation (0). This week is a close call: negative. Score: in the last 176 weeks, fifty-seven positive,
seventy-nine negative and forty neutral.
The data from
overseas this week was mostly negative (again) and, clearly, is another impediment
to our own economy’s struggle to sustain growth. Certainly, a positive result from the US/China
trade talks will help.
My forecast:
Less government
regulation, Trump mandated spending cuts, (hopefully) 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 and the global economy decelerates.
There appears to be an increasing risk that the economy may not be as
strong as even my forecast has portrayed it.
The
negatives:
(1)
a vulnerable global banking [financial] system.
EU banks are the most successful Ponzi scheme of all
time.
Fitch warns of a potential problem for collateralized
loan obligations.
(2) fiscal/regulatory
policy.
Trade remains front
and center.
[a] the
US/China trade talks. It looks like
progress is being made. China trade
officials were in the US this week, following a similar meeting in China last
week. Plus, China’s top trade official
met with Trump on Friday. In addition,
Trump hinted that the March 1 deadline for the imposition of additional tariffs
on China was not firm, an indication of goodwill if negotiations remain
fruitful. That said, the only thing
concrete that we have is that six memoranda of understanding are being worked
on, one of which is that China will increase its purchases of US agricultural
products, i.e. in my opinion, a bribe for leniency on industrial policy and IP
theft,
As of Friday
afternoon, Trump and Xi are negotiating the terms of a potential meeting between
the two.
[b] the US/EU
trade talks. Threats were exchanged centered
on auto tariffs but that is all that occurred---hot tongue.
As you know, I
have been supportive of Trump’s effort to negotiate fairer trade deals,
correcting the disparities that grew up in the post WWII world. If he is successful, I believe that it will
be a plus for US secular economic growth.
Bottom line:
whatever the positive impact that might to come from a US/China trade deal,
irresponsible deficit spending will restrain US economic growth.
(2)
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.
The major headline
this week was the release of minutes from the last FOMC meeting which confirmed
the easier monetary policy implications of the changed narrative from Fed
officials in the last month. Most important,
a drastically altered QT is officially on the agenda of the March FOMC
meeting.
Of course, the
Fed wasn’t the only central bank signaling easier monetary policy. Both the ECB and the Bank of Japan jumped on
board this week; and that follows the huge injection of liquidity into its financial
system by the Bank of China last week.
I don’t want to
be repetitive but, if QE returns, my takeaways are:
[a] easier central
bank monetary policy will not improve the prospects for economic growth,
[b] it leaves
the mispricing and misallocation of assets as a risk that must ultimately be
dealt with; though I have no clue as to when that could happen,
[c] it leaves
the central banks with two potential problems {i} if inflation accelerates, they
will ultimately be compelled to tightening policy irrespective of Market reaction
or {ii}if economic growth continues to decelerate, the ineffectiveness of QE (along
with central bank omniscience) will become increasing obvious; and if the
Markets lose the faith, look out below,
[d] I know that
this all sounds very negative; but I remind you that the Fed has never, ever,
ever in its history managed a successful transition from easy to normal monetary
policy. To be sure, it could do it this time;
but the weight of history suggests otherwise.
(3) geopolitical
risks:
Europe is a
mess with Brexit, riots in France and fiscal policy discord in Italy; and it continues
to be reflected in a negative way in the economic stats.
Plus, you never
know how the situation in Venezuela plays out.
(4)
economic difficulties around the globe. The stats this week were again negative,
continuing to point to a global economic slowdown:
[a] the February EU flash consumer confidence was down
but not as much as expected; the February EU and German flash composite and services
PMI’s were above estimates but their manufacturing PMI’s were negative, Q4 German
GDP showed no growth,
[b] December Japanese machine orders fell: the February Japanese
flash manufacturing PMI fell into contraction range; its January trade deficit
rose.
Bottom
line: on a secular basis, the US economy
is growing at an historically below average rate. Although some recent policy changes are plus
for secular growth, they are being offset by a totally irresponsible fiscal
policy.
Cyclically, the
US economy is once again slowing as evidenced by the data from both here and
abroad. As a result, my initial US 2019 economic growth rate assumption is at risk
of being too optimistic.
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.
Meaning that if the Fed thinks backing off QT will help support economic
growth, in my opinion, it will be disappointed.
The Market-Disciplined
Investing
Technical
The Averages
(DJIA 26031, S&P 2792) continued their relentless move higher. However, certain aspects of their charts are now
out of sync: (1) the S&P regained the lower boundary of its very short term
uptrend, the Dow didn’t, voiding that trend, while (2) the Dow ended above its
prior lower high (25977); the S&P did not. To be sure, the current upward
momentum will likely resolve this hitch in directional clarity to the upside;
but it still must get done.
Volume rose slightly
and breadth improved, though the flow of funds indicator is not acting well.
The VIX was down
6 ½%, mirroring the surge in stocks.
Adding to the already poor performance of its indicators, it has now
established a very short term downtrend.
The long bond recovered
½ %, but couldn’t recover the lower boundary of its very short term uptrend
(voiding that trend). Further, it has
made a triple top---not a positive technical occurrence. The concern here is that it could be losing the
upward momentum established after it reset its short term trend to a trading
range.
The dollar was down
one cent, ending above both MA’s and within a short-term uptrend. It remains stuck in that November to present
trading range.
GLD rose, its
chart remains strong.
Bottom line: the Averages just can’t
stay down. They are now somewhat out of
sync as the pace of the advance differs with respect to some key technical
levels. However, my assumption is that
those divergences will resolve themselves to the upside. If so, then the next stop is their all-time
highs.
Gold’s chart remains strong; UUP is
stuck in a range and the long bond may be starting
to suggest that rates could be moving up.
Friday in the charts.
Fundamental-A Dividend Growth
Investment Strategy
The DJIA and the
S&P are 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---which the
trend in the dataflow suggests is meager.
The risk is that it may not be that good.
In
addition, the results from the Q4 earnings season as well as the forward
guidance provided by companies suggest that the next couple of quarters could
be disappointing.
My thesis
is that 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. The current trade talks with China clearly
hold promise. Any deal will be a short
term plus assuming it leads to an increase in trade. But I worry that the Chinese out ‘art of the
deal’ Trump and there will be little progress on the long term
problems---industrial policy and IP theft.
(3) the
resumption of QE by the global central banks.
If QEII, QEIII and Operation Twist are any guide, they should be a big
plus for the Markets, at least in the short term.
(4) current
valuations. the Averages have recouped much of their October to December loss
and appear on their way to regaining even more.
Since they were grossly overvalued [as determined by my Valuation Model]
in October, they are now just slightly less grossly overvalued. That said, if the latest central bank
liquidity surge continues, valuations will remain irrelevant.
As
prices continue to rise, I will again be focusing on those stocks that trade
into their Sell Half Range and act accordingly.
Bottom line: while
fiscal policy is negatively impacting the E in P/E, a new regulatory regime,
any improvement in our trade regime with China along with proposed spending cuts
should have a positive impact on secular growth and, hence, equity valuations. More important, a global central bank ‘put’ appears
to be returning and, if history is any guide, will almost assuredly be a plus
for stock prices.
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 2019 Year End Fair Value*
14600 1800
Fair Value as of 2/28/19 14016
1724
Close this week 26031
2792
* 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.
