The Closing Bell
8/19/17
Statistical
Summary
Current Economic Forecast
2016 actual
Real
Growth in Gross Domestic Product 1.6%
Inflation
(revised) 1.6%
Corporate Profits (revised) 4.2%
2017 estimates
(revised)
Real
Growth in Gross Domestic Product -1.25-+0.5%
Inflation +.0.5-1.5%
Corporate
Profits -15-0%
Current Market Forecast
Dow
Jones Industrial Average
Current
Trend (revised):
Short
Term Uptrend 20772-23283
Intermediate Term Uptrend 18695-25946
Long Term Uptrend 5751-24198
2016 Year End Fair Value 12600-12800
2017 Year End Fair Value
13100-13300
Standard
& Poor’s 500
Current
Trend (revised):
Short
Term Uptrend (?) 2430-2715
Intermediate
Term Uptrend 2220-2994
Long Term Uptrend 905-2763
2016 Year End Fair Value
1560-1580
2017
Year End Fair Value 1620-1640
Percentage
Cash in Our Portfolios
Dividend Growth
Portfolio 59%
High
Yield Portfolio 55%
Aggressive
Growth Portfolio 55%
Economics/Politics
The Trump
economy is providing an upward bias to equity valuations. By
volume, the data flow this week was weighed slightly to the positive: above
estimates: the August housing market
index, July retail sales, weekly jobless claims, the preliminary August
consumer sentiment reading, the August NY and Philly Fed manufacturing index
and July import/export prices; below estimates: weekly mortgage and purchase applications,
July housing starts, month to date retail chain store sales, July industrial
production, June business inventories/sales; in line with estimates: the July
leading economic indicators
But the primary
indicators were negative: July retail sales (+), July housing starts (-), July
industrial production (-) and the July leading economic indicators (0). So the data pattern was very similar to two weeks
ago, i.e. mixed---stronger overall data, but weaker primary indicators. So I will score it the same: neutral: in the
last 97 weeks, twenty-nine were positive, fifty-two negative and sixteen
neutral.
This makes three
weeks in a row that I have graded the overall data as neutral. It is a bit early to call this a trend. Still it suggests that the economy may have
ceased to deteriorate. That clearly
doesn’t mean that it is improving or imply that our forecast should be
changed---only a string of positive weeks would do that. Nevertheless, it could mean that the odds may
be declining of further economic weakening.
Overseas, the
numbers were upbeat from around the globe with more good news out of Europe,
China returning to the plus side and Japan having its first good week in a long
time.
On fiscal policy, the good news is that
Trump again used his executive power to (1) lower regulatory barriers for
infrastructure projects and (2) appoint an expert to review Chinese theft of US
intellectual property---which as you know, has been a sore spot with me. In addition, NAFTA trade talks began. The latter may or may not prove to be good
news; but I choose to be hopeful.
The bad news is that Trump’s newest
reality show is getting very poor ratings from both the chattering and ruling classes. While I don’t really give a s**t what either
of them think, the resulting political turmoil could easily to slow or
terminate progress on the Trump/GOP fiscal program. To be sure, gridlock is not the worst thing
that could happen to us but the absence of healthcare and tax reform would be a
disappointment.
Bottom line: this
week’s US economic stats were mixed, confirming the pattern for the last 18
months---the economy struggling to keep its head above water. The improving EU economy and signs that China
may be following in its footsteps have to help at some point; and, indeed, they
may be behind the mixed data we have been getting of late.
Longer term, I
remain confident in my recent upgrading our long term secular growth rate assumption
by 25 to 50 basis points based on Trump’s deregulation efforts. This week’s move reducing regulatory barriers
to infrastructure spending will almost surely help. However, any further increase in that long
term secular economic growth rate assumption stemming from enactment of the
Trump/GOP fiscal policy is still on hold as the Washington morality play
unfolds.
Our (new and
improved) forecast:
A 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; though the odds of that are
uncertain and getting worse by the day.
Short term, the economy has seemingly flattened
out; though that doesn’t alter our former recession/stagnation forecast. A pickup in global economic activity may have
halted further deterioration---‘may’ being the operative word.
The negatives:
(1)
a vulnerable global banking system. Nothing this week.
(2)
fiscal/regulatory policy. This week:
[a] Trump continued his purge of the regulatory
system, slashing the process for gaining approval for infrastructure building
projects. As you know, it is on this
front that the Donald has furthered his/GOP fiscal reform. Also as you know, I have already raised our
long term secular economic growth rate assumption based on the scope of
deregulation. This latest move will
almost surely help.
[b] negotiations
for modernizing the NAFTA trade treaty have commenced. Certainly, this was needed to readjust the
playing field. That doesn’t mean that it
will be a success; so I am not scoring at such.
But I am hopeful.
[c] also
on the trade front, Trump appointed an individual to look into the Chinese
pirating of US intellectual property. I
have already dwelled on this issue sufficiently; so you know I believe it to be
a positive.
[d]
unfortunately, no one seems to be giving credit for these moves because once
again, Trump’s communication skills proved to be sorely lacking. I pursued this subject in Wednesday’s and
Thursday’s Morning Calls, so I won’t be repetitious except to summarize: {i} it
increases the probability of gridlock, {ii} which of course lessens the odds
that fiscal reform will occur and {iii} if it gets worse, it could spawn more
violence and further divide an already divided country.
As an
addendum, Friday, Steve Bannon left the White House. Bannon has been a lightning rod to liberals as
a major player in the alt right; and that focus became more intense following the
Trump response to the Charlottesville tragedy.
Plus, he had a reputation as a disruptive force within the West Wing.
held very tough trade protectionist positions and was at odds with Gary Cohn,
who, for better or worse, is viewed by many as the only adult in the White
House. So many observers believe that Bannon’s
departure is a plus for trade policy as well as stability within the
administration.
Things
could get worse (today’s 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.
This week, both
the Fed and the ECB released minutes of prior meetings. Both were dovish. Both expressed concerns about the effect of monetary
tightening on securities markets. No
s**t, Sherlock. As you know, my thesis from
the beginning has been that QE did little to improve the economy, so its
termination will have little adverse consequence; but it is a primary reason
for the sky high equity valuations, so unwinding it will likely mean lower prices.
The battle
between data and theory (medium):
(4) geopolitical
risks: the North Korean/US standoff took a positive turn this week as Un
appeared to back off threats of more missile launches. We can only hope that it lasts.
But…………..
Still there
remains plenty of hotspots that could explode any minute: Syria, the Qatar
sanctions, US/Russian confrontation, Trump’s aggressive language on Iran and
Venezuela,
I am not trying
to fear monger war; but I do think that Trump’s aggressive attitude toward
foreign opposition is overdone and increases the risk of a costly misstep.
(5)
economic difficulties around the globe. This week, the stats continued upbeat out of
Europe, mixed out of China and positive for Japan for the first time in a long
while.
[a] second quarter EU GDP growth was in line with
estimates while July UK retail sales were stronger than anticipated,
[b] the IMF raised its 2017 economic growth forecast for
China; though the country reported retail sales and industrial production below
consensus,
[c] Japan
reported second quarter GDP, business spending and private consumption above
expectations,
In sum, our
outlook remains that the European economy is out of the woods while China is
struggling to do the same. As for Japan,
one week does not a trend make. Follow
through.
Bottom
line: our near term forecast is that the
US economy is stagnating though there is a possibility that the improved
regulatory outlook and a now growing EU economy may be halting any worsening. Further, if Trump/GOP were to pull off a
(near) revenue neutral healthcare reform, tax reform and infrastructure
spending on a reasonably timely basis, I would suspect that sentiment driven
increases in business and consumer spending would return.
That said, this
week was the worst of the Donald’s term (if that is possible); enough so that
it likely lowers the odds of successfully implementing the Trump/GOP fiscal
program. However, that wouldn’t be a
negative for the economy; it just wouldn’t be a plus. In other words, the hope of the economy returning
to its long term secular growth rate will remain just that---a hope.
However, Trump’s
drive for deregulation and improved bureaucratic efficiency is and will remain a
decided plus. As you know, I inched up
my estimate of the long term secular growth rate of the economy because of it.
The
Market-Disciplined Investing
Technical
The indices
(DJIA 21675, S&P 2425) had another volatile day, closing down again. Volume was flat (despite option expiration);
breadth was weaker. Importantly, (1) the
S&P finished below the lower boundary of its short term uptrend; if it
remains there through the end of trading on Tuesday, it will reset to a trading
range, (2) it did so on day when it traded up intraday by nine points on the [good]
news of Bannon’s departure from the White House and (3) it is a short hair away
from violating another support level---its 100 day moving average.
However, it is
too soon to be getting beared up: (1) the S&P’s break of its short term uptrend
has not been confirmed and (2) to establish a true Market downtrend, the Dow
must also penetrate the lower boundary of its short term uptrend and that hasn’t
happened; indeed, it is almost a 1000 points away from doing so. Bottom line, the Averages may be about to
experience a hiccup; but they are a long way from confirming that they are
rolling over.
The VIX (14.3) actually
fell 8 ½ %, probably the result of the bulls shorting it on the thesis that the
‘buy the dip’ crowd is close by.
Nevertheless, it finished above its 100 and 200 day moving averages [both
support]. It also finished above the
upper boundary of its short term downtrend for the second day; if it remains there
through the close on Monday, it will reset to a trading range. This pin action
clearly provides substance to my open questions as to whether the VIX made or
is making some kind of bottom extending back to late July and if I was
premature resetting the intermediate term from trading range to downtrend.
The long
Treasury fell fractionally, but still ended above its 100 and 200 day moving
averages (both support), the lower boundaries of its short term trading range
and its long term uptrend and has now made a third short term higher high. That is a lot of support.
The dollar declined,
closing in a short term downtrend, below its 100 and 200 day moving averages
and did not make a new higher high.
GLD also fell, but finished above the lower
boundary of its very short term uptrend and its 100 and 200 day moving averages
(both support). Somewhat ominously,
intraday, it traded above the upper boundary of its short term trading range,
then couldn’t hold above that boundary or the prior day’s high---perhaps signaling
a loss of momentum.
Bottom line: the
indices not only had a rough day but did so on supposedly good news (Bannon’s
resignation). Importantly, the S&P fell
below the lower boundary of its short term uptrend. Even if this challenge is confirmed, as I noted
above, the Dow is a long way from a similar break. So at the moment, the assumption has to be
that the Averages are just experiencing a hiccup.
Fundamental-A
Dividend Growth Investment Strategy
The DJIA (21675)
finished this week about 66.3% above Fair Value (13032) while the S&P (2425)
closed 50.6% overvalued (1610). ‘Fair
Value’ will likely be changing based on a new set of regulatory policies which has
led to improvement in the historically low long term secular growth rate of the
economy (though its extent could change as the effects become more obvious); but
it still reflects the elements of a botched Fed transition from easy to tight
money and a ‘muddle through’ scenario in Japan and China.
The US economic stats
continue to point to a weak economy. If
I am correct about the economy slowing/stagnating, short term that means Street
economic growth forecasts will begin declining.
The question is when; and more important from a Market standpoint, given
investor proclivity for interpreting bad news as good news, whether they will even
care. I can’t answer that latter issue
except to say that someday, bad news will be bad news; and mean reversion will
likely occur.
Fiscal policy is
in disarray not only because the republican congress can’t get its house in
order but also because the Donald insists on making himself rather than the
good of the country the issue. I don’t
want to overly dramatize the impact of Trump’s response to the Charlottesville
tragedy, but I believe that it is safe to say that it clearly didn’t improve
the odds of successfully passing all or a part of the Trump/GOP fiscal
program. The good news is that the worst
case scenario is gridlock which is not all that bad. The bad news is that my hoped for improvement
in the long term economic secular growth rate is little more than a wet dream
at the moment. And that in turn means
lower equity valuations based on slower growth.
Mohamed El Erian
on the failure of the ruling class (medium):
Finally, the
central banks continue to confuse, obfuscate and pursue a policy that has
destroyed price discovery---and it is being done not to have some potential
positive effect on the economy, but to avoid a Market hissy fit. Not something that I believe is in the best
long term interests of the economy or the Markets. As
you know, I have long time believed that the loss of faith in or the dismantling
of QE will result in correcting the mispricing and misallocation of assets; and
that most assuredly will not be a plus for equity 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. While
I am encouraged about the changes already made in regulatory policy, fiscal
policy remains a mess. 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 on long term secular growth in our Economic Model are beginning to
improve as we learn about the new regulatory policies and their magnitude. Plus, there is a tiny ray of hope that fiscal
policy could make progress though its timing and magnitude are unknown. I continue to believe that the 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 potential ‘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 want to own cash in my Portfolio
and 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 8/31/17 13032
1610
Close this week 21675
2425
Over Valuation vs. 8/31
55%overvalued 20199 2495
60%overvalued 20851 2576
65%overvalued 21502
2656
70%overvalued 22154 2737
* 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.
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