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The Closing Bell

The Closing Bell


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%

Current Market Forecast

Dow Jones Industrial Average

Current Trend (revised):

Short Term Trading Range 21691-26646

Intermediate Term Uptrend 13399-29599

Long Term Uptrend 6410-29847

2018 Year End Fair Value 13800-14000

Standard & Poor’s 500

Current Trend (revised):

Short Term Uptrend 2566-3337

Intermediate Term Uptrend 1291-3106

Long Term Uptrend 905-2963

2018 Year End Fair Value 1700-1720

Percentage Cash in Our Portfolios

Dividend Growth Portfolio 59%

High Yield Portfolio 55%

Aggressive Growth Portfolio 55%


The Trump economy is providing a slight upward bias to equity valuations. The data flow this week was quite positive: above estimates: weekly mortgage/purchase applications, month to date retail chain store sales, weekly jobless claims, May wholesale inventories/sales, the July small business optimism index, June CPI, the June budget deficit, June import prices; below estimates: May consumer credit, June PPI, July preliminary consumer sentiment; in line with estimates: na.

There were no primary indicators reported. I rate this week a plus. Score: in the last 144 weeks, fifty were positive, sixty-seven negative and twenty-seven neutral.

The data continues to provide both positive and negative signals; though we are on a two week streak of upbeat numbers. That is not much of a trend. But it does support the notion that second quarter economy growth will be better than first quarter. I agree with that; but I don’t believe that this means the US economy is now experiencing some kind lift off. It will take a good deal more positive stats before I alter my forecast of an economy slowing improving economy but laboring to do so.

My skepticism arises from (1) the brevity of the current economy growth pick up, (2) the overhanging burden of high and rising level debt in all economic sectors [which have to be serviced with cash flow that would otherwise go to cap ex and wages], (3) the outcome of trade negotiations. As you know, I am hopeful about a positive outcome from the latter. But that hasn’t happened yet; and until it does, I am not getting jiggy with it.

Overseas, the numbers remain dismal. The EU lowered its 2018 GDP growth forecast; the Japanese yield curve is flattening---a traditional precursor to recession; and Chinese credit growth is slowing. As I noted previously, the ‘synchronized global expansion’ is yesterday’s story; and that means our own economy loses that as a tailwind.

Trade remains front and center on the economic stage. Late in the week, Trump kicked up the tariffs on Chinese goods to $200 billion. If implemented and reciprocated that will have an impact on growth. So a big risk in my forecast is some sort of trade war. On the other hand, a positive result would be a plus for the long term secular growth rate of the US.

Our (new and improved) forecast:

A pick up in the long term secular economic growth rate based on less government regulation. As a result, I raised that growth forecast. There is the potential that Trump’s trade negotiations could also lead to an improvement in our long term secular growth rate. Unfortunately, the reverse would also be true. In addition, the tax cut and spending bills, as they are now constituted, are negative for long term growth (you know my thesis: at the current high level of national debt, the cost of servicing the debt more than offsets any stimulative benefit) and could potentially offset any positives from deregulation and trade.

On a cyclical basis, the second quarter numbers are going to be better than the first, though there is insufficient evidence at this moment to indicate a strong follow through. So my current assumption remains intact---an economy struggling to grow.

The negatives:

  1. a vulnerable global banking system.

The Chinese banking system is developing heartburn as overall liquidity shrinks (medium:

  1. fiscal/regulatory policy.

The outcome of current trade negotiations are an important variable in our long term secular economic growth rate forecast. So far, those negotiations have been largely in public and have included lots of Trumpian aggressive rhetoric. That tactic has led to much criticism---which may prove correct. My only observation is that playing patty cake with our trade partners in the past did little to correct inequities. So maybe a different approach is needed. Plus I will reiterate the thesis that Trump’s strategy is more than just getting lower tariffs on US exports; he is attempting to reset the post WWII political/trading regime---with which I agree.

The main headlines this week were focused on:

[a] China---where Trump really cranked up the volume by imposing $200 billion in additional tariffs on Chinese goods. If he follows through with this threat that is going to smart. And the Chinese will not likely turn the other cheek which would not be good for the US. What bothers me about these particular negotiations is that the focus has been on tariffs with little being said about the most egregious Chinese infraction: theft of US intellectual property. In my opinion, a settlement that only includes some tariff reductions would be a failure---even though some tariff relief would be a plus.

[b] EU/NATO. Trump pressed our European allies to take more responsibility for their own defense---at this moment with uncertain results. I have noted that I think that this issue is interrelated with trade; so its resolution will likely impact all the outcome of trade negotiations.

Despite heartburn inducing headlines, I continue to be hopeful of a positive outcome; and if it is, I think that it will be a plus for the long term secular growth of the US economy. If a trade war results, there will be pain.

One other thing occurred this week that could have a significant impact on Trump’s deregulatory push; and that is the nomination of Bret Kavanaugh to the Supreme Court. This judge has a very pro-business leaning in his judgments and would likely advance the Donald’s efforts. The below post is to an opponent of Kavanaugh, so read it in that context.

Unfortunately, none of this says anything about an equally big problem to which Trump has contributed: too much national debt and too large a budget deficit which will usurp investment dollars that would otherwise be used for increased productivity.

  1. 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.

The demise of global QE appears to be moving forward. This week, the Fed took the extraordinary step of introducing a ‘new’ construct of the yield curve [as opposed to the real yield curve] in order to justify a continuing tightening of monetary policy at a time when the real yield curve suggests the opposite. I believe that this reflects the Fed concerns that its QE policy was a bust [economically speaking], that it has severely distorted the pricing of risk and that it is concerned about the consequences of both. Most specifically near term, that it needs to unwind as much of QE as possible before the next economic downturn hits so that it has policy tools to combat that downturn.

To be sure, I love it since I believe that the gross misallocation and mispricing of assets created by QEInfinity has to be corrected as a precondition for the capital markets return to efficiency. But that involves Market pain---which means this is not a widely held view.

In other central bank news,

[a] the Japanese yield curve is flattening {a generally accepted signal that a recession is in the works} in the midst of the most aggressive QE policy in history among the major economic powers. So the Bank of Japan is now facing the exact problem our own Fed {see above} is trying to avoid, i.e. it has no policy levers left to combat an economic downturn,

[b] the ECB released the minutes of its most recent meeting which showed that its plans for unwinding QE are on track---as long as there is no sign of economic weakness. The problem with that is that there plenty of signs of economic weakness as I have documented in these notes. So it seems to be taking a page from our own Fed’s current playbook: ignore the data, hype the rhetoric and pray hard that it can unwind enough QE before a recession hits so that it has policy room to combat it.

You can see the central banks’ dilemma: They believe that their QE policies worked in terms to stimulating economic activity following the financial crisis. Therefore with the signs of a recession increasing, they believe that they have to unwind enough QE in order to have firepower when the recession comes. But they can’t say a recession is coming because according to their logic, if they did, they would have to cease unwinding QE. Their hubris created this mess. Hopefully, humility will be result.

My thesis remains that {i} QE did little to assist the economic recovery following the financial crisis; so it is unlikely to be a major negative as it winds down. But {ii} it created a massive mispricing and misallocation of assets; and its unwinding will not be Market friendly.

  1. geopolitical risks: North Korea sent a very upbeat letter to Trump this week, raising hopes that a settlement can be reached. However, I believe that this is all intermeshed with the China trade negotiations. So Kim’s friendly attitude will likely last only so long as the US and China can work out a trade agreement.

  1. economic difficulties around the globe. Not a lot of stats released this week.

[a] July German economic sentiment was terrible,

[b] June Chinese CPI was up, in line;.

But, as noted above, there were macroeconomic signs that all is not well in the global economy: EU lowering its growth forecast, the Japanese yield curve flattening, the Chinese credit shrinking.

Bottom line: On a secular basis, US long term economic growth rate could improve based on increasing deregulation. In addition, if Trump is successful in revising the post WWII political/trade regime, it would almost certainly be an additional plus for the US long term secular economic growth rate. ‘If’ remains the operative word; plus we need to see the shape of any new agreement before changing our forecast.

At the same time, those long term positives are being offset by a totally irresponsible fiscal policy. The original tax cut, a second proposed new improved tax cut, increased deficit spending and a potentially big infrastructure bill will negatively impact economic growth and inflation, in my opinion. Until more evidence proves otherwise, my thesis remains that the current level of the national debt and budget deficit are simply too high to allow any meaningful pick up in long term secular economic growth.

Cyclically, growth in the second quarter will be surely be above that of the first quarter, helped along by the tax cuts. At the moment, the Market seems to be expecting that growth is accelerating and will persist. I take issue with both those assumptions, based not only on the falloff in global activity but also the lack of consistency in our own data.

The Market-Disciplined Investing


The Averages (DJIA 25019, S&P 2801) had another good day on slightly better volume and improved breadth. The Dow continued to trade above its 100 day moving average (now support), above its 200 day moving average (now support) and within a short term trading range. The S&P ended above both moving averages, in uptrends across all timeframes and above the minor resistance from its June high for a second day. The assumption has to be that it will now challenge its all-time high (2874).

VIX declined 3%, finishing below its 100 day moving average (now resistance), below its 200 day moving average (now resistance), within a short term trading range and appears headed for a challenge of the May/June double bottom---which would be logical if the Averages are going to assault their highs.

The long Treasury was up ¼ %, ending well above its 100 and 200 day moving averages, in a long term uptrend and above the upper boundary of its short term downtrend (if it remains there through the close on Tuesday, it will reset to a trading range).

The dollar was down fractionally, but stayed above both moving averages and in a short term uptrend. In addition, its 100 day moving average has crossed above its 200 day moving average---which technicians consider a good sign of further momentum to the upside.

Gold was down ½ %, continuing to trade below both moving averages and near the lower boundary of its short term downtrend. The only possible positive is that it is nearing minor support offered by its December 2017 low.

Bottom line: the technical position of the indices continues to improve as the S&P pushed above June highs---the only real negative being that both 100 day moving averages continue to fall toward their 200 day moving averages. The assumption remains that stock prices are going higher. TLT, UUP and GLD continue to perform like investors are betting on a relatively positive US economy versus the rest of the world’s economy. The only problem, in my opinion, is that doing less poorly than the rest of the world is not a reason for stocks to advance when they are already near historic high valuations.

Fundamental-A Dividend Growth Investment Strategy

The DJIA and the S&P are well above ‘Fair Value’ (as calculated by our Valuation Model). However, ‘Fair Value’ is being positively impacted based on a new set of regulatory policies which should lead to improvement in the historically low long term secular growth rate of the economy. A further increase could come if Trump’s drive for fairer trade is successful. On the other hand, a soaring national debt and budget deficit are negatives to long term growth and, hence, ‘Fair Value’.

At the moment, the important factors bearing on corporate profitability and equity valuations are:

  1. the extent to which the economy is growing. We have had two weeks in a row of upbeat data. Even though these numbers likely manifest a better second quarter, so what? Everyone accepts that growth will pick up in Q2. But it hardly supports the thesis that the secular economic growth rate is rising; and that ultimately that is what gets plugged into my Economic/Valuation Models. True, those stats could be a signal that longer term growth is improving; but ‘could be’ are the operative words. I am not going to change a forecast based on a fortnight’s worth of numbers.

Also, lest we forget, the economic growth rate in rest of the global is starting to slow; and that can’t be good for our own prospects. It is certainly possible, even probable, that the US can continue to growth in this environment. But it is not likely that its growth rate will accelerate. My thesis remains that the financing burden now posed by the massive US deficit and debt has and will continue to constrain economic as well as profitability growth,

Another must read article from Jeffrey Snider:

  1. the success of current trade negotiations. If Trump is able to create a fairer political/trade regime, it would almost certainly be a positive for secular earnings growth. However, the reverse is also true; and at the moment, the outcome is becoming increasing uncertain as tariff threats fill the air,

  1. the rate at which the global central banks unwind QE. The optimists believe that they will tighten only to the extent as to not disrupt the Markets. Of course, the Markets haven’t been disturbed yet. The immediate problem is that as the risk of recession increases, the banks may be losing control of their own narrative. Certainly, the Bank of Japan is being backed into a corner in which it has lost its ability to respond to an economic downturn. The Fed, and to a lesser extent, the ECB have at least started to create some room for policy responses. However, in my opinion, they have waited too long [as they always have].

The central banks’ problem is that they believe QE worked and therefore they need to tighten monetary policy in order to have policy options to combat the next recession. What they are missing is that QE did diddily for the economy and that the longer they tighten the greater the impact on the Markets which will start to correct the real damage that QE has wrought---the misallocation and pricing of assets [risk]. And that won’t be good for equity prices.

Bottom line: a new regulatory regime plus an improvement in our trade policies should have a positive impact on secular growth and, hence, equity valuations. On the other hand, I believe that fiscal policy will have an opposite effect on economic growth. Making matters worse, monetary policy, sooner or later, will have to correct the mispricing and misallocation of assets---and that will be a negative for the Market.

Our Valuation Model assumptions may be changing depending on the aforementioned economic tradeoffs impacting our Economic Model. However, even if tax reform proves to be a positive, the math in our Valuation Model still shows that equities are way overpriced. That math is simple: the P/E now being paid for the historical long term secular growth rate of earnings is far above the norm.

As a long term investor, with equity valuations at historical highs, I would want to own some cash in my Portfolio; and if I didn’t have any, I would use any price strength to sell a portion of my winners and all of my losers.

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.


Current 2018 Year End Fair Value* 13860 1711

Fair Value as of 7/31/18 13643 1682

Close this week 25019 2801

* 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 50 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.