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The Closing Bell

The Closing Bell

3/23/19

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 14178-30379

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 Term Uptrend 1353-3163 Long Term Uptrend 913-3191

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 mixed: above estimates: weekly mortgage/purchase applications, February existing home sales, weekly jobless claims, month to date retail chain store sales, the March Philly Fed manufacturing index, January leading economic indicators; below estimates: January factory orders, the March flash composite, manufacturing and services PMI’s, January wholesale inventories/sales, the February budget deficit; in line with estimates: the March housing market index.

However, the primary indicators were positive: January leading economic indicators (+), February existing home sales (+) and January factory orders (-). I rate the week positive. Score: in the last 180 weeks, fifty-eight positive, eighty-two negative and forty neutral.

While this week’s data keeps alive the hope that the US economy could be stabilizing, I don’t think that we can ignore other developments that seem to be pointing to a world that is either in or on the cusp of a recession: (1) deteriorating global stats, (2) falling bond yields and an ever flattening yield curve and (3) the sudden about face of Fed policy.

On the latter, I have contended all along that its ‘the economy is improving’ narrative flew in the face of the facts on the ground. Its recent policy reversal, in my opinion, confirms that thesis.

For the moment, I am sticking with my assumption that the US can continue to grow albeit at a reduced rate even if there is a global recession. Clearly, this week’s stats support that notion. Nonetheless, it may about to be tested.

Finally, one week does not a trend make. So, the aforementioned negatives could prove to be a one off. Still, another week like the one we just had and the warning light will start flashing.

The data from overseas this week was negative, especially the manufacturing stats. That could potentially change if there is a decent US/China trade deal; though those prospects appear to be diminishing. Net, net, the global economy remains an impediment to our own economy’s struggle to sustain growth.

My forecast (for the moment):

Less government regulation, (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, exemplified by Trump’s new budget proposal, 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. However, even if the economy were to improve cyclically, it will still be unable to overcome the secular negative of too much debt to service.

The negatives:

  1. a vulnerable global banking [financial] system.

(2) fiscal/regulatory policy.

It was yet another see saw week in the US/China trade talks. First, Trump/Xi trade summit was apparently pushed out to June. It was then reported that the Chinese were not happy with the progress of the negotiations. But once again Trump rescued the narrative by announcing that he was sending Lighthizer to China because the talks were going so well. Finally, he reversed himself saying that the tariffs on Chinese goods could remain for a long time [meaning apparently that the talks aren’t going so well].

I opined earlier this week that I don’t think anyone knows the true state of the negotiations, including perhaps [with all due respect] Lighthizer. The Chinese are just as tough as the Russians and remember how long it took to reach some sort of reduction in tensions in the Cold War. It was only after Reagan hit them in the head with a 2x4, that they chose to back off. And then it was only because they had no other choice. I see the US/China trade standoff in the same light.

To repeat, I think that Trump is doing the right thing; but I also think it will take a long time before the Chinese play fair on industrial policy and IP theft---if they ever do.

Bottom line: whatever the impact that might come from a US/China trade deal, irresponsible deficit spending will restrain US economic growth.

Budget deficit hits record level.

US Budget Deficit Hits A Record $234 Billion As Interest On Debt Soars

  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 asset bubbles in the stock market as well as in the auto, student and mortgage loan markets.

This week’s major headline was the FOMC meeting and the subsequent formal introduction into a policy statement of the ‘patient’ narrative that has dominated Fed speeches the last two months. Indeed, the Fed statement was even more dovish than most had anticipated, nixing any rate hikes in 2019, stopping QT earlier than expected and downgrading [just barely] its economic forecast.

I am not going to repeat my prior comments in Thursday and Friday’s Morning Calls, except to observe again that [a] the 180 degree turn in policy in the last three months {i} demonstrates the extent to which the Fed has been kidding itself/you/me and {ii} clearly supports my long term thesis that the Fed has never in its history managed a successful transition from easy to normal monetary policy and [b] easy money will do little to improve economic growth but, if history is any guide, will keep investors buying every asset in sight.

I believe that the Fed has finally painted itself into a box from which there is no easy exit: [a] if inflation accelerates, the Fed will ultimately be compelled to tightening policy irrespective of Market reaction or [b] if economic growth continues to decelerate, any additional QE will prove ineffective in halting the slowdown; and Markets don’t like recessions. Must read:

The Fed Threw In the Towel On the 'Boom,' Doesn't Know Why | RealClearMarkets

The Fed’s historic mistake.

The Fed's Historic Policy Error In One Chart

I said that I would try to find an analyst with a positive take on the FOMC’s new policy. So far, these are as close as I can get.

https://www.bloomberg.com/opinion/articles/2019-03-22/the-federal-reserve-has-a-new-paradigm?srnd=premium

And.

The Fed's policy switch may be too late to save the economy from fading

  1. geopolitical risks:

Europe is a mess with Brexit [which now has a very short shelf life], riots in France and fiscal policy discord in Italy; and it continues to be reflected in a negative way in the economic stats.

You never know how the situation in Venezuela plays out.

And now we must deal with Trump’s support of Israel’s annexation of the Golan Heights [I wonder if the same thesis holds for Russia’s takeover of the Crimea]. [Note, this author has a history of being extremely pro-Russian]

Crimea's Reunification With Russia - A Landmark Event

  1. economic difficulties around the globe. The stats this week were again negative, continuing to point to a global economic slowdown or worse:

[a] January EU construction output fell, its January trade balance improved, March economic sentiment and consumer confidence dropped less than expected; the March EU flash composite and manufacturing PMI’s were below estimates {as was the German flash manufacturing PMI} while the flash services PMI was in line; February UK retail sales were much better than forecast, February inflation was in line, PPI was slightly below forecasts and the industrial orders index declined,

[b] January Japanese industrial production declined less than anticipated capacity utilization was terrible, the January leading economic index was in line; the February flash manufacturing PMI was below projections while February inflation ran hotter than consensus.

Bottom line: on a secular basis, the US economy is growing at an historically below average rate. Although some recent policy changes are a plus for secular growth, they are being offset by a totally irresponsible fiscal policy.

Cyclically, the US economy is slowing as evidenced by the data from both here and abroad. Further, the reversal of Fed policy and plunge in interest rates put an exclamation point of that notion.

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 25502, S&P 2800) executed a waterfall formation on Friday, with the S&P closing right on the lower boundary of its very short term uptrend and the critical 2800 level (clearly below other technicians 2811/2815 resistance quad top). So, as of the Friday close, nothing is technically amiss---just a test of support levels. Of course, how the S&P handles this level will likely have a major impact on directional momentum. Nothing to do but wait for Monday.

Volume was up and breadth negative.

The VIX soared 21%. Intraday, it challenged its 200 DMA and fell back. It continues to mirror the S&P closely (VIX 200 DMA = S&P 2800); so, I see nothing informational in Friday’s pin action.

The long bond popped 1 ½% on big volume, suggesting more upside. However, it gapped open on Friday and usually those gaps are closed. But whenever that occurs, it will have no negative impact on the chart. At the risk of stating the obvious, bond investors are clearly expecting further rate declines (a weaker economy).

Yield Curve Inverts For The First Time Since 2007: Recession Countdown Begins

The dollar was up slightly, ending with a positive chart (above both MA’s, in a short term uptrend and above a prior low). UUP doesn’t always rise on lower interest rates. In this case, I think that it means that investors are more concerned about the rest of world’s economic growth than the US’s.

GLD continued its advance off a minor double bottom and remains above both MA’s and in a short term uptrend.

Bottom line: the S&P closed at an important crossroads. Monday’s pin action will be important. It could also tell us whether or not equity investors have finally concluded that the Fed’s QE policy is not as good as they have heretofore believed.

TLT, GLD and UUP are, at the moment, pointing to lower interest rates/a weaker economy.

Friday in the charts.

Bank Bloodbath Brings Down 'Bull Market' As Yield Curve Crashes

One last warning on oil.

One Last Warning For The U.S. Shale Patch

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 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. I have already noted that this week’s move by the Fed plus the fall in interest rates raise questions as to whether the globe and, perhaps, even the US is slipping into recession. That is not my call, at the moment; but it is subject to change.

In short, the economy is not a negative [yet] but it is not a positive at current valuation levels.

  1. 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. Unfortunately, I can’t tell from the inconsistent narrative the true state of the current trade talks with China. Although the one fact that we do know is that the Trump/Xi trade summit has been postponed. As you know, I have been somewhat skeptical that a comprehensive agreement on Chinese industrial policy and IP theft could be reached in the short term. So, this delay is not surprising.

My concern is not that we get no deal or a small deal but that the Chinese out maneuver Trump and he gives away the need for progress on industrial policy and IP theft just to get a deal.

  1. the resumption of QE by the global central banks. If QEII, QEIII and Operation Twist are any guide, the latest Fed move should be a big plus for the Markets, at least in the short term (maybe).

  1. 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: fiscal policy is negatively impacting the E in P/E, although a new regulatory environment is a plus. Any improvement in our trade regime with China should have a positive impact on secular growth and, hence, equity valuations---if it occurs. 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 3/31/19 14074 1731

Close this week 25502 2800

* 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.