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The Closing Bell

The Closing Bell

7/13/19

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 Uptrend 23375-33605

Intermediate Term Uptrend 14513-30732

Long Term Uptrend 6849-30311

2018 Year End Fair Value 13800-14000

2019 Year End Fair Value 14500-14700

Standard & Poor’s 500

Current Trend (revised):

Short Term Uptrend 2506-3450

Intermediate Term Uptrend 1383-3193 Long Term Uptrend 937-3217

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. Not much data this week and what there was, was slightly negative: above estimates: May consumer credit, month to date retail chain store sales, weekly jobless claims; below estimates: May jobs openings, the June small business optimism index. May wholesale inventories/sales, June PPI; in line with estimates: weekly mortgage/purchase applications, June inflation/core inflation.

There were no primary indicators reported.. This is pretty thin gruel upon which to make a directional call; so, I am rating this week a neutral. Score: in the last 196 weeks, sixty-three positive, eighty-nine negative and forty-four neutral.

As you know, while I have not changed my forecast, I did start the yellow light flashing. This week stats provide little informational value one way or the other.

The overseas data was slightly negative with the EU and China mixed but Japan bad---not that helpful for our own economy.

[a] May German industrial production was below forecasts; its inflation rate was in line, but wholesale prices were above projections; the May UK trade deficit and construction spending were upbeat, GDP was in line and industrial production was below estimates; May EU industrial production was better than expected,

[b] June Chinese vehicle sales and PPI were less than anticipated while CPI was in line; exports dropped less than consensus while imports decreased more; new loans were below forecast while social spending was more,

[c] May Japanese machine tool orders, June bank lending, June economic sentiment and June PPI were below projections while industrial production was above.

Developments this week that impact the economy:

  1. trade: not much on the trade front this week following the US/China ceasefire. Of note, however, is that as part of the new trade truce, China said that it would increase its purchases of US goods. So far, that hasn’t happened. I have to wonder how long that remains the case before Trump renews the trade confrontation.

Fading A China Trade Deal

Trump’s Huawei reprieve was a huge mistake.

Trump's Huawei Reprieve Is A National Security Debacle

The other item worth mentioning is Trump’s increasing calls for a weak dollar. His reasoning is that it helps trade---which initially it does. However, it also makes US assets [read US Treasury debt] less attractive, i.e. it takes a higher interest rate to lure investors, hence prices fall. If the government wasn’t running massive deficits that might be okay. Unfortunately, it is; and that makes financing those deficits more expensive.

So, a weak dollar has two negative secondary effects: higher interest rates and exacerbating the federal deficit. In my opinion, the dollar is like the stock of a country in the sense that you want investors to have confidence in its future value---and that means a stable (or higher) dollar.

Counterpoint (and a must read):

Albert Edwards: The US Is About To Take Global Currency War To A Whole New Level

  1. monetary policy: of course, the big news of the week was the capitulation of the Fed to the Market, which is to say, an ultra-dovish policy where the only question is how many more rate cuts are in our future.

I did my rant in Thursday’s Morning Call, so I won’t be repetitious except to note that [a] the Fed’s economic and policy narratives are not consistent and [b] despite the Fed’s previous unprecedented QE policy, the result was a below average economic recovery {even if you assume it made a positive contribution to the anemic economic growth rate, which I don’t} and the massive mispricing and misallocation of assets.

Has The Bond Market Become A 'Giffen Good'?

  1. tensions in the Middle East remain at a slow boil. The violence remains contained but the war of words goes on with abandon. The bad news is that the threat of violence remains which if it occurs could lead to severe economic consequences in a worst case scenario. Remember a large percentage of global oil supplies transits the Straits of Hormuz, which is bordered on one side by Iran. Any military action that would choke off those supplies would be a negative for the global economy.

US weighing UN ‘snapback’ sanctions against Iran.

Washington Weighing 'Snapback' Of UN Sanctions On Iran

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 totally irresponsible fiscal (running monstrous deficits at full employment adding to too much debt) and monetary (pushing liquidity into the financial system that has done little to help the economy but has led to the gross mispricing and misallocation of assets) policies.

Cyclically, the stronger than expected Q1 GDP dataflow seems to have faded which is not surprising given the lethargic global economy and the continuing threat of trade wars. Indeed, the recent dataflow has been negative enough that I have started the yellow light flashing for a possible downgrade in my forecast.

The Market-Disciplined Investing

Technical

The Averages (27332, 3013) had another good day, with the S&P finally closing above the 3000 level. Both are above their MA’s and in uptrends across all time frames. Still volume was down, remaining anemic; breadth was again mixed. In addition, last Friday’s gap up open still needs to be closed. My assumption is that they will challenge the upper boundary of their long term uptrends (29947, 3191), though the aforementioned conditions remain a potential early warning of a reversal.

The VIX fell 4 1/8 %, drawing ever closer to its historic lows---which should provide pretty stiff resistance. That said, it finished below both MA’s and in a very short term downtrend. So, impetus is lower.

The long bond rebounded 1/8% from Thursday’s shellacking. Importantly, it held at an obvious minor support level. Given its big runup since late May, the consolidation so far has been well within the bounds of ‘normal’. Nonetheless, it is above both MA’s, in a very short term uptrend and has a gap down open which needs to be filled. The big question, which I raised yesterday, is how TLT will act longer term in response to the Powell’s recent surprisingly dovish tilt.

"There's No Escape": One Japanese Bank Owns Over Half A Trillion Dollars In US Bonds

And:

"Well That Escalated Quickly": Is Stagflation Coming?

The dollar was down five cents, but still ended above both MA’s and in a short term uptrend---not what I would expect with Trump crying for a lower dollar and the Fed seemingly accommodating him with a more aggressive expansion of monetary policy.

GLD was up 5/8 %, leaving it above both MA’s, in a short term uptrend and in a very short term uptrend. Still, it has made one gap up and one gap down opens and those need to be dealt with.

Bottom line: despite being overbought (and getting more so) on weak volume, deterorating breadth indicators and the need to fill gap up opens from the prior week, my assumption remains that the Averages are on their way to challenging the upper boundaries of their long term uptrends.

The other indicators appear to have shaken off the initial shock of the Fed’s push to QEIV. However, I would like to see another week of trading before drawing any conclusion about whether the Fed’s action has altered their investors’ outlook.

Friday in the charts.

Stocks Surge To Record Highs As Payrolls & Powell Spark Bond Bloodbath

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. After an upbeat start to the year, the economy has settled back into the doldrums and it isn’t being helped by a slowing global economy, the fallout from the US/China trade skirmish and the burden of the carrying costs of too large a deficit and national debt.

The big question is how the slowing economy will impact the second quarter earnings season which will begin next week.

My sluggish growth forecast is a neutral but that could change if the stats continue to deteriorate and/or the upcoming earnings season and forward guidance prove disappointing.

  1. the success of current trade negotiations. If Trump can create a fairer political/trade regime, it would almost surely be constructive for secular earnings growth.

At the moment, the elephant in the room is China. While investors got jiggy with the recent trade truce, I believe that the Chinese are just buying time and that, ultimately, they will not even consider making any compromise before the 2020 elections, if ever. The current evidence of such is that China has yet to fulfill its promise made as part of the ceasefire to increase purchases of US goods---this after Trump reversed a portion of the sanctions against Huawei. If that doesn’t change, then Trump [a] will likely re-ignite the confrontation and [b] he would then face more than a year of potential bad news on Chinese trade. And given that he measures his success by the level of the Market, the question is, will he fold if the Market declines in a meaningful way?

That may be a moot point right now, but it is a long way to November 2020 and much can happen.

  1. the resumption of QE by the global central banks. That is now occurring worldwide. I reviewed above the increased dovishness of our Fed. In the EU, Draghi is stepping down but not before suggesting a resumption of ECB QE; and he is being replaced by Christine Lagarde who many believe is even more dovish than Draghi.

I have maintained for some time that the key to the Market is monetary policy, more specifically, the total capitulation of the Fed to the whims of the equity market. At the moment, I don’t see anything that is going to change this paradigm of central market/stock market co-dependency.

https://www.zerohedge.com/news/2019-07-12/definitely-not-fed-juiced-melt-nope

That makes no sense to me but that is what we are stuck with. Unfortunately, I have no clue when this model changes; but Herb Stein once said, something that can’t go on forever, won’t. (must read):

Pre-emptive... Or Bubble-Making Monetary Policy

  1. current valuations. I believe that Averages are grossly overvalued [as determined by my Valuation Model].

At the moment, [a] the US economic numbers are not that great, the global stats are worse and, absent a US/China trade deal, are not apt to get better---all of which augurs poorly for corporate profits, [b] long term interest rates are falling, suggesting that a weaker economy, and perhaps even recession may be in our future, and yet [c] equity prices are at their all-time highs. The only explanation that I have for this is in the context that the global central banks measure their success by the performance of the stock Market and act accordingly. As long as that is the paradigm, fundamental economics and valuations will likely remain irrelevant.

As prices continue to rise, I will be primarily focused on those stocks that trade into their Sell Half Range and act accordingly. However, there are certain segments of the economy/Market that have been punished severely (e.g. health care) with the stocks of the companies serving those industries down 30-70%. I am compiling a list of potential Buy candidates that can be bought on any correction in the Market; even a minor one. As you know, I recently added AbbVie to the Dividend Growth and High Yield Buy Lists.

Bottom line: fiscal policy is negatively impacting the E in P/E. On the other hand, 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’ has returned 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.

Disclosure: I am/we are long ABBV.