After the self-destruction of the Obamacare repeal, and given the fact that the market has priced in a tax cut, it is hard to know what to expect. The priority has apparently shifted to tax reform but it has to be regarded as very questionable as to whether that tax reform will actually get done and what it might contain. The market weakness last week has improved valuation metrics but not much. Earnings and unemployment still look OK. Sentiment is also improving but is just neutral now. My model is continues to find 20 good ideas to buy so it is fully invested but there could be some volatility ahead as the Republicans regroup and give guidance on their next move.
I don't like the idea of paying so much attention to the Federal Government when we are supposed to be in a capitalistic system but, as I stated last week, I think it is very important that the health care bill get passed in some form. The house will probably vote this week and then we will have to worry about the Senate. If it does not pass I think the prospect for tax reductions this year is poor and I believe valuation is super high because investors have priced in tax cuts (at least for corporations). Meanwhile, earnings estimates are still in an upward trend and unemployment is low and stable. Sentiment is still poor but there have been some improvements in the last couple of weeks. My model is still finding 20 stocks to buy so it is fully invested. Last week was a good week, thanks in part to KMG and its favorable earnings report.
Last week was ugly as the broad market continued to do worse than the major averages, essentially losing all the year's gains. I think it is mostly a political problem having to do with the repeal of Obamacare. It is looking more and more like the proposed law will not be passed and, if that is true, everything including tax reductions will be pushed back and become more questionable. There is no doubt in my mind that investors have been discounting a reduced corporate tax rate by bidding stock prices up to extreme valuation levels. Last week caused some uncertainty and that is likely to continue. My model does not take such factors into consideration so I am left with poor valuation, neutral to negative sentiment, earnings that are still expected to be higher and unemployment that is low and stable. My model is again holding 20 stocks this week but I am toying with the idea of hedging some of my exposure until the political situation is clearer.
The major averages just continue to forge ahead but under the surface there are still serious problems. Last week there were again more stocks down than up while both the Russell 2000 and the Value Line Geometric Average were lower. It has been tough to keep up with the major averages this year and my portfolio is no exception. These are technical signals but they show weakness. Fortunately, earnings estimates are still in an uptrend and unemployment is OK. Valuation remains horrible, though, and sentiment is still neutral to negative. My model has found some additional stocks to buy so I am back to 100% invested this week.
Richard Moore, CFA
With my wife in Hawaii