Valuentum Exclusive Analysis for the Discerning Investor

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Valuentum: 2017 Is the Year of Evangeline Adams

By Brian Nelson, CFA

“Entrepreneurs are never satisfied. They want to do things better. They strive for perfection and use all the ingenuity to their command to achieve it.” – J.W. Marriott

My Inbox Was Overflowing with Kindness

Your positive replies to my last email, “Words Cannot Express How I Feel” were simply incredible. My inbox was flooded with so many emails, so many kind words. There were so many that I’m still working through them. If you haven’t received a personal reply, plan on getting one. You’re very important to me. It’s quite possible that I may very well be the luckiest man to have such wonderful members, and I truly mean that. Thank you.

Sometimes I let the critics get the best of me, and as one that strives for perfection day in and day out like ol’ J.W., whose quote graces the top of this article above, maybe I take too many things to heart, things even beyond my control. But that’s what it takes to strive to be the best – I’m never satisfied. I always feel like I can do better. After all, there’s just too much information on the web this day and age. Investors need a place that they can count on – that’s where Valuentum comes in.

Sorry That We Couldn't Accept Your Gifts

I wanted to let you know that I am more motivated than ever, and your rejuvenating words had a lot to do with it! It is both an honor and a privilege to serve you, and I do my best to incorporate any and all feedback, so keep it coming. A quick note: Our team decided to forgo your gifts, and I do apologize for the inconvenience on the matter. I got swept away during the holiday season a bit. I don’t want anything to jeopardize our independence or our status as a publisher, but I thank you very, very much for your kind gestures. Having you here, reading our work, is more than enough.

Our efforts to drive outperformance in the newsletter portfolios and provide ongoing systematic investment research coverage that meets your needs remains undeterred. I’m thinking 2017 may be a break-out year for Nelson Exclusive ideas, too. We’re gearing up to release a treasure trove in coming editions, and we may add another incremental idea to the publication (in light of what may be a fantastic 2017 for the stock market – keep reading). Thus far, I wish some ideas would have done better out of the gates, but I’ve been satisfied with the performance of the Nelson Exclusive, all things considered, particularly in light of a whipsawing market from the Presidential election.

One more housekeeping item. I wanted to remind you that a subscription to Valuentum is typically ongoing, and that based on the payment cycle that you’ve chosen, the payments are generally recurring. I mention this because I don’t want you to be surprised that there may be a payment consistent with your billing cycle in the future. I remember several years ago when the Wall Street Journal charged me for a renewal. I was so disappointed. But then I thought about it – and I decided that I wanted to keep the membership because I found the content compelling, so it didn’t bother me that it was a recurring payment. I wanted to add this quick reminder about the payment plan that you’ve set up in PayPal. Please let our team know if we can be of any assistance.

Let Us Begin

With all of this out of the way, the S&P 500 (SPY) closed at 2,249.92 Wednesday, December 28, 2016. The latest reading for US GDP growth came in at 3.5% during the third quarter of 2016, and despite the throngs still under-employed in the US, the country’s unemployment rate fell to 4.6%, the lowest level since 2007 – the last year before the very worst of the Financial Crisis that claimed Lehman Brothers, Bear Stearns, and Washington Mutual, and threw General Motors (GM) and AIG (AIG) into a tailspin.

As of this week, the forward 12-month price-to-earnings ratio, albeit a terrible way to calculate intrinsic value in light of all the shortcomings of relative value assessments (i.e. systemic overvaluation risks, non-GAAP flexibility, and the like), stands at ~17 times on a 12-month EPS estimate of $132.40, according to the latest from Factset (FDS). The 10-year average of the measure, which includes an ever-optimistic economic recovery on earnings levels much lower than those of today, is a mere 14.4 times. The 5-year average stands at ~15, a level that many view consistent with very long-term averages. Assuming a reversion to the 5-year average, a decline of ~13% would be a base case scenario for the S&P 500 for 2017.

However, that’s not what I think is going to happen next year. Though my words have been laced with cautiousness and prudence held dear for the past few years (and especially in the inaugural edition of the Nelson Exclusive), I believe the election of Donald Trump will serve as the catalyst to usher in a year of stock-market speculation like no other, at least no other in the last 85 years or so. Am I saying that Donald Trump will be a great President? He might be, but that’s not why I think 2017 may be one of the best years of this aging bull market, even if it may be followed by some tough times. Let me explain.

I am calling the year of 2017 “The Year of Evangeline Adams.” For those that have never heard of Ms. Evangeline Smith Adams, she was an American astrologist during the early 20th century that called New York City her home. She owned a burgeoning astrological consulting business, and her stock-market prediction newsletter (on the basis of astrology reading) in the 1920s had one of the largest followings, even by today’s standards. Though her work has largely been discredited in more recent years, she, in my opinion, defined the euphoria that drove the stock market bubble in 1929. From one of my favorite PBS documentaries of all time, a must-watch if you haven’t already, “The Crash of 1929:"

Even at the height of the speculative frenzy, only a small percentage of the American public actually invested in stocks, but the market had entered popular culture. Wall Street became Main Street. Everyone was talking stocks. Watching the ticker became a national sport. Popular magazines covered financial news. Dozens of best-sellers promised investors the inside track. The characters in the popular comic strip “Gasoline Alley,” were investing in a company called “Rubber Keyhole.” Stock tips came from everywhere. Some investors followed the advice of Evangeline Adams, an astrologer.

She was able to calculate the variations of the stock exchange so accurately that there was practically no difference to having have read it in a ledger somewhere. Among her more interesting clients were Charles Chaplin, Mary Pickford and J. Pierpont Morgan.

In February, Evangeline Adams looked at the stars and predicted a dramatic upswing in stock prices for the coming months. The stock market, once considered a highly risky place to put your money, was now beginning to attract a whole new group of amateur speculators. Among the new players was one Julius Marx. Everyone knew him by his stage name, Groucho.

May 1929. Stock prices were going up and up. With so much money to be made, people were borrowing more money than ever before to buy stocks. Market leaders like William Durant, far from being worried, were ecstatic. Off on his annual visit to Europe, he announced that everything would be fine as long as we all continued to believe: “Confidence — not halfway confidence, but 100-percent confidence — is the real basis for our prosperity.”

Astrologer Evangeline Adams was now putting out a newsletter. Her 100,000 subscribers learned how the Zodiac could influence stock prices. Her advice for the coming summer: buy.

September 2nd, Labor Day. It was the hottest day of the year. The markets were closed and people were at the beach. A reporter checked in with astrologer Evangeline to ask about the future of stock prices. Her answer: the Dow Jones could climb to heaven. The very next day, September 3rd, the stock market hit its all-time high.

How confident market participants must be to continue to park assets in index funds at any price. How confident investors must be to reinvest dividends at any price. “Confidence – not half-way confidence,” as William Durant said, but “100% confidence.” How many indexers and dividend growth investors are operating with 100% confidence these days? How many readers are following the Evangeline Adams of today, and may not even know it. Sure – they’re probably not reading astrology, but they might as well. The market needs Valuentum’s sobriety more than ever. But it is with this backdrop that my predictions for 2017 may be shocking! Let’s talk about why I think 2017 is the Year of Evangeline Adams.

Just a quick little note: The only thing I know for sure is that my predictions for 2017, even if they are in the ballpark, will be precisely wrong -- and while I believe the following is likely to happen in 2017, certain unknown unknowns can alter my thesis during the year, much like a Trump victory has changed the game from mid-2016. I don’t like making predictions at all because they are not essential to long-term success in the stock market, but I do think sharing all of my thoughts is an important part of the value we provide. Please also note that none of this is prompting me to make any changes to the newsletter portfolios.

1) The Stock Market Bubble Continues to Inflate

There are a few things that I think will drive stocks indiscriminately higher during 2017. First, the indexing game. The new DOL Fiduciary Rule may be driving more and more money blindly into indexes such as the S&P 500, for example, which is stretched well beyond its normalized multiples. The DOL rule goes into effect in April, so the market could literally keep going higher regardless of news for the next few months of the year.

The justification for indexing may be as simple as “stocks always go up,” but in light of the amount of cash flowing into indexes coupled with the popularity of dividend reinvestment and corporate buybacks (some leveraged ones), the stock market, in my view, is in a bubble, perhaps to nobody’s real surprise. But maybe to some surprise, I don’t think this bubble will burst in 2017, nor does it have to. I think it will only get bigger next year. Just like Evangeline Adams said in 1929, it's possible 2017 may be the year that “stocks climb to heaven.”

I worry immensely, however, about the implications once this bubble does pop (in 2018? 2019? – will rising interest rates be the catalyst?), which is why we continue to exercise caution and prudence in the newsletter portfolios, but their respective returns, too, may reach all-time highs…yet again…during 2017. We expect most of the alpha-generation in the newsletter portfolios to occur during an inevitable reversion-to-the mean scenario, which may not occur until after next year.

Making money is only part of the story. Keeping it is the most important other part! That’s why we’re not going all-in in this frothy market, even though we think 2017 will be another good year, albeit for unsustainable (and behavioral) reasons.

2) The 10-Year Treasury Yield Rises to 4%

The Federal Reserve continues to implement contractionary monetary policy, and the market has now pushed the 10-year Treasury to ~2.5% more recently. We expect the Fed to continue to tighten during 2017, and even start to talk more openly about the frothiness of equity prices in the US. Think Greenspan in 1996.

We don’t think this will stop the rise of stocks in 2017, however, as I believe what is driving stocks during this phase of the bull market is more index speculation driven by the ongoing proliferation of passive investing, itself bolstered by dividend reinvestment. Indexing is not new, of course, and while its existence may not be hazardous as a small portion of global investing assets, its proliferation can introduce myriad risks markets have not yet seen.

Throngs of investors not paying attention to the price-versus-value equation (as indexers do) is far more dangerous than unhedged derivative positions at the big banks, high frequency trading, or even algorithms trading on the same information (think Flash Crash). When “everyone” indexes, market prices detach from reality, and I believe this is what is starting to happen. 2017 may be in the biggest year for indexing yet…and because indexing itself is speculating without care for underlying valuations, it sets the stage for more air to continue to be pumped into this stock market bubble.

I believe “safe” US Treasuries will be sold en masse as a result of continued greed-driven stock market strength, and the 10-year yield may reach ~4% before year’s end as a result. It is highly unusual for stocks and Treasury yields to move together for long periods of time, at least since the early 1990s, but I think it will happen in 2017.  

3) Crude Oil Settles Near $75 Per Barrel

“By the end of 2020, our base-case forecast for the price of crude oil is roughly $75 per barrel…After applying the previously-derived margin of safety of ~$30, our upside case by 2020 is approximately $105 per barrel, while our downside case is approximately $45 per barrel.” – Valuentum, March 2015 (about 20 months ago)

We think crude oil prices will settle at the high end of our forecasted range next year. The supply/demand market continues to show signs of improvement, and traders have been backing the price advance. OPEC has come to the negotiations table, and global GDP may serve as a healthy boost to the demand side of things.

The price of crude oil has already doubled since the doldrums of January/February, but a continued rise to $75 before the end of 2017 may be in the cards, in our opinion. We like Continental Resources (CLR) as our favorite idea to play the forecasted surge in the price of Texas tea.

4) Consumer Staples Stocks Underperform

We think investors are wising up to the risks of consumer staples stocks, and increasing risk-free rates seem to already be complicating the investment decision-making process for many investors.

Consumer staples equities in the S&P 500 are currently trading at ~19.4 times forward 12-month earnings, well above their sub-17 times 10-year trailing average. We believe investors will continue to swap out of these steady-eddy, but overpriced, gems in the near term, in favor of higher-beta commodity and energy-oriented companies as the market sets up to surge in 2017.

We have been warning about the tipping point in Treasury yields and implications on dividend-paying consumer staples equities for some time.

Household Products: CHD, CL, CLX, ENR, HELE, KMB, JNJ, LBY, PG 

5) Donald Trump, the Wizard Behind the Curtain

In true Wizard of Oz fashion, President Donald Trump will do whatever he can to drive the US equity market higher during his first year in office. He will have his hands in everything, far more than any other President before him.

I believe he will influence Fed policy. I believe he will be successful modifying the tax code. Parts of Dodd-Frank and Obamacare are on the chopping block and will likely be chopped. I believe that he will pull years and years of US growth into his first year at the helm of this country, a move that will provide a false sense of the true pace of economic growth in the US. The pace may even convince many that the US is somehow ushering in a new era of unbridled expansion, giving misguided support to the euphoric rise in stocks during the year.

Donald Trump wants to win. He has to win – and the stock market is one of the biggest yardsticks to measure whether he wins or not. We’re not ready to say the latter part of a Trump Presidency will result in the next stock market crash in US history (odds are it might), but I believe 2017, his first year, will be one of the best for stock holders.

Look at how his tweets are impacting Boeing (BA) and Lockheed Martin (LMT) among others. It will only be a matter of time before he starts tweeting about the Dow Jones Industrial Average and the S&P 500.

What to Do?

It depends, of course.

We continue to expect strong risk-adjusted performance from both newsletter portfolios during 2017, so those interested in how we’re approaching today’s market in a portfolio setting should look into those ideas.

As for readers looking for three brand new ideas each month, the Nelson Exclusive may meet your needs. Please have a look at ordering the Exclusive here. I’m excited about what 2017 may bring, even as I’m worried about 2018 and beyond.

Have a Happy New Year – and thank you again for the messages!

Actual results may differ from simulated information being presented. The Best Ideas Newsletter portfolio and Dividend Growth Newsletter portfolio are not real money portfolios. Results are hypothetical and do not represent actual trading. Valuentum is an investment research publishing company.

P.S. Please be sure to visit the website frequently. We don’t send out everything by email. 

Now read: Nelson: The 16 Most Important Steps To Understand The Stock Market