January 2018 Larsen macroeconomic and market scenarios plus projections - evaluates performance to date - July 25 2018

July 25, 2018 Lewis G. Larsen, Copyright 2018 All rights reserved 1
January 17, 2018: Larsen released PowerPoint on SlideShare
Discussed today’s macroeconomic/market landscapes; made projections
Contact: 1-312-861-0115 Chicago, Illinois USA
lewisglarsen@gmail.com
Lewis Larsen
July 25, 2018
How well have projections performed so far from January 2018 through today?

2018
Image credit: Hywards/Dreamstime
You ain’t seen nothing yet.

Below are key projections published on January 17, 2018
Items noted below are directly quoted from that PowerPoint presentation
▪ Slide #67: “Key long-term macroeconomic and technological forces
that have driven 30-year secular uptrend in stock market prices and
decline in both interest and inflation rates continue to operate as
explained in Larsen qualitative models.”
▪ Slide #67: “Recent increase of ~6,000+ points (33%) in DJIA over past
year occurred with limited price volatility and little retracement or any
significant % technical corrections. Consequently, a healthy
downward technical price correction in stock market indices is
probably overdue after such a painless meteoric rise. Such a
correction would typically entail a hard, freakish decline --- seemingly
out of nowhere --- followed by choppy, sideways trading-range market
for some period of time. Size of break would depend on exactly what
triggered it. 66% retracement or 4,000 points (“Fibonacci” correction)
is not impossible and would not violate parametric boundaries of
long-term secular uptrend. At today’s price levels, initiating new
positions or adding to previous positions on strength is not prudent;
buying during corrections would be a better strategy.”
Projected correction in DJIA did occur: technical break was roughly 3,257 points

Below are key projections published on January 17, 2018
Items noted below are directly quoted from that PowerPoint presentation
▪ Slide #68: “Resumption of strong increases in productivity will put a
strong damper on wage-price inflation and further reduce costs of
goods and services. This will create downward pressures on prices of
manufactured products and help prevent overall inflation rates from
increasing very much beyond today’s levels. This will help keep short-
and long-term interest rates in roughly steady-state at relatively low
values; 30-year secular downtrend in those rates is over, for now.”
▪ Slide #69: “U.S. Federal Reserve presently appears to be hell-bent on
more tightening to ‘fight inflation.’ This could trigger temporary market
corrections, depending on how it is perceived by investors. In any case,
its primary effect would be to flatten or invert the yield-curve. Fed actions
will have minimal effects on long-term interest rates as long as ongoing
CPI inflation rate continues to remain well below 3 - 5% threshold
▪ Slide #69: “U.S. had already regained international competitiveness
before Trump’s very bold initiatives to slash burdensome regulations and
cut corporate tax rates. Those new actions further boosted U.S. economic
prospects: 4 - 6% GDP growth [is] now possible.”

As projected: DJIA corrected; entered into ~ flat trading range
Correction = 3,257 points from high in January or ~ 50% of 6,000 point run
Adapted and annotated graph by Yahoo! Finance

As projected: short-/long-term interest rates slightly higher
1/17/2018: 3-mo T-bills 1.44% 30-yr T-bonds 2.84% July 20: 1.99%; 3.03%
Short- & long-term interest rates seem to be ~ steady-state at relatively low values

30-year U.S. T-bond yield in secular downtrend since 1979-80
As projected: 30-year secular downtrend in yield has likely bottomed-out
Further passage of time will confirm if lows in secular decline are now behind us
?
1980
2018
Adapted and annotated graph by Trading Economics

Finer details: 30-year T-bond yield values since January 2018
30-year yield may have reached its secular lows in Oct. - Dec. 2017 period
?
New trading
range ~ 2.9 - 3.3%
?
Further passage of time will confirm if lows in secular decline are now behind us

https://www.bloomberg.com/news/articles/2018-04-18/u-s-yield-curve-nears-an-
unprecedented-flattening-streak-chart
Quoting: “The Treasury yield curve from 5 to 30 years is
approaching unprecedented territory: It flattened Wednesday
for the ninth straight session, to about 29 basis points. The
spread has narrowed 10 consecutive times on only a few
occasions, and has never compressed 11 trading days in a row,
according to Bloomberg data going back to 1992. ‘The yield
curve can’t flatten every day,’ said Jim Vogel, a strategist at FTN
Financial Capital Markets. ‘But it certainly seems willing to try’.”
As projected: U.S. yield curve flattens from Fed tightening
Federal Reserve continues to “fight inflation”: increases short-term rates

https://www.bloomberg.com/news/articles/2018-04-18/u-s-yield-curve-nears-an-
unprecedented-flattening-streak-chart
Bloomberg chart shows two types of yield spreads going back to 2005
2018
Adapted and annotated graph by Bloomberg

Yield curve started flattening in January of 2017 and hasn’t stopped since
2018
Quote: “But instead, the yield
curve changed course at the
beginning of 2017 and
started flattening --- and
hasn’t stopped since ... The
phrase ‘yield curve inversion’
may not be up there with
‘Taylor Swift’ or ‘Kim
Kardashian’, but it has by
now cropped up in the media
so often that people are
Googling it all of a sudden.”
“Yield-curve inversion consensus rouses contrarian in me”
by Wolf Richter July 17, 2018
https://wolfstreet.com/2018/07/17/yield-curve-inversion-consensus-rouses-contrarian-in-me/
Jan. 3,
2018
July 3,
2018
Adapted and
annotated graph by
Wolf Street

Chart shows yield curves on Dec. 14, 2016 (black line) vs. today (red line)
2018
Quote: “The chart below
shows the yield curves on
December 14, 2016, when the
Fed got serious about raising
rates (black line); and today
(red line). Note how the red
line has “flattened” compared
to the black line. The spread
between the two-year and the
10-year markers, at just 24
basis points today, is
minuscule compared to the
127-basis point spread on
December 14, 2016.”
https://wolfstreet.com/2018/07/17/yield-curve-inversion-consensus-rouses-contrarian-in-me/
Adapted and
annotated graph by
Wolf Street

Many worried that yield curve inversion could be predictor for a recession
2018
https://www.reuters.com/article/us-global-markets-yieldcurve/commentary-in-defence-of-the-yield-curve-
idUKKBN1K21J5
Jamie McGeever, Reuters columnist in DAVOS on July 12, 2018
Quoting: “Yield curve … has been calling [recessions] right for 45 years.”
“All five U.S. recessions since …1970s have been preceded by an inverted curve.”
“Inflation has remained stubbornly low since the crisis and the second longest
U.S. expansion in history hasn’t led to significant wage growth. Many say
traditional relationships between growth and inflation have broken down thanks to
technology, weak labour bargaining power, a more flexible labour market and the
‘gig economy’.” [Note: very consistent with scenario in Jan. 17, 2018 PowerPoint]
“One indicator they and others might want to look at is the Philly Fed’s ‘Anxious
Index’, which measures the probability of GDP contraction in the next quarter. It’s
historically low right now, near levels that have preceded every recession in the
past half century.” [Note: this indicator of recession risk must be watched closely]
“Given its past accuracy and the lack of alternatives, the yield curve is one of the
few recession-forecasting tools economists have. Maybe it won’t be different this
time after all.”

Fed claims that Anxious Index rises sharply at beginning of recessions
2018
https://www.philadelphiafed.org/research-and-data/real-time-center/survey-of-professional-forecasters/anxious-index
Grey-shaded
periods
indicate
recessions
Anxious
Index has
not yet
started
rising in
2018, but
will it rise
later this
year?
2018
2nd quarter
2018 Index
was at 8.6%,
which is
quite low
Indexvalue(%)
Year
8.6 %
Adapted and annotated graph by Federal Reserve Bank of Philadelphia

http://www.businessinsider.com/us-economy-atlanta-fed-gdpnow-forecast-spikes-may-not-last-2018-5
Quoting: “The Atlanta Federal Reserve's GDPNow model is at it again. Its
latest weekly forecast is that the US gross domestic product will grow at
an ample annualized rate of 4.1% in the second quarter. That would be a
nice jolt from the first quarter when the economy grew 2.3% according
to an advance estimate.”
“The GDPNow model was revised up to 4.1% from 4% last week because
of strong retail sales data for April, led by spending on clothes.”
“There are times, like the second and third quarters of 2014, when the
economy's performance blows past the GDPNow model. So it may be
unwise to conclude that this won't happen again. We'll know for sure as
the Commerce Department releases its estimates of second-quarter
GDP, starting on July 27.”
As projected: U.S. GDP growth rate seems to be accelerating
January 17, 2018: said I think that “4 - 6% GDP growth is now possible”

Quoting: “Real gross domestic product (GDP) increased at an annual rate of
2.0 percent in 1st quarter of 2018, according to "third" estimate released by
Bureau of Economic Analysis. In 4th quarter, real GDP increased 2.9 percent.”
National Income and Product Accounts
Gross Domestic Product: First Quarter 2018 (Third Estimate)
Corporate Profits: First Quarter 2018 (Revised Estimate)
Released: June 28, 2018
Latest forecast: 4.5 percent released July 18, 2018
Latest estimates: U.S. 1st quarter GDP = 2.0%; GDPNow 2nd quarter = 4.5%
Quoting: “GDPNow model estimate for real GDP growth (seasonally
adjusted annual rate) in the second quarter of 2018 is 4.5 percent on July
18, unchanged from July 16. After the Federal Reserve Board of Governors'
industrial production release on Wednesday, July 17, modest increases in
the nowcasts of second-quarter real consumer spending growth and
second-quarter real private fixed investment growth were offset by a
decrease in the nowcast of second-quarter real private inventory
investment. The nowcast of second-quarter real residential investment
growth inched down from 0.4 percent to 0.0 percent after this morning's
new residential construction release from the U.S. Census Bureau.”

Chart compares GDPNow model’s forecasts with Blue Chip consensus
https://www.frbatlanta.org/cqer/research/gdpnow.aspx
4.5%
GDP
est.
Adapted and annotated graph by Federal Reserve Bank of Atlanta

https://www.zerohedge.com/news/2017-01-27/barack-obama-now-only-
president-history-never-have-year-3-gdp-growth
2018
GDP growth ≥ 4% = exceptional performance; avg. 1.48% from 2008 - 2016
4.0%
GDP
1950
Adapted and annotated graph by ZeroHedge

U.S. labor productivity continues to grow at excellent rates
Automation is displacing labor at highest rate since Industrial Revolution
2018
https://tradingeconomics.com/united-states/productivity
Increased productivity & automation short-circuit U.S. wage-price inflation spirals

U.S. labor cost increases continue to be surprisingly modest
June 2018 U.S. unemployment rate = 4.0%; some say ~ “full employment”
2018
https://data.bls.gov/timeseries/CIU1010000000000A

2016 - 2018: price of crude oil increased from ~$30 to $70/bbl
Recent real crude oil price of ~US$ 70/barrel expensive in historical terms
2018
https://www.quandl.com/data/BP/CRUDE_OIL_PRICES-Crude-Oil-Prices-from-1861
Refreshed June 22, 2018
US$ 72.58
20182013
Market closing prices on July 19, 2018
(2016$)
Adapted and annotated graph by Quandl

Energy intensity measures how energy benefits an economy
Megajoules (MJ) of energy used per $ of gross domestic product (GDP)
2018Energy intensity (abbreviation = EI): “Measures how much a bit
of energy benefits the economy. This value is calculated by
taking the ratio of total primary energy use (TPES) (all of
the fuels and flows that a country uses to get energy) to GDP (the
total money made in a country). This quantity (measured MJ/$) is
used to indicate how effectively a certain economy is using
their fuels and flows. When a country reduces wasted energy it
becomes more efficient, this lowers its EI (lower EI is better).”
Further quoting: “This ratio quantifies how much good a little bit
of energy provides. Energy use per capita describes only how
much energy is being used, and provides no details as to how
that energy is helpful. EI clarifies 'what energy does for a person',
which certainly varies from country to country. Wealthier
countries almost always use more energy per capita than poor
countries and EI accounts for this discrepancy in wealth.”
https://energyeducation.ca/encyclopedia/Energy_intensity

Value of U.S. EI has decreased dramatically since mid-1970s
Oil price spike caused by 1973-74 Arab oil embargo altered U.S. behavior
2018
https://energyeducation.ca/encyclopedia/Energy_intensity
“Great Recession”
of 2008
U.S. had enormous
gasoline shortages
during oil embargo
Oil embargo caused U.S.
retail gasoline prices to
quadruple in short period
MartyLederhandler/AP
Adapted and annotated graph by University of Calgary

EI of U.S. and world have decreased by > 1.2%/yr. since 1990
World economy now much more resilient to oil price shocks vs. 1973-74
2018
https://yearbook.enerdata.net/total-energy/world-energy-intensity-gdp-data.html
Quoting: “Global energy intensity (total energy consumption per unit
of GDP) declined by 1.2% in 2017, slightly below its historical trend
(-1.5%/year on average between 2000 and 2017 and -1.8% in 2016).”
Adapted graph by Enerdata

U.S. economy now vastly less vulnerable to oil price shocks
Persistently high real oil prices or spikes much less inflationary vs. 1970s
2018
https://www.usnews.com/news/national-news/articles/2018-07-10/eia-us-net-oil-imports-
to-drop-to-lowest-levels-in-60-years
Quoting: “U.S. NET OIL IMPORTS are projected to drop by nearly 60 percent next
year compared to 2017, falling to their lowest levels since 1958, the U.S. Energy
Information Administration said Tuesday in its latest Short-Term Energy Outlook.
‘That certainly is eye-popping,’ says Patrick DeHaan, head of petroleum analysis for
GasBuddy. Net imports are expected to fall from an average of 3.7 million barrels
per day last year to 2.4 million bpd this year and 1.6 million bpd next year – ‘a pretty
staggering number,’ he says. The reduction in net imports of foreign oil – a measure
of the amount of oil imported versus the amount of oil exported – is being driven by
record-setting production that is poised to see U.S. producers extract more oil per
day next year than the last record set in 1970. The forecasts, if proved right, would
continue trends unleashed by the U.S. shale oil and gas boom of the past decade.
The U.S., in short, may in a few years become a net exporter of oil – a major shift in
world markets and the country's economic makeup – but it will always remain
‘energy interdependent,’ says Tom Kloza.”

https://en.wikipedia.org/wiki/United_States_Consumer_Price_Index#/media/File:Inflation_and_oil.png
As projected: U.S. annual rate of inflation remains low ~ 2.8%
Recent high real $ price of crude oil has done little to accelerate inflation
BLS (June 15, 2018): “Consumer Price Index up 2.8 percent
over the year ending May 2018.” Note: average monthly rate
of inflation from Jan. thru May 2018 = 0.2 %/month (BLS data)
Adapted and annotated graph by Wikipedia

CRB does not suggest significant reacceleration of inflation
Behavior of CRB data since 2016 still within boundaries of 9-yr. downturn
2018
Long-term downtrend in CRB Index could be bottoming like 30-yr. T-bond yields
Adapted and annotated graph by BigCharts

As projected: U.S. annual rate of inflation remains low ~ 2.8%
Larsen’s long-term macroeconomic scenario is intact if inflation < ~3 - 5%
Note: U.S consumer prices rose
+2.8% in the twelve months up
to June 2018; this was fastest
increase since February 2017
and before that, February 2012
2018
3%
5%
Adapted and annotated graph by John Kemp (Reuters)

Gold has been in sideways trading range since August 2017
Price drop ~$100/oz. so far in 2018; suggests no acceleration of inflation
2018
2018: Gold price went down ~$100/oz. while crude oil price went from ~$60 up to
~$70+/bbl; decreases in world EI attenuate inflation impact of oil price increases
Adapted and annotated graph by Goldprice

DJIA to Gold price ratio has been increasing; will it continue?
Price appreciation in equities substantially better than Gold for 5 years
2018“This interactive chart tracks the ratio
of the Dow Jones Industrial Average to
the price of Gold. The number tells you
how many ounces of Gold it would take
to buy the Dow on any given month.
Previous cycle lows have been 1.94
ounces in February of 1933 and 1.29
ounces in January of 1980.”
Adapted and annotated graph by macrotrends

U.S. Dollar is presently very strong versus other currencies
Increases $ price of oil, cuts U.S exports, but dampens U.S. inflation rate
2018
Trade-weighted U.S. Dollar Index: January 4, 1995 through July 11, 2018
Today’s value of Index close to peaks seen in Feb. 2002 and Dec. 2016 - Jan. 2017
https://fred.stlouisfed.org/series/TWEXB
Adapted and annotated graph by
Federal Reserve Bank of St. Louis

Overview: current values of major stock indexes & P/E ratios
Most P/E ratios today not markedly different from values of one year ago
2018

Chart: value of S&P 500 P/E ratio from Jan. 1928 to Jan. 2018
July of 2018: S&P 500 = 24; DJIA = 23; Nasdaq 100 = 26; Russell 2000 = 81
24 P/E at upper-end of 90-year range; in healthy market environments, stock price
increases should be earnings-driven --- that will happen if U.S. GDP growth ≥ 3%
Adapted and annotated graph by macrotrends

2018
Image credit:
Will bull market uptrend in stocks resume?
When might that happen and how will we know it?
What specific risk factors could prevent this from occurring?
Old Wall Street adage: “A bull market climbs a wall of worry.”

Reference: PowerPoint uploaded to SlideShare Jan. 17, 2018
Adobe Acrobat pdf download copy available at URL provided down below
https://www.slideshare.net/lewisglarsen/lewis-larsen-dowjones-industrial-average-
reaches-26000-what-happens-next-boom-or-bust-jan-17-2018

Chart of DJIA as of July 20, 2018: now in a sideways pattern
Questions: (1) will 2016-17 uptrend resume? ; (2) when might that happen?
2018
Fundamental market forces will trigger breakout if long-term scenario stays intact
Adapted and annotated graph by Yahoo! Finance

If uptrend resumes DJIA must exit its recent sideways pattern
Chart below shows an idealized breakout from roughly triangular pattern
2018
Adapted and annotated graph by DailyPrice Action

See Jan. 17, 2018 Larsen PowerPoint for details of models
Economic and technological forces continue to support bullish scenario
2018
Key long-term macroeconomic and technological forces that have driven a 30-
year secular uptrend in stock market prices and decline in both interest and
inflation rates continue to operate as explained in Larsen qualitative models.
▪ U.S. had already greatly regained much of its international competitiveness
before Trump’s bold initiatives to slash burdensome regulations and reduce
corporate tax rates. Those recent actions further boosted U.S. economic
prospects: 4 - 6% GDP growth is now possible. To assess present rate of
U.S. economic growth see estimated 2nd quarter 2018 GDP released July 27
▪ Strong GDP growth of 3% or more in 2nd quarter 2018 estimate may well be
a necessary but not solely sufficient condition for a stock price breakout.
While excellent GDP growth boosts corporate earnings, market participants
might still be quite worried about: (1) earnings and GDP hits from tariff-
driven trade wars with China and EU; (2) triggering of U.S. recession by Fed
policy error in continuing to increase short-term interest rates (unaware
that major reacceleration of U.S. inflation rate is really not a problem); and
(3) risk that Republican party could possibly lose control of U.S. House, an
event that could lead to Trump’s impeachment and removal from office ---
this would be quite negative for markets due to reversals of Trump policies

Long-term economic and technological forces are ameliorating inflation
2018
▪ Long-running trade wars via imposition of tariffs is a non-trivial risk for
future U.S. economic growth and corporate earnings. If and when market
participants become convinced that Trump will very probably be able to
negotiate fairer trade deals with China and EU and drop newly imposed
punitive tariffs, that risk will disappear as impediment to upside breakout.
Watch for key signs that trade negotiations may be headed for ‘soft landing’
▪ Multiple long-term fundamental economic and technological parameters
indicate that U.S. rate of inflation is well under control and very unlikely to
exceed key 3 - 5%/year threshold level for any significant period of time. If
that holds true, Larsen’s long-term macroeconomic scenario will remain
intact and long-running secular bull market in U.S. stocks should continue.
This further implies that upside breakout of today’s sideways price pattern
is inevitable; only remaining question is when that event might happen.
Caution: breakout could be delayed by lingering worries that U.S. Fed (still
planning more interest rate hikes in 2018) might boost rates way too much,
invert the yield curve, and then trigger a U.S. recession due to policy error
Sideways market price patterns very often characterize periods during which
market participants are assessing likely probabilities for key risk factors. Up or
down price breakouts occur once market fundamentals are better clarified

No obvious economic reasons for U.S. recession during next 3 - 9 months
2018
▪ Since the U.S. economy is just beginning to strongly re-accelerate --- and
absent any near-term Fed policy errors or totally unexpected, exogenous
economic calamities --- there are no compelling economic reasons for it to
slide into a recession during the next 3 - 9 months (which would trigger a
downside price breakout). See how market reacts to further interest rate
hikes & additional yield curve flattening or inversion; also watch behavior of
Philadelphia Fed’s Anxious Index. Although it is not infallible, if Fed’s Index
‘flashes red’ one should evaluate total market exposure and closely monitor
new economic data for any confirmation that a recession may be imminent
▪ Absent obvious onset of U.S. recession and/or all-out China/EU trade war
with no hope for negotiating better trade agreements, watch carefully for
classic technical breakout event similar to what is illustrated on Slide #37.
Given U.S. GDP ≥ 3%, upside breakout from sideways price pattern would
receive additional impetus from any successful resolution of present vexing
U.S. trade issues with China and/or EU. However, breakout may not occur
until and unless Fall election results eliminate risk for Trump’s impeachment
Markets do not always wait to stage breakouts of sideways price patterns until
probabilities for fundamental economic and/or political risks are fully resolved.
Consequence: one must always be alert for technical breakouts as in Slide #37

Upside price breakout of DJIA is likely to occur within next 3 - 6 months
2018
▪ Recent bellicose communications between U.S. and Iranian leaders have
raised specter of hostilities between U.S. and Iran leading to possibility of
Iran blocking transit of oil tankers through Strait of Hormuz. If this event
occurred, and depending on duration of shipping interruption, spot crude
oil price would skyrocket and oil markets would drastically invert. Similar
cataclysm that occurred during 1973-74 Arab oil embargo helped trigger a
global “stagflation” recession that lasted from 1973-75. Situation of U.S.
and global economy are different today: world EI is much-reduced from
levels prevalent in 1970s and oil price increases have much lesser impact
on current rates of inflation (see lower chart on Slide #21). Unlike 1970s,
there is now substantial capacity for manufacturing hybrid or all-electric
vehicles. Today, consumers could very rapidly switch from vehicles being
powered by gasoline or diesel fuel to electricity if economics are favorable
▪ Conclusion: long-term macroeconomic scenario outlined in Jan 17, 2018
PowerPoint remains intact. Consequence: long-term secular uptrend in
U.S. stock prices is still underway. Given that inflation rate remains < 3 - 5%
and long-term interest rates appear to be in ~ steady-state at relatively low
levels, and barring any serious Fed policy errors and near-term recession,
upside price breakout of DJIA is likely to occur within the next 3 - 6 months

January 2018 Larsen macroeconomic and market scenarios plus projections - evaluates performance to date - July 25 2018

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