2018: Taking Away Monetary Life Support Systems

As the global economies continue to accelerate entering 2018, monetary authorities’ “great experiment: QE” will slowly come to a close after 10 years. Economists will debate for years whether it was a success or even needed in the first place. Personally, I felt that it was a success, saved the global economies from sinking into the abyss and ended deflationary fears. So, I tip my hat to Bernacke and other monetary leaders for taking such a bold, unorthodox approach at a time of great need and despair in the world.

As we look into the New Year, the amount of QE universally will be gradually reduced until it is non-existent, followed by a gradual unwinding for the balance sheets reducing the billions upon billions of government and other forms of debt bought during this program. The Fed, ECB and BOJ balance sheets may never go back to where they were 10 years ago. However, reducing the balance sheets will give the monetary bodies the ability to do it again if needed sometime in the future. Let’s hope not!

There is no need to fret about the end of QE and the unwinding of the balance sheets even though this process is at the margin restrictive. It will not slow down the global recovery for several reasons: fiscal policies will competitively ease around the world led by the U.S.; bank and financial oversight will ease now that capital and liquidity ratios have risen so much; government regulatory policies will loosen and inflationary expectations will stay contained limiting future short term rate hikes.

It is clear that momentum continues to build for an accelerating economy as we enter 2018: business and consumer confidence is at a multi-year high everywhere which has led to an acceleration in consumer spending, hiring and capital spending; inflation and interest rates remain incredibly low due to global competition, technology and the disruptors; financial capital and liquidity ratios have continued to rise, therefore there is more than enough capital to finance the continued expansion; fiscal policy changes are happening everywhere after years of restraint even in Europe although China may be tightening lending regulations at the margin which is a short term negative but a long term positive; and finally, corporate profits have taken off for the right reason—growth—not cost reduction.

None of this has gone unnoticed by the global stock markets as virtually every single one of them is at multi-year NEW highs. Will it continue in 2018 is the $64,000 dollar question and our answer remains YES!

But not all markets, industries nor all companies may participate for a host of reasons that we have been discussing for years. Change is everywhere and unless managements recognize it and are willing to make major changes in strategic planning and implementation, they are apt to not only fall behind but also die. Hence, we can create a long/short portfolio.

We are not surprised that holiday sales started with a burst with the biggest gains done over the Internet. There was a huge shift in sales origination to the internet even before Cyber Monday. While some of the box stores may survive, it is hard for them to profitability compete over time with such high fixed costs compared to a company like Amazon. Amazon and other disruptors will continue to enter new markets where sales volume is huge and delivery can be done overnight or even the same day.

I started Paix et Prospérité five years ago after a 6-year hiatus in investment banking after a 35-year successful run managing hedge funds. All to prove that it was not the asset class that was bad but the management of hedge funds as the class became over saturated reducing the quality of the management.

We have successfully outperformed all averages by a wide margin during this period. I attest our success to a number of things. First we are disciplined and allow our core beliefs to guide us; we are global investors having invested overseas since 1973; we have been mentored and have partnered with the best of the best including George Soros; we are open-minded always looking for change; we are independent thinkers and do our own research and we are always focusing on where we can be wrong and are willing to admit mistakes. We do not pretend to be all things to all people. We stay in our lane. We do not invest in areas and companies that we do not understand nor have first-hand research on.

The bottom line is that the preconditions for a market top are simply not present despite the run up this year. We continue to emphasize financials, namely major city centered banks, that will benefit from volume loan growth and a steepening yield curve; global industrials that will benefit from growth in capital spending that has been lacking for many years; technology at a fair price to growth; low cost, under leveraged industrial commodity companies as volume growth outstrips supply growth therefore inventory levels decline and prices rise; Chinese consumer and technology companies which will benefit from a shift in government emphasis away from production to consumption and special situations where managements have made the hard decisions to implement dramatic change to thrive in a globally competitive landscape.

Finally, we expect the U.S. government to not only pass major tax reform by early next year, but also a sorely needed major infrastructure program before elections in 2018. Patience is necessity to let all of this unfold as it is easy to take profits but there is more to come for the investor.

So remember to review all the facts; pause, step back and consider mindset shifts; look at you asset allocation along with risk controls; do independent fundamental research and …

Invest Accordingly!

Bill Ehrman
Paix et Prospérité LLC

 

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