Bridge Over Troubled Waters

We are living in a period of rapid change—whether it is political, economic, financial, regulatory and/or trade. This informs our strategy of investing in companies whose management has the foresight to stay one step ahead of the competition; adapt to an ever-changing marketplace; and invest for growth. Our investment process focuses on management’s corporate strategy, execution and ability to create added shareholder value. Sounds like Buffett’s approach, doesn’t it?

Successful investors listen to, but more importantly understand, quarterly earnings reports. Management not only reviews its past quarter but gives a view of their future ways to enhance shareholder value. Unfortunately, the media only gives snippets of from these reports, which often are misleading as a result. Prime example: Media outlets highlighted last week that DowDuPont’s higher raw material costs represented headwinds while failing to mention that management has not only found ways to offset these pressures but were in fact raising their sales, margin and earnings growth estimates for the year. Without that additional context that sound bite could drive a decision in the wrong direction. You have to do your own homework and do your own fact checking.

Chairman Ed Breen added that the split up of the company into three independent entities was ahead of schedule for 2019. We could give many more examples of misleading headlines and comments of corporate earnings and strategy from business media outlets. It is imperative that you do the work yourself. Investment opportunities are created all time for those who do the work and are in position to profit from the misinformation out there. By the way, these media outlets never go back and correct past false reports.

The US economy is in great shape. Second-quarter earnings are registering a 24% year over year gain; consumption is accelerating; the Inventory to Sales (I/S) ratio continues to fall which presages stronger production ahead; employment rose by 157,000 in July despite a loss of nearly 25,000 jobs due to the Toys R’ Us bankruptcy; employment was adjusted up by a net 59,000 additional jobs in May and June; hourly wage earnings rose 2.7% year over year alleviating fears of much higher inflation ahead; and the overall unemployment rate fell to 3.9%.

It is next to impossible to forecast much of an economic slowdown in the US over the next 12-18 months due to creation of over 3 million new jobs since Trump entered office and his already passed pro-growth, pro-business agenda including lower individual and corporate taxes; a one-year write-off of capital spending; reduced regulations and his trade policy. It does not hurt that much lower interest rates overseas continues to put downward pressure on our rates from what they otherwise may be. Also the BOJ and ECB are maintaining over aggressive easy monetary policies while our Fed stays one step behind no matter what they may say fearing an overly strong dollar and an inverted yield curve.

While we remain concerned that Trump’s trade policy and the fear of rising tariffs may impede global growth for a while, the truth is that it will be transitory including a near-term burst in inflation worldwide. If you listened to earnings calls, you would have heard that company after company are already altering/adjusting/shifting their manufacturing and trade plans to shift their trade patterns without hurting over all revenues/margins. For instance foreign producers who import from abroad will increase their US production/capacity over time while US manufacturers will move production/capacity offshore to offset tariffs overseas too.

The bottom line is that shifts in trade patterns/supply lines will be a zero sum game down the line unless trade deals are reached first. In fact there be may be near-term supply disruptions as these changes take place/implemented and prices/inflation will rise until added capacity is opened here by foreigners and overseas by US producers to offset the tariffs if they take place.

It is important to note that it appears that the US and Mexico are near a trade deal, which we believe will be followed by one with Canada. That’s very important! Have you noticed that Secretary of State Pompeo has been in the Southeast building our relationships in that region? Don’t you believe that China is noticing our new working relationship with the European Union too?  Imagine if Trump builds a coalition against China and its trade/IP abuses everywhere?

Might the Chinese stock market and currency be sniffing this out? China may have much more to lose than the US over time than many think. We are watching all of this very closely but now believe that longer-term risks due to global trade conflicts are less than most perceive and that the chance of trade deals with many of our long time allies has improved putting China in a box. Change is everywhere. Could Trump be that smart?

The Chinese government is not blind to what is happening and is pulling all its strings to boost its domestic economy. Monetary and fiscal polices are being loosened reversing policies put in place less than a year ago to reduce leverage and abuses. If China’s trade skirmishes with the West continue to escalate, the real risk to its economic growth won’t hit until next year. And then it will get increasingly difficult for the country to stop currency outflows from putting further downward pressure on the yuan.

Notwithstanding, we still expect a trade deal with China after our November elections. If so, we will have taken the bridge over troubled waters and 2019 can be a great year for global growth and the financial markets.

How are we positioning our portfolios today?

While we are optimistic that we will reach trade deals with our key trading partners over the next 9 months, we hedge our bets and have created a win/win portfolio no matter how things unfold. We only own companies who are staying one step ahead planning to win competitively no matter which way trade issues go.

We continue to emphasize the financials; industrial and capital goods companies; technology at a fair price to growth; some healthcare and consumer non-durable stocks; industrial commodity companies generating significant free cash flow while reducing operating costs; and special situations where internal changes will increase shareholder value.

One of the best managers/analysts has decided to close shop and start his own family office. I have known Lee Cooperman beginning when he was Head of Research at Goldman Sachs. He is one of the very beat money managers/analysts that I have known over my 48-year career in this business. I wish him the very best.

Remember to review all the facts; pause, reflect and consider mindset shifts; look at your asset mix with risk controls; do independent first hand research and…

Invest Accordingly!

Bill Ehrman
Paix et Prospérité LLC

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