Buffett Likes A Bargain

Do you believe that a 3.20% 10-year bond yield alters Buffett’s preference for stocks over all other asset classes? Not a chance! It’s not even close that bonds compete with stocks at these or even slightly higher bond yields compared with all-time record levels of corporate earnings and cash flow. The earnings yield whips bond yields by a country mile.

So, where’s the beef? Are you really afraid of bond yields rising slightly above 3.5% in an expanding economy with nominal growth over 5% and inflation around 2.0%? Growth is good! While we will see less growth in 2019 and 2020, no recession is in slight. Inflation will stay contained too as productivity accelerates holding down unit labor costs after a sharp boost in capital spending in 2018. Corporate profits and cash flow will continue to increase too. Stop looking in the rear-view mirror at historic multiples as interest rates, even after the rise to 3.25%, are historically low. Our stock market is undervalued today!

We live in a VUCA (volatile, uncertain, complex, and ambiguous) environment. So, plan accordingly by controlling risk and maintaining excess liquidity to take advantage of volatile moves in the market. And only buy best in breed with superior managements and winning strategic long-term plans. Like Buffett, invest for the long term. It’s better to buy down than pay up. Buffett likes a bargain. So do we!

Maybe Powell made an error saying that rates are not even close to normalization. But what is normalization anyway? We have lived through many years of excessive monetary ease which included a ridiculously low Federal Funds rate plus the Fed massively buying government debt of all maturities. While that policy kept our economy from falling into the abyss, broad economic growth really did not occur until there were changes in tax and regulatory policies under Trump. Yes, give Trump some credit for boosting our underlying economy. The economy did grow under Obama’s Presidency, but it was due for the most part to monetary stimulus. It did not hurt that bonds yields fell to next to nothing, and the stock market multiple rose dramatically increasing stock prices. It’s time that we come off a sugar high and move toward normalization. That’s good.

Let us state unequivocally that inflation is NOT a problem for all the reasons we have stated many times. Our Fed and all other monetary bodies should promote growth first and foremost as the alternative is far more dangerous for the world economies. Deflation still remains the number one enemy.

We expect the Fed to raise rates in December and no more than two times in 2019, if that. We expect Powell to lower his view of normalization to below 3.0% too. We expect the BOJ. ECB and Bank of China to remain extremely accommodative. The dollar will stay anchored at higher levels until trade deals are reached and global economies reaccelerate. Our deal with Canada and Mexico should go into effect in November. We do expect deals with Japan and the ECB in the foreseeable future too, so be patient. China may be a different story. Corporations have begun shifting their supply lines to other countries away from China with negative longer-term implications for the Chinese economy and its people. China 2025 is at jeopardy unless the government really opens up its economy to multinationals taking less ownership while agreeing that IP must be protected. The ball is squarely with the Chinese government to act as we do not expect Trump to ease up. Nor should he! Give him credit for playing the long ball.

So where are we now?

The US economy has continued to hum along while growth overseas has slowed. Trade issues have hurt business and consumer sentiment everywhere. The IMF has reduced its global economic growth forecast to 3.7% for 2018 and 2019 stating that risks are to the downside without trade issues being resolved. Again, we do expect deals to be reached with Japan and the ECB using the deals with Canada and Mexico as templates. These new deals are not onerous and will be beneficial to global growth. Trump and Chinese President Xi will most likely meet the end of November. Will they pull a rabbit out of the hat? Right now, no one believes so, which is good.

Third-quarter earnings reports have begun in earnest. While we expect strong numbers, managements may decide to temper their enthusiasm due to trade issues. Look over the valley, and don’t focus so much on the short term as there is so much noise out there. You must admit that it was incredible how fast the pundits turned from so bullish to so bearish. The sky is not falling; the economy is strong; corporations are doing just fine, and stocks are undervalued.  Could Nucor raise prices $50/ton if the economy was weakening.? You know that there was some capitulation last Thursday when the defensive stocks, like healthcare, fell as much as everything else. We bought, and are sure that Buffett did too, as others panicked. Think like an investor, not a trader.

We continue to recommend the largest and financially strongest banks who will benefit from loan growth and a steepening yield curve; industrials and capital goods companies; technology at a fair price to growth; domestic steel and aluminum; healthcare; cable and special situations. We do NOT own bonds and are flat the dollar.

If  you are to invest for the long term and buy when others panic, patience and strong belief in your core values is a necessity!

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

Invest Accordingly!

Bill Ehrman
Paix et Prospérité LLC

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