Call to Action

The global economies are in a synchronous slowdown. Unfortunately, there is not much more that the BOJ, Bank of China, ECB, Fed and all other major monetary bodies can do at this point.

Interest rates are low, and we are not suffering from a lack of money or liquidity. While all of this may be good for financial assets, it is not boosting the global economy. The real problem is a total lack of business and consumer confidence that the powers to be will act responsibly by reaching trade deals, easing fiscal policies and reducing overly burdensome regulations.

We need a “Call to Action” as economic risks remain more to the downside than the upside. Economic growth and inflation forecasts continue to come down for China, the ECB, the emerging markets, Japan, India and even the U.S.. Fortunately, it would not take much to change the direction of the global economy.

We still remain optimistic that trade deals will be reached this year, but it is about time for all sides to walk the walk and stop the talk. President’s Xi and Trump want to reach a deal for political and economic reasons, but it is unlikely that one will be concluded within the initial 90-day period. We expect a 60-day extension without additional tariffs as Trump and his team recognize that the U.S. economy and financial markets would get hit otherwise. In addition, we expect a final deal before year-end to benefit Trump’s 2020 reelection hopes.

Reaching a deal with the Eurozone may be even more difficult than reaching a deal with China. It is next to impossible to expect each country in Europe to accept a pact negotiated by European Commission President Juncker that serves each country’s self-interest. We will watch closely next week to see how Trump responds if car tariffs are recommended by the Department of Trade against imports from the Eurozone for national security reasons. Security reasons? Really! Trump is holding the best hand versus the Eurozone. Did you see the revised forecasts for Eurozone growth in 2019 and 2020? Down considerably from prior forecasts. And then there are building risks throughout Europe from a potential hard Brexit too. Carney’s comments last week on Brexit uncertainty cascading through their economy was a worthwhile read.  It’s time for Germany to ease up on its European brethren. It is clear that each country’s government has a “Call to Action” to increase spending and reduce taxes/regulations to stimulate growth and to combat rising deflationary forces.

President Xi and the Bank of China will do whatever it takes to stimulate their economy maintaining reported real growth near 6% in 2019 and 2020. Expect further easing in capital controls, additional monetary stimulus, further tax cuts and huge government supported spending projects to be announced after the Chinese New Year celebration ends February 19th. Notwithstanding, China needs a trade deal badly as confidence in their economy is waning causing countries to question China 2025. It does not help that many companies are relocating to other parts of Southeast Asia. Finally, consumer confidence/spending are weakening too. President Xi has clearly reacted to a “Call to Action”. A trade deal is a necessity to sustain real growth at or above 6% for the foreseeable future.

While the U.S. economy is clearly cooling off from its 3+% growth achieved in 2019, it will continue to benefit in 2019 from continued outstanding growth in consumer spending. Don’t forget that over 2.6 million new jobs were created last year with hourly wages rising by 3.2%. We continue to believe that the Fed should NOT have raised rates in December. In fact, we said then and reiterate now that the Fed’s next decision should be to cut rates and pause on unwinding its balance sheet. The Fed needs to stimulate growth here to offset decelerating growth, weakness overseas, failing inflationary pressures and declining business/consumer confidence. The dollar remains just too strong as money continues to flow here from abroad. If/when trade deals are reached, global growth may resume but not for several additional months as it takes time for deals to be ratified and production/pipelines to be adjusted. The Fed needs to hear our “Call to Action” now!

Unfortunately, our political system is paralyzed, so don’t expect any additional fiscal/regulatory boosts to our economy. Our hopes are pinned on the Fed easing further and trade deals being reached over the course of the year. It is obvious that Trump will do whatever is possible to boost the economy and the stock market which are his gauges of success/failure. Herein is a key reason why we are optimistic that trade deals will be reached this year.

Have we shifted our investment view? Not at all!

Our basic premise is that all of the major monetary bodies are becoming more and more accommodative which will at a minimum stabilize the global economy while offsetting deflationary forces. Excess capital will flow into financial assets boosting stock and bond prices.

We clearly expect that many key governments have finally heard the “Call to Action” due to weakening growth. We expect fiscal/regulatory relief in China, many countries in the Eurozone, Japan and in India in particular. It will happen elsewhere, too, as political pressures are mounting quickly.

If/when trade deals are reached, businesses/consumers will let out a huge sigh of relief as there will finally be some certainty in future trade flows so hiring/spending can be enacted after holding back. Global growth will resume soon thereafter which could lead to a surprisingly strong 2020.

Our bottom line is that stocks remain undervalued. Stop listening to the pundits who change their view almost instantly based on the markets’ last tick. Also listen to as many earnings conference calls as possible to get a true indication of the global/domestic operating environment.

We still expect S&P operating earnings to increase by at least 5% in 2019 despite a strong dollar. Don’t forget that interest rates continue to fall with the 10-year treasury now beneath 2.7%. The pundits want you to believe that a 17 or 18 multiple is high maybe historically but rates have not been this low historically. If rates plus some risk factor are the discounting mechanism, clearly the current market multiple is low especially with bank capital and liquidity ratios so high.

What are we doing?

We became more positive on the markets in December after the Fed clearly altered its stance away from further tightening. We were concerned that the Fed could push us into a recession by the second half of 2019. Now it is equally clear that the Fed is done raising rates and might even consider lowering them and pause on reducing its balance sheet. We shifted our defensive stance and added to economically sensitive stocks selling at recession level valuations.

We maintained our exposure to drug stocks with accelerating growth benefiting from new products. We do not expect the government to come together and effect change in drug pricing over the foreseeable future. We also maintained our exposure to technology focused on improving corporate productivity and security. We also added some chip stocks that were just too cheap. Since, we no longer expected a recession we did add some industrial, capital goods and industrial commodity companies selling at recession levels with super strong balance sheets, cash flows, dividends and buybacks. Finally, we continue to have an over weighting in special situations where internal management decisions will close the gap between the current price and underlying value.

We are flat the dollar although we expect it to decline after the Fed lowers rates or overseas governments implement fiscal/regulatory change or trade deals are reached. We do not own bonds nor overpriced private equity/real estate deals.

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

Invest Accordingly!

Bill Ehrman
Paix et Prospérité LLC

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