Christmas Comes Early

The financial markets had one of their best gains last week anticipating that Fed Chairman Powell would moderate the Fed’s view on future hikes in the funds rate at his speech to the Economic Club of New York. Secondly, they anticipated that President’s Trump and Xi would reach a temporary ceasefire on additional tariffs between the two countries during their dinner Saturday night. Both outcomes occurred as we fully anticipated in last week’s blog. By the way, the G-20 meeting was a success too, which included the formal signing of the new US, Canada and Mexico trade deal.

The investing glass went from half empty to half full virtually overnight. We are cautiously optimistic as we wait for the deals to be completed. That is a slippery slope as we all know. We still have not completed trade deals with the Eurozone, Japan, Australia and India. And there is Brexit to be dealt with, too. While it is clear that there will be at least a short-term burst in business as well as consumer and investor confidence from all of this, we doubt that the global economies will actually re-accelerate without signed deals in place. Congress then has to approve them too, including the deal with our neighbors. Here again, we are dealing with perception vs. actual realities of future outcomes.

But let’s not be so cynical today as we are clearly better off after Powell’s speech and the G-20 conference including the news of the temporary cessation of ratcheting trade tensions between the US and China.  

Let’s delve into this further.

Chairman Powell fully acknowledged last week that the risks to our economy were balanced and that the funds rate was close to normalization contradicting prior comments made a few months ago that the funds rate was far below normalization. We felt then that he had misspoken but this was his first direct comment walking back from those comments. It is clear that the US economy is slowing as well as inflationary pressures.

Just look at all the recent economic data. We still expect the Fed to raise rates a quarter point in two weeks and then pause. It is likely that the Fed will have one eye on trade negotiations since success or failure will impact our economy in many ways including inflationary expectations. For instance, failure in the trade talk brings higher tariffs, a boost in short term inflationary pressures, weakening consumer purchases and lower industrial production. On the other hand, success in the trade talks bring a boost in consumer demand and industrial production, an accelerating economy but with lower near-term inflation. And the Fed will have to factor all the impacts overseas too. By the way, as we expected, the Fed has one eye on the global economy as they should.

The bottom line is that the Fed will be on hold for at least 90 days into 2019 awaiting the outcome of trade talks.

The US and China both agreed to a 90-day ceasefire on any additional trade tariffs. Included in the standstill agreement was that China would purchase a substantial additional amount of agricultural, energy, industrial and other products from the US. To gain added support from China in our negotiations with North Korea, Trump agreed in return to acknowledge the one-China policy. China also agreed to designate the opioid Fentanyl as a controlled substance and would show a willingness to reconsider the NXP Qualcomm merger if it is renewed.

So what is the bottom line?

Will there be a deal in 90 days? We doubt it. But for now, we are in a better place than before. We still believe that the US should move quickly to conclude deals with the Eurozone, Japan, Australia and India. Once done, we should include our allies in the negotiations with China as it only strengthens our bargaining position.

Will the expected near-term relief from the ceasefire lead to an acceleration in global growth? No! Talk is talk, and we have been down these roads many times before. Would you as a corporate executive change your spending plans before any trade deal is completed? Of course not! We would expect corporations to take this pause in escalating trade tensions as an opportunity to further shift their supply chain from China to other Far East countries like Vietnam and Thailand.

What are the investment conclusions from all of this?

Clearly the financial markets will breathe a sigh of relief. Here again we expect the perception of what will occur down the road will be far from reality, but it won’t matter for the foreseeable future. We would expect the yield curve to steepen slightly as pressure will be off the short end of the curve with the Fed on hold after December; the dollar should weaken; all commodity prices will lift; and stock prices will broadly rise into year-end at least. Yes, we will have our Christmas rally.

We do not expect global growth to pick up until trade deals are actually concluded next year. Business uncertainty and skepticism will remain high, but consumer confidence will rise as the outlook appears better than just a week ago.

We have NOT altered our global economic forecast. Growth will slow during 2019; but if trade deals are reached, the economic outlook beyond 2019 will improve which would necessitate a shift in asset mix from a currently more defensive one. We would expect the Fed to then resume raising rates too. We would expect many mini-cycles over the next year depending on various outcomes. It is best to invest identifying the long-term winners and trading less as you are likely to get whipsawed as events fluctuate.

We will continue to buy best in breed identifying superior management teams with winning long-term strategies; above average volume growth with pricing power; rising operating margins, income, and free cash flow; above average and rising dividends and finally large stock buybacks.

Our portfolio includes some financials; healthcare, consumer nondurables; cable with content; domestic steel and aluminum; global industrials; airlines; agricultural commodities; chemicals; technology at a fair price to growth and many special situations where internal structural moves will significantly enhance shareholder value. We own no bonds and are flat the dollar even though we look now for near-term weakness.

We want to acknowledge the passing of George H.W. Bush, our 41st President. He was a great public servant who put country above all else. We should all learn from his example.

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

Invest Accordingly!

Bill Ehrman
Paix et Prospérité LLC

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