Christmas Sales Have Begun

The global financial markets continued to weaken last week as it became more apparent that the global economy was slowing, including China. Unfortunately, monetary authorities continue to strive to reduce monetary stimulus, except in China, just at the wrong time. The simple truth is that we are moving off of a sugar-high toward monetary normalization which comes with pain, imbalances and harsh adjustments. It certainly does not help that trade tensions remain everywhere; Brexit is up in the air; Italy still does not have a budget that satisfies the ECB; and the Trump administration is on the defensive.

We are finishing the year with global markets hitting new lows; record funds outflow; rising investor pessimism; a global synchronous economic slowdown; trade problems; consumer and business confidence falling; rising fears of deflation; and monetary authorities having it wrong. Just the opposite view that existed a year ago. It does not help that the pundits are hitting us every second of the day with a totally negative bias including a technical view that our market has another quick 10+% downside. Systematic trading is dominating the marketplace putting more downside pressure as the markets decline, scaring the fundamental buyers away. There is a total lack of buying and a whole lot of tax-selling going on, too. Some Santa Claus rally.

Adversity creates opportunity for investors with a more than one-second time frame. The sentiment is so low which typically means that we are nearing a bottom. Fortunately, we significantly reduced our net equity exposure in October; lowered our economic sensitivity including the sale of all financials; added stable growers with above average dividend yields above the 10-year treasury rate.

Christmas sales and markdowns have begun!  We have our shopping list ready to go depending on what comes out of this week’s Fed meeting.

While we expect the US economy to slow next year, we do not agree with the pundits that we will enter a growth recession. In fact, we are finishing the year with more economic strength than we envisioned a month ago. Fourth-quarter real GNP growth should be close to 2.8%. We are estimating 2019 real-growth near 2.3% or so. It could be more or less depending on Fed policy and trade deals.

We expect the Fed to raise the funds rate one more time next week but then, pause. In fact, we don’t think that the Fed should even raise rates once more as the inflationary pressures are subsiding, global growth is rapidly decelerating and the dollar is super strong. The economic data points out of Europe and China are weaker than even we expected.

The US economy is the only beacon of light in a weakening global outlook. The consumer remains strong as well as business in the industrial heart land. Don’t forget that over 2 million new jobs have been created this year alone with hourly earnings rising above inflation. Do not underestimate the strength in the industrial heartland too. As an example, Nucor, the largest and most profitable steel company in the world, commented Friday that preliminary fourth-quarter net income would be up 60+% from last year; their order books were strong across the vast majority of their business lines; price realizations were rising; the company purchased nearly $500 million in stock out of free cash flow in the quarter alone reducing the share count by 4%. The company has another $1.5 billion left on their buyback. The stock sells at 8 times trailing 12 months earnings and we expect higher earnings in 2019. Nucor is certainly on sale.

Let’s quickly review the key data points that the Fed will be looking at this week:

  1. Holiday retail sales are strong climbing 0.5% in November ex-gasoline
  2. Employment and hourly wages continue to increase strongly
  3. Businesses/consumers are less confident about the outlook for the coming year
  4. Auto and housing sales have peaked
  5. Trade/tariff issues are a major concern boosting inflation, raising costs, hurting profit margins and delaying capital projects
  6. Industrial commodity prices are falling
  7. Inflation and inflationary expectations remain beneath the Fed 2.0% threshold
  8. The budget deficit is widening
  9. Stock markets are declining while bonds yields are falling
  10. Industrial sales and consumer spending growth fell well beneath forecasts in China
  11. ECB cuts its growth forecast again but still ends its bond buying program tightening policy
  12. Brexit is in doubt as another referendum may be called

It is clear that risks to the Fed outlook are more to the downside as we enter 2019 than balanced, as they have said before. It behooves the Fed to pause after this meeting and hold off on any additional rate hikes until there are additional data points signaling an all-clear for the US economy next year. Our concern is that even this rate hike is too much and may cause a further flattening in the yield curve and strength in the dollar pressuring commodity prices more. Fears of deflation will rise!

Trade issues remain a major impediment to global growth. While we hear that talks are going well with China, we hear nothing of the discussions with the Eurozone, Japan, Australia and India. Without real deals, we see no reason that business confidence and spending will improve next year. We are concerned that global growth forecasts will continue to fall as we move through 2019 without trade deals. The delay in added tariffs for Chinese goods give all corporations an opportunity to further diversify their supply chains. Once deals are reached, the outlook for global growth will improve overnight.

What should we do now?

We enter 2019 with a view diametrically opposite the outlook that investors had entering 2018. Investors are pessimistic and the markets are ending on a low note. The simple truth is that our market, especially specific stocks, are offering great value for the investor willing to look over the dip in the valley.

We will move cautiously but stocks are selling today at recession levels and valuations. While the outlook abroad is indeed weak, we are still forecasting above average real GNP growth in the US next year led by the consumer. S and P earning are likely to increase 6+% to over $170 per share in 2019 while the 10-year treasury bond may hit 3.2% depending on Fed policy and the outcome of trade deals. And the outlook beyond 2019 could change overnight once/if trade deals are reached.

The bottom line is that our market is significantly undervalued today. Remember the adage: buy low and sell high. Also buy when there is extreme pessimism and blood in the streets as is today. But move slowly and buy only best in breed with strong financials, above average dividend yields, and large stock buyback programs. We can’t wait to see how many billions of stocks Buffett purchased this quarter.

Our portfolios are concentrated in healthcare; consumer non-durables; cable with content; technology at a reasonable multiple to growth; domestic steel; and many special situations. We have a very high level of cash and liquidity; own no bonds and are dollar neutral. We suggest reducing real estate and other hard asset holdings as well as inflated private equity investments.

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

Invest Accordingly!

Bill Ehrman
Paix et Prospérité LLC


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