Don’t Bet Against City Hall

The global financial markets continue to climb walls of worry each week with the pundits/experts still focusing primarily on the shift in the Fed’s stance last December. While that move was pivotal (for us, too) and created a bottom for all markets, the truth is that so much more is happening globally that supports remaining optimistic for the foreseeable future.

If we were to tell you the following, would you think that the markets had run their course or that there was a lot more room to go?

  • All major monetary bodies are accommodative with money supply outstripping demand
  • Fiscal policies are easing with more spending and less taxes
  • Inflationary pressures remain muted
  • Interest rates are ridiculously low
  • Trade negotiations with China are reaching a climax with Japan/U.S talks on deck
  • Brexit will most likely be delayed

We fully recognize that there will be glitches along the way and that corrections could occur at any time, but the simple truth is that the wind is to our backs and will be so for the foreseeable future.

Let’s look at the pivotal economies in the world to see if our outlook is validated by the facts—or not:

  • Fed Chairman Powell had hearings before the House and Senate this past week where he acknowledged that future rate hikes were on hold and that the unwinding of the balance sheet will most likely end in a few more months. Fourth quarter GNP data was released last week, too, and was much stronger than generally anticipated led by consumer spending and much better than expected capital spending data. It is important to note the 13.1% increase in technology spending which portends strong productivity gains down the road. Core inflation remained below the 2% Fed threshold for yet another year.

    First quarter economic stats have begun on a weak note impacted to a small degree by the government shutdown in January. The government is traditionally off in its first quarter stats due to weather and seasonal adjustments. We would expect the first quarter to be the weakest one reported for the year and the economy to pick up in the springtime. Housing sales should benefit from the recent sharp decline in mortgage rates.

    Our economy will continue to benefit in 2019 from that sharp reduction in taxes and increased domestic spending. And then consider the benefit to our economy once/if trade deals are reached which look more and more likely. It even appears that U.S. officials are finalizing a trade deal with China that both Presidents can sign the end of this month. Has to be a plus for both of our economies as well as for the global economy!

    Finally, we expect President Trump to do everything in his power to have a strong domestic economy as we approach national elections in 2020. Don’t bet against city hall.
  • No doubt the Chinese economy has slowed down considerably over the last few months. The Bank of China has not only lowered reserve and capital requirements, it has also shoveled billions of dollars into the financial system even lowering lending requirements once again after having raised them last year. Expect some big announcements next week from President Xi when he speaks to Parliament. Look for additional spending plans, lower taxes and optimism on reaching a trade deal with the U.S..
  • The BOJ remains overly accommodative as both economic growth and inflation remain well below targets. Japan’s Lower House just passed a record budget for 2019 starting April 1st with increased spending along with tax cuts. Japan economic minister Motegi wants to proceed immediately with bi-lateral trade talks with the U.S.. We are confident that a deal can be reached before the end of the summer.
  • The Eurozone is the problem child as growth is stagnant and inflation is running at around 1%, well below the ECB targets. ECB President Draghi has maintained an overly accommodative stance throughout 2018 and appears willing to increase the ECB balance sheet further beginning before year end. Europe is clearly suffering from weakening exports especially to China. We were pleased to see that Germany has approved a $170 billion 4-year plan to increase spending for infrastructure, education, housing and technology. Clearly all members of the Eurozone need to do the same, but it will have to come at the expense of rising deficits which we do expect to happen. We remain concerned that trade discussions between the Eurozone and U.S. will be difficult, but we do expect a deal before year-end as Trumps needs the win for his election run.

While it is clear that global growth weakened as we entered 2019, big change is in the air. Thank heaven that all of the powers to be recognize the need to stimulate their economies as the consequences of any alternative are unthinkable. Don’t be surprised to see a big lift in both consumer and business sentiment. While none of this will occur overnight, it appears that the die has been cast and growth will accelerate especially if trade deals are reached. All of these actions normally occur at market bottoms, not tops.

Don’t bet against city hall!

We realize that this is a minority view, but we are not paying for it anyway. The general outlook, which includes the IMF forecast, is that global growth continues to slow as we move through 2020. We disagree for all the reasons stated above. We are fully cognizant to the risks in our view. Debt levels are too high. We are also bothered by the rise in socialism/far left in American politics and populism abroad.  What ever happened to working together for the common good? Despite all of these problems, Buffett would tell you that our economy will thrive over time, so invest for the long term.

The bottom line is that our market as well as many of the foreign markets remain undervalued today. We keep hearing that our market is fully valued at 17+ times estimated 2019 earnings. That doesn’t make sense to us with bond yields so low and financial capital/liquidity ratios so high. Expect first-quarter earnings comparisons to be the weakest ones for the year. We are amazed how many great companies are selling at less than 10 times forecasted 2019 earnings. No surprise that M&A is on the rise.

Our portfolios have one overriding theme… best in breed with excellent management, strategic plans to excel, great financials with superior returns on capital, and shareholder friendly. Our holdings are in healthcare with accelerating new product flow, capital goods and industrials, technology at a fair price to growth including semis, domestic steel and aluminum, low cost industrial commodity companies, cable with content, and many special situations. We do not own bonds as we expect the yield curve to steepen later in the year nor are we long the dollar anymore.

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

Invest Accordingly!

Bill Ehrman
Paix et Prospérité LLC

 

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