Good News Is Good News for Financial Markets

What a week! Trump addressed the United Nations National General Assembly; the Fed met; and the next, and most likely final, attempt to repeal/amend Obamacare has gone down in flames, yet again.

Consensus was: Trump would make a fool of himself in his address but did not; the Fed would hold off on raising rates but begin shrinking its balance sheet, which it did; and John McCain in a sign of defiance against Trump came out against and essentially blocked the Senate Bill to revise the healthcare bill. Trump supported his base by trying. Now it is full steam ahead on taxes, then trade, and finally, the infrastructure. All good for the financial markets.

It is finally clear that good news is good for the financial markets. I have written about this now and again over the past few years. And this is how it should be.

The key risk that remains is geopolitical: North Korea and Iran. The truth is that there is always conflict in the world that we must be aware of and factor into our investment decisions. The good news is it appears that China is fully on board to help us with North Korea, shown by their decision to curtail exports of energy products to them. The quid is an apparent pause in additional trade sanctions/tariffs from Trump/Ross against China for now. But if China does not voluntarily cut down on dumping of steel, aluminum and other products, Trump/Ross will impose added sanctions/tariffs down the road so this is not a dead issue, just dormant for now.

While there has been a sentiment shift to the more positive side, most of the pundits still remain cautious. One of the lead articles in this week’s Barron’s was to “prepare for the next move down.” I still have not seen anyone talk about preparing for the next leg up. I continue to say that the path of least resistance is up, which has proven correct since I mentioned it a few weeks ago.

Paix et Prospérité continues to outperform all indices for all the right reasons. We see global growth accelerating but not inflation; interest rates staying ridiculously low for this stage in a global economic recovery but with the yield curve steepening; the dollar finally strengthening as it appears that Trump will pass parts of his pro-business, pro-growth agenda over the next six months and earnings taking off as volume improves while costs stay under control. But not all markets or stocks are equal. That is our strength!

Let’s take a look at key events reported last week and see how they support, or not, our investment thesis:

  • The United States appears ready to become the engine of global growth in 2018 even after a pause in the third and fourth quarters caused by the two horrific hurricanes. Total damages and work stoppage exceeds $300 billion. That will all reverse and add to growth in 2018 and beyond.

    Here are just a few of the data points reported last week that support a strong base for acceleration in growth in 2018:

    • U.S. household net worth hit another all time high at $96.2 trillion
    • Holiday retail sales are projected to increase 4.0 to 4.5% in 2017 topping the 3.8% gain in 2017
    • Housing starts, impacted by the hurricanes were down slightly but permits rose a surprisingly 5.7%
    • The Business Roundtable index of hiring plans rose to a six-year high of 80.2
    • Senate Republicans are actively considering a $1.5 trillion-dollar tax cut over the next 10 years with a corporate rate falling to around 20%
    • It is worth adding that Daimler is investing $1 billion in an Alabama plant that will hire 600 people initially
    • Trump and his administration are emphasizing that tax reform is number one on their agenda with trade and infrastructure close behind
    • Toys “R” Us filed bankruptcy, another brick and mortar retailer bites the dust thanks to Amazon!
  • Just a few comments on the Fed decision last week, which was no surprise to us, as you know. While the Fed penciled in one more rate hike this year, officials pushed out their inflation expectations while lowering their path of interest rates over the next few years. Officials raised their forecast of growth to 2.4% in 2017, 2.1% in 2018 and 2.0% in 2019, which is the year that the Fed expects inflation to finally reach its 2.0% threshold. Policy makers expect 3 hikes in 2018, 2 in 2019 and 1 in 2020. Longer term the Fed expects interest rates to peak out at 2.75%, which is just incredible. Remember double-digit rates? I do!
  • The Fed will only reduce its holdings of all securities by $10 billion a month initially increasing by $10 billion each quarter to a maximum of $50 billion from October of next year if all goes well. Janet Yellen commented many times at the conference call after the Fed decision that low inflation is just transitory. I disagree and so does the BIS. Globalization is here forever putting pressure on pricing and inflation as well as the disruptors.
  • Growth in the Eurozone remains well above expectations as the 18% increase in the Euro year to date has not penalized exports for now. Eurozone consumer sentiment hit a 16-year high, which will provide support to surprisingly strong growth for the foreseeable future. Don’t forget that low inflation helps real disposable income and keeps the ECB from raising rates. The Eurozone PMI hit a multi-month high of 56.7 last month, too.
  • Growth in Japan should remain strong for the remainder of the year at least. The BOJ maintained its overly accommodative stance on Thursday maintaining its targets at around zero for government bond yields with short-term deposit rates of minus 0.1%. The Bank maintained its target of purchasing 80 trillion of government bonds over the next year. It was reported last week that exports rose at the fastest clip in four years in August expanding 13.4% despite a strong yen.

Let’s wrap this up!

The financial markets continue to rise on a wall of worry as most market participants look through the same prism of the past while not looking forward. I have been successfully managing money for 40 years and have rarely seen an environment so conducive for profitable investing both on the long and short sides of the markets as exists right now: economic growth is accelerating while inflation remains controlled; earnings growth is accelerating too as volume is finally growing with costs under control and financial risk has diminished as banks continue to increase their capital and liquidity rations.

Add to all of this the prospect of Trump passing tax reform, trade relief and a huge infrastructure program. None of this is reflected in the market yet as few believe that Trump can pass any of his pro-business, pro-growth agenda. But, I saw the pendulum begin to swing when he fired Banyon and Preibus then reach across the aisle to Schumer and Pelosi. Trump is a New Yorker and more a centrist than a right-wing conservative, as he has appeared to be to garner votes and support. But think about this: the Democrats need to be part of the solution and the right-wing Republicans have nowhere else to go without being labeled obstructionists. Some of Trump’s agenda will pass, and the markets will have a true Trump rally.

We continue to emphasize the large money center banks as the yield curve continues to steepen as the Fed remains one step behind; the U.S. domiciled multi-national industrials which will benefit from global growth and a weak dollar year-to-date; technology at a fair price; industrial commodity stocks including domestic steel and aluminum which will benefit from a huge reduction in Chinese capacity over the next few years; and special situations like Dow/DuPont, Huntsman and Praxair.

Remember that good news should now be considered good for the markets; so review all the facts, pause, reflect, consider mindset shifts, look at your asset composition and risk controls, do independent research and as always,

Invest Accordingly!

Bill Ehrman
Paix et Prospérité LLC



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