Growth

The key question facing investors is whether global growth will accelerate or stagnate from this point onward.  

Our view remains that growth has already bottomed in the United States and China but not in Europe, Japan and most of the emerging markets. Managements are running tight ships so we would expect any acceleration in growth to translate quickly to surprisingly strong earnings and higher stock prices. Growth will solve many of the problems that now exist while stagnation will lead to political unrest and a cry for change. We continue to find the U.S. market undervalued. We also see China’s markets undervalued as well, even after their sharp moves upwards since the beginning of the year. Unfortunately, our outlook for the European, Japanese and many of the emerging markets are more sanguine as growth won’t return until trade deals are reached first.

Let’s take a look at the key data points of the week that support our view:

1.) Jamie Dimon’s comments about the United States, after reporting  sensational first-quarter earnings results at JPMorgan Chase, said it all: “ Even amid some global geopolitical uncertainty, the U.S. economy continues to grow, employment and wages are going up, inflation is moderate, financial markets are healthy, and consumer and business confidence remains strong…Consumer spending remains robust with credit card and merchant processing volume up double digits…investment banking results were strong”. And, picked up big time in March along with loan growth.  

The Fed minutes from their March meeting came out last week and confirmed that the Fed will be patient reacting to a domestic slowdown in the fourth quarter, a sharp slowdown in growth overseas and surprisingly low inflation despite a tightening labor market. Hopefully, the Fed is finally understanding that low inflation may be here to stay due to global competition, rapid technological advancement and the rise of disruptors industry by industry. In fact, core inflation rose less than forecasted in March increasing by only 0.1% from the prior month.

It is clear that the U.S. economy has accelerated as we moved through March, and we see no reason to alter our view that first-quarter growth will be the low point for the year coming in at approximately a 2.0% real gain, accelerating to gains near 2.8% for the remainder of the year.

If/when trade deals are reached, we would expect the positive impact to fall into 2020 and beyond. We remain optimistic that a deal will be struck with China, then Japan, and finally the European Union before year end. The EU finally agreed last week to move forward on trade with the U.S. focusing on slashing tariffs on industrial goods but excluding agriculture which could be a sticking point.

2.) China’s economy has clearly accelerated as it moved through March, as we expected. It is not surprising that all the monetary and fiscal stimulus started in December is stimulating growth today. Just look at the credit and trade figures for March reported last week to support this view: money supply rose 8.6% year over year vs 8.0% last month; aggregate financing was 2.86 trillion yuan compared with 700 billion yuan in February, 1.69 trillion of new loans were made in the month, M1 increased by 4.6%, the fastest pace since mid-2018 and exports rose 14.2% from a year ago while imports fell 7.6% in dollar terms resulting in a trade surplus of $32.6 billion vs a $7 billion estimate. We were disappointed that auto sales declined in March, but we expect them to improve slightly from here on out.

We remain confident that China will expand by 6.3% this year and will be even better next year once/if a trade deal is reached with the U.S. removing a huge uncertainty over both businesses and consumers in China.

3.) Unfortunately, there really isn’t any positive news to report from the Eurozone. We were not surprised that Brexit was kicked down the road until October 31st. It is so clear that the Eurozone needs a major overhaul of its fiscal, monetary, regulatory and trade policies to better compete globally. But here again, how can one body represent each country that has different needs, wants and objectives? The French are asking for tax cuts as are the Italians and Spaniards. Will the ruling body over the Eurozone permit higher spending, lower taxes and wider deficits? Doubt it. So herein lies the dilemma. While we acknowledge that trade deals will help, it will not be the long-term panacea for the Eurozone. And there really isn’t much more that the ECB can do to stimulate growth no matter what they say to the contrary.

We want to avoid investing in the Eurozone no matter how inexpensive it may appear until the needed reforms are passed.

4.) Japan is also stuck in the mud until some trade deals are reached. We do not believe that any domestic consumption growth will be sufficient to offset weakness in exports. The government hands are tied thereby unable to introduce domestic spending programs and/or lower taxes to stimulate growth as the deficit is already way too large.

We want to avoid investing in Japan until actual trade deals are reached as the risks are too high without one.

We have not mentioned India in quite some time. We remain enamored with this country and are always looking for investments to benefit from the country’s high growth potential. The head of the Reserve Bank of India, Governor Shaktikanta, recently stated at the IMF event that the government is looking at structural labor and land reforms to accelerate growth above the 7.2% rate achieved over the last few years. We are monitoring closely the national elections coming up to see what, if any, major changes may take place in the government that will lead to major positive change in India that will improve the country’s potential.

The bottom line is that it is all about growth. We invest in areas that we see it and avoid those without it.

We see no change in our global economic and investment view. The economies of both the U.S. and China have begun to improve while the Eurozone, Japan and many of the emerging markets are still stuck in the mud waiting and hoping that trade deals are reached unleashing growth opportunities for them.

Two other events are worth mentioning that took place last week.

Disney’s investment day was something to watch as it really showed a management team’s willingness to adapt to a new world where streaming is taking over traditional means of delivering content to the consumer. And who has more content than Disney? We have recommended owning cable companies with content such as Comcast and Disney, two of our largest holdings.

The other key event was Chevron’s mega $33 billion-dollar deal to acquire Anadarko Petroleum. The U.S. energy industry is on a high note increasing production for domestic needs and also to be exported abroad. Wow, what a change from 10 years ago when we were captive to OPEC and Russia.

We find the U.S. market undervalued by 10% as we have raised our S & P 500 earnings forecast to $168 per share with the 10-year treasury yield ending 2019 at about 2.85%. We see further economic growth in 2020 with or without a trade deal along with higher earnings. Clearly, we expect trade deals to be a boost to the markets well before they kick in accelerating global growth.

Our portfolio composition has not changed much over the last few months as we anticipated an acceleration in growth in the U.S. and China and structured our portfolios accordingly. While we still own some drug stocks with major new product flow, we have reduced the areas in favor of more economically sensitive areas such as financials, mainly large U.S. domiciled global banks. In addition, we own global industrial and capital goods companies; technology including semis; low cost industrial commodity companies with huge positive cash flow; domestic steel; housing related companies; cable with content; and many special situations with we expect management to close the gap between intrinsic value and current price. We are flat the dollar and expect the yield curve to steepen as growth accelerates.

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

Invest Accordingly!

Bill Ehrman
Paix et Prospérité LLC

 

 


 

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