Is the Party Over?

Paix et Prospérité has significantly outperformed all averages and ran circles around the Hedge Fund Index. Naturally, it would be easy to take our chips off the table, call it a day and protect our gains, but is that the right strategy to pursue as we enter 2018? Not that simple!

The economic and financial backdrop is just too good:

  1. Accelerating global growth with muted inflationary pressures
  2. Incredibly low interest rates due in part to continuing QE in the ECB and Japan putting downward pressure on interest rates here
  3. A pro-growth, pro business administration in the U.S. that has enacted tax and regulatory reform which will force other countries, for competitive reasons, to follow suit bolstering global growth and corporate profits
  4. Rising capital and liquidity ratios at financial institutions reducing systematic risk
  5. Close to $3 trillion dollars being repatriated to the United States that will be used to reduce debt, grow capital expenditures, hire new employees, used to fund M & A, raise dividends and finally, buy back even more stock. Corporations’ stock buybacks have reduced the supply/float of common stock while boosting earnings per share and prices.

Corrections can happen at any time and for any reason; but cyclical tops occur when alternative investments, which may include cash, are more favorable to own than stocks. Liquidity trends need to turn negative, too, but not now nor soon.

Where would you rather have your money invested today:

  1. Cash which still earns next to nothing?
  2. Bonds where the 10-year treasury yield is beneath 2.5% in the United States and much lower elsewhere?
  3. Commercial and office real estate where prices are way up, yields down and usage is changing (would you want to own a mall with box stores as key tenants)?
  4. Commodity prices which have room to run? (We do like the space and have invested in those companies with superior management, low cost positions and strong balance sheets.)
  5. Private equity where prices are through the roof and too much money is chasing too few investments?
  6. Stocks where earnings growth is accelerating, the multiple is still fair relative to bond yields (especially after factoring in tax reform) and supply is shrinking?

The answer is pretty obvious to us. Remember that the trend is your friend and the pendulum has clearly begun to swing back globally from an excessively restrictive financial, regulatory and political (budgetary) environment to one that is less so supporting economic growth.

The big surprise has been the failure of inflation to pick up moving closer to that magical 2% level after billions of QE, economic growth far stronger than anticipated and unemployment declining meaningfully without a real increase in wages. We have discussed this phenomenon for months now including the failure of the Philips curve. Global competition and the disruptors have put a lid on inflationary expectations. Whether the “Inflation Genie” comes out of the bottle by the end of 2018 is one of the big questions we face. We are watching this closely but all clear for now.

What other areas are we monitoring closely which may lead us to shift our positive bias?

Geopolitical risks are ever present as well as a potential shift in the political winds. Right now we are focused on North Korea as well as the Middle East. It is next to impossible to factor either one into your asset allocation other than maintaining excess liquidity at all times. We are also watching to see if the Democrats can finally present a decent alternative vision for the United States other than anti-Trump. Right now it does not exist but clearly we are concerned about the 2018 elections and a change in the now Republican-controlled Congress.

We are also keeping an eye on how China and Russia are trying to improve their status/power overseas filling a void created by Trump’s foreign and trade policies. Big changes are occurring in global relationships that need close monitoring. I want to reiterate that the U.S runs huge trade deficits especially with China, Germany and Japan who run huge trade surpluses so who has most to gain and who has most to lose by shifts in trade patterns? I expect a surge in new plants being built in the U.S. due to Trump’s tax, regulatory and trade policies.

Our major investment themes that will benefit from these afore-mentioned trends include:

  1. Financials that will benefit from accelerating loan growth, a steepening yield curve and regulatory relief
  2. Global industrials and capital goods companies that will benefit from acceleration in capital spending, “America First” and an infrastructure bill that I expect to pass this year.
  3. Industrial commodities that will benefit from higher prices as demand increases faster than supply over the next year coupled with China’s policies to reduce pollution and zombie companies.
  4. Technology at a fair price as growth will only strengthen for all the obvious reasons. Change is everywhere due to technology and that won’t change anytime soon. Disruptors are popping up everywhere changing the dynamics of so many industries while putting downward pressure on prices.
  5. Special situations have always been a meaningful percentage of our portfolio as corporate managements with board support make strategic changes that alter future growth, returns and stock valuations.

A successful investor must always look to the future and be willing to change his/her investment view if warranted. We are always looking for the proverbial hole in our thesis while being patient to let events unfold as long as they are consistent with our belief system. We tend to be very early in identifying new trends and also we tend to sell early as others catch up to us. Tax reform was a perfect example.  We positioned our portfolio months ago with the simple thesis that the Republicans had to unify behind it or run the risk of losing the elections big time in 2018. Right now the Democrats have no real platform and are considered the obstructionists. I expect a major infrastructure bill this year. We are positioned for that, too.

Trump’s pro-growth, pro-business agenda turned investment psychology upside down in 2017. Give him and the Republicans credit where it is due even if you don’t like him as a person.

The bottom line is to stay the course, as there is more room to run. The party is not over. At least not yet!

We wish you all a very Happy, Healthy and Prosperous New Year!

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

Invest Accordingly!

Bill Ehrman
Paix et Prospérité LLC


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