“It’s the Economy, Stupid!”

Trump will be in a tough race for the White House in 2020. He saw a record number of Americans watching the Democratic debates and realizes that the key to his success is a strong domestic economy. James Carvel coined the phrase “the economy, stupid” as campaign manager for Bill Clinton’s successful 1992 presidential run against sitting President George W. Bush. Bush failed run suffered from a recession and the ground war in Kuwait in 1991. The two other key messages for the Clinton campaign were “change vs. more of the same” and ‘don’t forget healthcare.” Sound familiar?

Trump and his team feel that the strength of the economy and his message about less taxation, more regulatory relief, a strong defense, protecting the borders from illegal immigrants, a conservative Supreme Court, and a more level playing field for trade protecting IP will carry the day over his personality, ethical and common decency flaws. “Make America Strong Again” will ring just as true today as four years ago as long as he can run on his record in his first term of a strong economy creating millions of new jobs with rising real wages. After all, Clinton succeeded a second time despite his character flaws. Right?

We were not surprised that Presidents’ Trump and Xi called a truce yesterday on any additional tariffs and announced that negotiations on a trade agreement protecting IP would recommence almost immediately. Clearly there was a lot of give and take in the talks as Trump surprisingly agreed to lift the restriction on U.S. companies supplying Huawei while China agreed to massive purchases of American agricultural products. Trump needs the farmer on his side and the G-5 technology supply chain intact while China badly needs our pork and soybeans as the Chinese people are suffering from huge local production problems.

You could hear a global sigh of relief yesterday after a truce was called between the United States and China. Markets will clearly rally as a huge cloud has been lifted. Markets will no longer have to fear that global trade and growth would slow even further if additional tariffs were imposed. While we continue to doubt that a final agreement will be made anytime soon, we also do not expect Trump to impose additional tariffs later in the year or in 2020 if talks fail as it would hurt the U.S. economy and his re-election chances. Trump will most likely kick the trade can down the road into 2021. Same goes with his negotiations with Europe. Don’t expect any tariffs against European car manufacturers as it would be too disruptive to the U.S. economy.

It is important to note that both the United States and China spent a lot of time at the G-20 conference solidifying relationships with other countries who clearly will benefit from the U.S./China ceasefire. For instance, we remain confident that the U.S. and Japan will reach a trade deal by the end of the summer. We also expect corporations to use this time to further diversify their supply chains reducing where possible their reliance on China.

Now that trade concerns have been pushed aside for now, we are back to focusing on the economy and monetary/fiscal policy. After all, “it’s the economy, stupid.” We continue to believe that the U.S. is best positioned as we look out into next year. Our consumer is strong and the Fed has the leeway to make several stimulative rate cuts as well as ending its portfolio runoff unlike most other monetary bodies. It remains clear to us that the Fed should cut rates at least once and possibly twice this year bringing the Fed funds rate down to 2% or even slightly lower at a minimum as inflation continues to run well beneath the Fed 2% target. If so, the yield curve will steepen and the dollar will fall. The mere fact that most everyone is anticipating a Fed cut has already led to dollar weakening as we had anticipated.

Let’s take a look at the recent data points which support our view that there is no place like home:

1.) The U.S. economy continues to muddle through with consumer strength offsetting manufacturing weakness: personal income increased 0.5% in May; disposable personal income increased 0.5% also in May while personal consumption expenditures rose 0.4%. It is important to note that the PCE rose only 1.5% year over year remaining well beneath the Fed 2% target for the tenth year now. The Michigan index of consumer sentiment remained at a very high 98.2 with current economic conditions at 11.9 but consumer expectations fell to 89.5 which was still above year ago levels.

On the other hand, the Chicago PMI fell to 49.7 in June, the first time in contraction territory in two years; new orders for durable goods, excluding transportation and defense, decreased 0.6% in May while shipments actually rose 0.4% in May after declining 1.6% in April; and finally, unfilled orders for manufacturing goods decreased 0.5% in May while inventories rose 0.5%. Not too good!

We believe that the trade truce along with expected Fed cuts will boost consumer/business confidence and economic growth later in the year into 2020. Clearly that would be Trump’s intention. We continue to expect the Fed to cut rates once or twice this year and stay out of the way in 2020, an election year, unless data points glaringly force their hand.

2.) The trade truce should be a game changer for China as there clearly will be a surge in business/consumer confidence. The Chinese government will continue to institute very aggressive fiscal policies to stimulate growth which will be supported by the Bank of China. We would expect second quarter growth to be the low point for the year with improving performance sequentially as we enter 2020. The trade truce significantly improves our outlook for China and its financial markets.

3.) While the U.S./China trade truce will improve both consumer/business sentiment in the Eurozone, we remain pessimistic about longer term growth potential without major fiscal, regulatory and trade policy changes. There is no way that one policy fits all as long as the region is comprised of have and have-not nations controlled by Germany. There is very little that the ECB can do to stimulate growth. Finally, we do not see a trade deal with the U.S. anytime in the future.

We began making subtle changes to our portfolio composition over the last few weeks anticipating a trade truce and a change in fed policy. In addition, we were then, and remain even more confident today, that Trump will do everything in his power to stimulate the domestic economy boosting the stock market over the next year as he runs for reelection. A perfect example was his trade truce with China permitting sales to Huawei. Don’t forget the power of the Trump’s ego to win next year at all costs. It won’t be his personality that carries him over the goal line but the strength of the economy, stupid.

As you can glean from our comments, we have increased our market exposure primarily by increasing the economic sensitivity of our portfolios while reducing some of the defensive holdings. In addition, we are more confident that the dollar has peaked and the yield curve will steepen as the Fed cuts the funds rate.

Our portfolios comprise technology; global capital goods and industrials; low-cost commodity companies generating huge free cash flow; large global domestic banks (we correctly anticipated the stress test moves by the banks); cable with content; housing related to benefit from low mortgage rates; healthcare with major new product flow; and many special situations including farm related.

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

Invest Accordingly!

Bill Ehrman

Paix et Prospérité LLC

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