No Need for Pessimism

Why is everyone so pessimistic? After all…

  1. IMF has raised its forecast for global growth from 3.1 % in 2016 to 3.5 % for 2017 and inflationary expectations remain muted. 2018 is projected to be even better than 2017.
  2. Monetary authorities remain accommodative, interest rates remain amazingly low, and the financial system is awash in liquidity.
  3. Earnings are accelerating with first-quarter gains the best reported so far in 7 years.
  4. Trump’s pro-growth, pro-business agenda is on the horizon.
  5. Global trade tensions have eased and fear of trade wars have diminished.
  6. The U.S. has shown itself willing to defend human rights and long-term relationships rather than being an isolationist as many feared.
  7. The U.S. is working well with China while becoming a growing adversary of Russia, North Korea, Syria and Iran.
  8. OPEC and non-OPEC members are working together to maintain stability in the oil markets.

Change is everywhere creating opportunities for profitable investing yet investor sentiment is as negative as I have seen in some time. Virtually everyone is calling for a 5-10% correction at a minimum or saying that we have entered the next bear market. Few are calling for another leg up. I like those odds, as the majority is rarely right.

The preconditions for a market top are just not evident. And yes, corrections can come at any time but rarely happen when everyone is looking for it. Markets make tops when there is excessive optimism/exuberance and bottoms occur when pessimism is at its maximum.

I constantly review my core set of investing beliefs to see if and where I may need to make some adjustments. A successful hedge fund manager always has a bearish tendency thinking that the glass is half full. We always doubt ourselves looking for that missing fact(s) or perception that may alter our view. While we recognize that there are always global tensions and political uncertainties in the world, it is difficult to know when and if ever it will occur, so it is difficult to hedge.

How do you hedge against a possible “accident” with North Korea? It certainly appears that China is working hard to defuse the situation. After all, North Korea counts on China for virtually everything that it consumes including its energy. Did you hedge the Brexit vote? If so, how did that work out? France is up next, followed by Italy. I still expect that the Eurozone will need to make major changes or not survive.

The economic surprise so far this year is that China’s growth accelerated in the first quarter to 6.9%, the best performance since the fall of 2015 while the U.S. decelerated from a strong fourth quarter. IMF forecasts global growth of 3.5% in 2017. Here is a breakdown by region: U.S. growing 2.3% in 2017 up from 1.6% in 2016; China growing by 6.6% in 2017 versus 6.7% in 2016 and developing nations accelerating to a 4.5% gain in 2017 as compared to 4.1% in 2016. Global trade volume, an indicator of health in the global economy, is projected to rise by 3.8% in 2017 and 3.9% in 2018 versus 1.8% in 2016. What I find important is that the IMF has not factored much, if any, of Trump’s pro-growth agenda in its forecasts.

Comments last week out of key members of the ECB, BOJ and also our Fed supported the notion that monetary policy will remain accommodative. Both the ECB and BOJ specifically mentioned that their bond buying programs would be extended well into 2018 with no intentions to let any of the debt on their balance sheets run off. Stanley Fischer and other members of the Fed went out of their way to assure the markets that there may be only 2 more rate hikes this year and any roll off of debt, if it begins this year, will be very minor and won’t impact the markets as many pundits fear.

Germany’s 10-bunds finished the week at 0.25%; Japan’s 10-year JGB closed at 0.01% and the U.S. 10-year treasury at 2.25%. Finally did you notice the improved capital and liquidity ratios of all the major U.S. banks reported last week? As Jimmy Dimon said on JPM’s earnings conference “the economy is primed to accelerate, and we are ready to supply all the capital needed.” Other bank chairmen echoed his comments. One of our core beliefs remains that the supply of capital exceeds the demand for capital, which is good for financial assets.

First-quarter earnings calls have been excellent so far with revenues, volumes, margins and profits expanding at a faster pace than in the fourth quarter, which happened to have been the best overall earnings report in 4 years. I suggest that you listen to as many of these calls as possible to gain a sense of comfort that, in fact, the global economic environment, including the U.S. is improving. The chairman of Nucor, the best run and most profitable steel company in the world, commented that construction and infrastructure spending has already begun to pick up. By the way, Nucor had a sensational quarter and forecasted even better days ahead. The stock still sells at only 60% of the market multiple and remains undervalued. It is one of our core holdings. I continue to believe that second-quarter U.S. economic growth will snap back from a slow first quarter and the U.S. will expand by at least 2.3% in 2017 even before Trump’s agenda to “Make America Great Again” is enacted.

The next point is that it appears that Trump is about to re-introduce his healthcare bill, and surprisingly, will also announce his plan to cut both corporate and individual taxes next week. Clearly he would not come back with a rejiggered healthcare program unless it had sufficient support within his own party to pass the House. While the devil is in the details, I remain confident that Trump and his team learned from the last fiasco and won’t come forth with this or any major programs unless there was sufficient support to pass his own party. I fully expect changes in the Senate and then in committee will make these bills more palatable to both parties and eventually pass.

And then there is the infrastructure program, which I am most confident will pass Congress this year with only minor changes. The surprise will be that it won’t impact the federal budget much, if at all, as it will be publicly and privately funded. All of these programs, once passed, will accelerate U.S. growth into 2018 and 2019, which has not been factored into anyone’s numbers.

Trade has become a two-way bargaining chip with all our trade partners. China is the perfect example as we asked for China’s help in easing tensions with North Korea and offered “better” trades deals if successful. I remember all too well that the pundits biggest fear was that the U.S. would become isolationists no longer supporting our long-term partnerships like NATO and cause trade wars to erupt.
Clearly our actions show differently, which has benefited our relations abroad. Also, I am glad that is appears that a border tax will not be part of Trump’s tax reduction program. It looks like Trump’s trade team will do everything in its power to promote a level playing field and enact punitive tariffs if dumping can be proven to protect our industries from unfair, illegal competition. Steel may be the poster child, but it will extend to aluminum and other industries too.

I am not surprised that OPEC and major non-OPEC nations are working to maintain stability in the energy markets holding oil prices above $45/barrel while aiming for $60/barrel. The Mideast countries could not support their domestic spending needs with oil below $45/barrel so they had to work together or go down together. And this includes Russia! The fly in the ointment is that U.S. shale production has recovered much faster than expected therefore the benefit of OPEC cutting production has been muted. OPEC has had no choice but to extend the cuts into the high demand summer months too. Oil prices should stay range-bound between $45-$60 per barrel which is good for both businesses and the consumer. Have you noticed that the price at the pump remains below $2.30 per gallon?

I want to end by elaborating on my belief, which is that all this change is creating tremendous opportunities to profit. Whether it’s government, business or the consumer, the status quo is not a recipe for peace and prosperity. Technology is progressing at an amazing pace and disrupters are rising everywhere providing more services with better distribution at lower costs. You must always look towards the future.

Paix et Prospérité continues to outperform. We do not accept the status quo as fact and recognize that change is a dynamic and evolving process making passive management passé. If you don’t change along with it, you fall behind. We also know that change won’t happen overnight, so patience is a key virtue. We know how hard it is to stay conscious and present as the news bombards you throughout each day, but you must not react.

Don’t be pessimistic. The best is yet to come!

Review all the facts; step back, reflect and consider mindset shifts; adjust your asset composition and risk controls if needed; and finally, do in-depth independent research on each idea and…

Invest Accordingly!

Bill Ehrman
Paix et Prospérité LLC

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