It’s Not Just China That’s Growing

The financial and commodity markets overreacted last week to a slight deviation in growth for China around the mean of 6.5% growth still expected for the year. Just a few weeks ago the government announced a change in planning/policy putting quality of life ahead of the absolute amount of growth. That does not mean that China won’t continue to grow faster than all of the major industrialized countries for the foreseeable future—it will. Whether growth will exceed 6% over an extended time is questionable but who could argue with even 5+% growth over the next five years, as that is faster than all other major industrialized nations. China’s economy has gotten so large that the law of compounding plays a role here, too. China will emphasize consumption over production as other emerging markets with even lower costs willingly take market share away from China, which is fine and good.

Investors need to focus on the fact that global growth will accelerate as we enter 2018 led in good part by the United States, which has been lagging for the last few years. Just think about what’s happening here: a new more stimulative tax policy, reduced regulations, a shift in trade policy to focus on fair trade and a lower the trade deficit.  All of these changes will boost growth in the U.S. at the margin. And we like buying where the incremental margin or rate of return is improving. Is there a loser here? Not really except maybe the UK.

The investment environment remains favorable as we move into 2018.

  • Global growth continues to exceed forecasts and is accelerating
  • Inflation continues to surprise on the downside and is not likely to reach the 2% target of all monetary bodies until sometime in 2019. Therefore monetary policies will remain accommodative
  • Interest rates will stay historically low impacted by downward pressures asserted by globalization and disruptors popping up everywhere
  • Bank capital and liquidity ratios will rise reducing systematic risk the dollar will increase as the yield curve steepens
  • Industrial commodity prices will increase as utilization rates rise and inventories fall
  • Finally, profits will surprise on the upside as positive operating leverage and productivity gains finally kick in

Let’s take a look at what economic and financial data points were reported last week that support or challenge our current investment view:

1.) As we discussed earlier, we expect the U.S. to be the engine for an improving global economy in 2018. Here is what was reported last week which supports that view: industrial production rose 0.9% in October bouncing back from hurricane induced weakness in prior months; capital utilization rose to 77% which is still well below the historic average; core CPI rose 0.2% and is up 1.8% year over year; retail sales increased 0.2% in October and are up 4.6% on an annualized basis; November chain store sales are estimated to increase 0.4% in November; the PPI jumped 0.4% in October boosted by service inflation and higher gasoline prices; the small business optimism index jumped 0.8%; consumer sentiment fell  slightly to 97.8 in November and finally housing starts rose nearly 6% in October to a seasonally adjusted rate of 1.3 million starts.

The House Republicans passed their tax reform package last week and the Senate is moving to approve its version most likely right after Thanksgiving. Then the bill moves into conference and reconciliation with a final bill ready to be voted on later this year or early in 2018. The odds for passage have risen to over 80%. Whether it is effective for 2018 or 2019 is really not relevant as it can be factored into future forecasts and brings some sense of certainty for business and individual planning that has been missing for so long.

Now that Trump’s trip to the Pacific is over, I expect to see Ross and his trade team make some policy moves on dumping from abroad that will benefit U.S. industries like steel and aluminum to show that they mean business and are not paper tigers.

2.) Growth in the ECB continues to surprise on the upside. Germany, the largest economy, is headed for its best year since 2011 with quarterly growth around 0.8% led by exports despite a strong euro and capital investment. The European Commission raised its growth forecast for 2017 to 2.2% with continued low inflation.

3.) Growth in China slowed slightly in October: industrial output rose 6.2%, retail sales rose 10%, an fixed investment rose 7.3%. Nothing wrong with these numbers. Growth should exceed 6.5% for 2017 and be around 6.2% in 2018. Not too shabby.

4.) Growth in Japan grew at a 1.4% annual rate in the third quarter making it the longest period of growth in 16 years boosted by strong global demand. It is no surprise that stock prices are at the highest level in 25 years. I was pleased that Abe has taken this strength as an opportunity to improve the country’s financial picture by recommending that the national sales tax increase to 10% in October 2019.

The bottom line is to stay the course.

It clearly has become a two-way market as skepticism is everywhere as opposed to euphoria or excessive optimism which would concern me. Traders are quick to pull the trigger fearing a sell off more than another leg up, which creates opportunities for investors to profit. Remember: the trend is your friend and there appears no reason to change our investment view at this point in time.

Paix et Prospérité continues to outperform all indices by remaining true to our core beliefs and disciplines. We are living through volatile, uncertain, complex and ambiguous times which create tremendous opportunities for open minded, clear thinking global investors. Focus on managements with business plans who have strategies to not only survive but also thrive in a VUCA environment. Do your research. Listen to their quarterly investor calls or hire someone to do it for you. And, lastly patience and confidence is a must to succeed in times like these.

We continue to emphasize the financials; global industrials, low cost, financially strong industrial commodity companies including domestic steel and aluminum; technology at a fair price to growth like Cisco which we have owned for over a year and finally took off this week (patience!); and special situations like DWDP, HUN, FMC and PX. By the way, FMC plans to split into two companies next year with one being a pure lithium play needed for electrical cars.

So 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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