An Optimistic But Cautionary Outlook

We fully anticipate blow-out results for second-quarter earnings reports this week. Managements will remain optimistic but also present a more cautionary outlook of the future due to the potential impact of widening trade skirmishes/tariffs and a strengthening dollar on translating results. It is important though that managements continue to invest in the future and do not alter their long-term game plan to enhance their global competitive position, while strengthening their balance sheets. We remain optimistic but caution that managements may offer some outs if trade skirmishes escalate into trade wars. Invest in those companies willing to look over the valley and invest throughout this period to enhance their global competitive position as this too shall pass.

The Past Week

It was an eventful week on the global trade scene as added tariffs went into effect almost everywhere. Clearly, all governments want to show that they mean what they say and say what they mean so they had no choice but to move forward on retaliatory tariffs against Trump’s prior actions. Virtually all corporations and trade groups here and abroad came out against tariffs as a means of resolving trade inequities. Important to note is that European automakers advanced the notion to get rid of all tariffs going both ways for American, European, South Korean and Japanese carmakers. Sounds like Trump’s plan to us. Will this be the thaw that breaks the ice on global trade deals? We hope so!

The Weeks Ahead

We hope that Trump’s upcoming European trip brings some positive movement on trade and other important issues. Beside meetings in the UK and with our NATO partners, Trump is meeting with Putin too.  We also expect that the US will open trade talks directly with Mexico now that their election is over. We may very well end up with bilateral deals with Canada and Mexico.

China is a more complex issue as we want to influence their long-term plans to be dominant in technology by protecting our IP. We were not surprised that North Korea is now raising some red flags in negotiations denuclearizing the Korean Peninsula. Could China be in the background here? Clearly China is playing their North Korean card in its trade discussions with Trump. Smart! Remember that Trump want to win the Nobel Peace Prize.

We are not concerned about trade skirmishes as it is a means to an end in global trade negotiation. If it stays contained, it won’t impact global growth too much and the higher inflation will be transitory. Clearly, we are watching closely to see if it escalates much further.

The financial markets are being held prisoner by global trade concerns. Many of the markets lifted last week after the European automakers made their offer to remove all tariffs. Our market got an additional lift from absolutely terrific employment numbers reported Friday.

Let us state categorically that the global stock markets would have a huge rally and bond yields would rise if there were some resolution of the trade conflicts.

So where are we now?

The US economy is in great shape. The Fed notes came out Wednesday and showed that they believe that the economy is strong and that future inflation will stay contained. However, its members are getting more concerned about trade and noted that if the trade conflict escalates that this may influence their future trajectory of raising the Fed Funds rate.

The employment data reported Friday was strong, but wage gains weakened adding support that the Fed should move slowly raising rates if at all right now. While the Fed discussed a flattening yield curve, which they do not want, members added that it does not mean a slowing or a topping economy as it may have in earlier periods.

The bottom line is that the US economy is doing just fine. Growth will be near or slightly above 4% in second quarter and is likely to exceed 3% for the rest of the year. S & P second-quarter earnings growth is likely to exceed 20% and reach $160 per share for the year. We see further improvement in 2019 too, but the degree depends on trade and consumer/business confidence. A recession is nowhere in sight right now but our antennae are up looking for warning signs. But not yet.

We fully expect growth in the ECB and Japan to improve as we move through the rest of the year and into 2019 after a rough patch caused by weakening production penalized by a very strong Euro and Yen until recently. Here again, we are watching trade negotiations closely as both economies are overly dependent on exports for growth. Clearly the BOJ and ECB are on hold maintaining overly easy monetary policies,

No need to worry about growth in China too, unless the US really raises trade tariffs against Chinese imports. We see no reason to alter our forecast for 6.5% growth in 2018 and slightly less in 2019 led by rising domestic consumption and technology spending. Have you noticed that China is adding reserves and loosening bank-lending rules reversing prior policies? Clearly the government is more concerned about growth and declining stock prices due trade conflicts than they want us to believe.

So what are we doing?

We have made some changes to the composition of our portfolios as the market has created some unique buying opportunities in healthcare, cable, technology and special situations. Our portfolios are still concentrated in financials, capital goods, industrials, technology, industrial commodities including domestic steel and aluminum, and special situations. The common thread is that we own the best in class with the strongest managements with strong financials willing to invest for long-term success. We remain short bonds and long the dollar.

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

Invest Accordingly!

Bill Ehrman
Paix et Prospérité LLC

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