Past Is Not Prologue

Now that the first half of the year is wrapping up, it’s time to review what happened and more importantly, where we are likely to go over the foreseeable future knowing that past is not prologue.

The biggest surprises so far this year to me have been:

  1. Trump’s agenda got held back by all the backlash to Russian involvement in the last election; his dismissal of Comey, former head of the FBI; internal conflicts within his own party; and no cooperation whatsoever from the Democrats. Washington halted to a grind. So what else is new?
  2. Global growth was surprisingly strong led by growth overseas while the U.S. stayed stuck with growth averaging 2+% for the half year.
  3. Inflationary pressures were non-existent, which remains of great concern to all monetary authorities that fear deflation more than inflation. The price of energy and industrial commodities fell throughout the past six months ending near the lows for the year. Wage pressures remain muted despite significant declines in the unemployment rate here and abroad. Finally, disruptors popped up everywhere putting downward pressures on selling prices and profits for those who can’t change and compete.
  4. Interest rates stayed surprisingly tame with the U.S. 10-year Treasury bond yields remaining below 2.2% despite a few hikes by the Fed. Yes, the yield curve flattened rather than steepening as we had anticipated.
  5. Corporate profits have been much stronger than forecasted with the multinationals leading the way. Growth overseas and changes in trade patterns have helped the multinationals.
  6. The dollar stayed range-bound rather than strengthening as we had anticipated due to the failure of Trump and his administration to move forward with tax cuts and a huge infrastructure program, which are at the heart of his agenda.
  7. The Trump’s administration moved closer to China, Japan, Israel, Saudi Arabia and Egypt while distancing themselves further from Western Europe, Australia, Mexico and Russia.
  8. Consumer and Business confidence ratios rose to new heights.
  9. All stock markets have done exceptionally well in the first half of the year with the Emerging Markets leading the way. The U.S. market gains have already exceeded its historic annual average gain despite all of Trump’s problems.

I could discuss even more surprises that occurred but that would be looking in the rear view mirror while successful investing is all about looking through the windshield.

So, let’s get to the important question, where are we going from here?

  1. Global growth will continue to surprise on the upside. Growth in the U.S. will accelerate as we move into 2018 with key parts of Trump’s pro-growth, pro-business agenda are passed including a water-downed tax bill skewed toward lowering business taxes; a huge infrastructure program financed by government and private sources; continued aggressive regulatory reform; and trade deals promoting fairness which will include tariffs on dumped or foreign government subsidized goods. Expect the U.S steel and aluminum industries to be major winners here. Also expect major changes in Dodd-Frank that will benefit the financials.
  2. China will exceed its growth targets for the year while stabilizing the Yuan and boosting capital requirements for its financial institutions. Excessive speculation and over leverage will remain under the microscope of the government that will serve to support longer, more sustainable growth in the future. Expect China to become the key player in global trade while improving its relations further with the U.S..
  3. Merkel and Macron will lead efforts in Europe to bring members of the Eurozone closer together while improving trade deals with other partners to offset any trade issues with the U.S.. We expect regulatory and social changes that will support growth in the future. Brexit will continue but may not be as bad as currently viewed as both sides moderate their stances. Don’t expect any resolution for five years here.
  4. All monetary authorities will maintain easy policies while cautioning that policy changes will occur in 2018 as long as the economies continue to improve and inflation begins to pick up. The Fed will raise rates only once more this year and won’t begin to normalize its balance sheet until 2018.
  5. Inflationary pressures will remain subdued although we expect some acceleration by year-end into 2018 as commodity prices recover including oil and wages improve too. Expect some improvement in productivity as well.
  6. Interest rates will rise into year-end, as it appears that key parts of Trump’s agenda will be passed and inflation begins to pick up even in a minor way. Expect the yield curve to steepen mildly too.
  7. The dollar will rally into year-end, as it appears that key parts of Trump’s pro-growth, pro-business agenda will become law.
  8. Corporate profits will continue to surprise on the upside with expectations for continued growth in 2018 and 2019. Corporations will continue to generate significant free cash flow, which will be used to raise dividends and increase buybacks.
  9. There will be no resolution from the commission investigating Russia’s involvement in our elections this year. But expect to hear a lot of chatter in the press against Trump and his associates.
  10. The pundits will continue to call for market tops but expect the financial markets to continue to grudgingly move higher broadening out to include the value and more economically sensitive stocks that have paused most recently. The financials will benefit from regulatory reform and stronger financials permitting significant increases in buybacks and dividends for the foreseeable future.
  11. Merger and acquisition activity will accelerate across all borders to offset the impact of globalization and to create a sounder footing to compete against the disruptors.
  12. Active management will outperform passive management for the next eighteen months, as stock selection is paramount in this ever-changing globally competitive landscape.

Paix et Prospérité has had an exceptional run over the last few years continuing to outperform all averages and especially all hedge funds by sticking to and adjusting our core beliefs as needed. We put ourselves out there writing a weekly blog expressing our views and even giving some broad investment ideas. Specific investment selections are for our clients. Our batting average is out there for all to analyze and it is pretty damned good. It is not only our global perspective, but also our independent research capability; searching for unrecognized value and most of all searching for and identifying change. Change is everywhere but we seize the opportunity to profit from either the long and short sides of the market.

So, in closing, remember to review all of the facts you are hearing; pause, reflect and consider mindset shifts; analyze and change your asset allocation and risk controls as needed; do your own independent research and …

Invest Accordingly!

Bill Ehrman
Paix et Prospérité LLC

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