Congress, really only the Republicans led by the President, is about to give our country a huge Christmas gift: tax reform. And it’s about time. The financial markets have marched upward in anticipation of it for weeks, so now the question remains whether the market will sell off on the news once it is passed next week. We say: no! Why?
- The market has another 15+% left in it for 2018 supported by global growth led by the United States
- Tax reform will lower the corporate rate to 21% boosting U.S. profits
- A 100% write off of capital expenditures will add to cash flow
- Incredibly low interest rates due to low inflation and continued QE in the Eurozone and Japan continues to exert downward pressure on our rates
- Continued strengthening in bank capital and liquidity ratios reduces the chance of systemic risk
Not a bad recipe for higher prices.
We have been talking about tax reform passing for the last six months and positioned our portfolios accordingly, which has led to our continued outperformance. The benefits of tax reform are broad-based and will lead companies, both domestic and foreign, to expand their U.S. operations, building new plants here, and hiring additional employees. It has not hurt that Trump has drastically reduced restrictive regulations, too. Finally, there will be some certainty to the tax code, so companies and individuals can plan accordingly. The benefits of tax reform will last over the next several years as all of this unfolds. Change does not occur over night. So don’t expect an economic downturn soon as many pundits have already predicted. Stay the course, and be patient!
The backdrop of global economic and financial news has been surprisingly strong through the fall and into the holiday season, which has supported the upward move in most of the stock markets. While growth has continued to improve, inflationary pressures have not built up which continues to confound the monetary authorities. Both the Fed and ECB met last week and raised their growth targets for the next several years but NOT their inflation forecasts. Again I say that the Philips curve is outdated. No wonder why most Artificial Intelligence (AI)-run portfolios continue to underperform. The past is NOT prologue. Mathematicians run money looking in the rear view mirror rather than through the windshield at what’s ahead.
Let’s take a look at some of the economic and financial stats that were reported last week to see if they support or detract from our continuing thesis of accelerating growth without inflationary pressures, low interest rates and higher corporate profits.
1.) The U.S. is again becoming the engine of global growth: Industrial production rose 0.2% in November after a revised 1.2% gain in October despite a 1.9% decline in utility output; capacity utilization was 77.1 in November, up 3.4 percent from a year ago but still well below the 10-year average; retail sales boomed 0.8% in November and were up 1.0% excluding automobiles; manufacturing sales rose 0.6% in October while inventories actually fell 0.1% which bodes well for future sales gains; import prices rose 0.7% in November led by fuel while export prices rose 0.5%; and finally the CPI increased 0.4% in November but core prices rose only 0.1% and only1.7% from a year ago.
It now appears that we will have another quarter of 3+% growth even before tax reform becomes law.
2.) The Fed met last week and raised the Fed funds rate a quarter percent as widely anticipated. I found it interesting that the Fed raised its growth forecast meaningfully for 2018 to 2.5% but did not alter its inflation forecast or the number of expected hikes in the fed funds rate. Inflation is not expected to reach 2.0% until the end of 2019. When Janet Yellen was asked whether stock prices were too high, she answered that economists are notoriously bad predictors of future stock prices. I will miss her, as she was excellent in so many ways.
3.) The joint reconciliation committee of Congress finally announced its final version of the new tax code at 5:30pm on Friday. There were only minor tweaks from earlier versions to garner enough support to pass both the House and Senate this week and be on the President’s desk before Christmas to sign. It is a shame that not one Democrat would support this bill. While not perfect, it is far better than our former tax law and begins to bring back manufacturing jobs to America. Let me reiterate: This bill is tremendous for corporate America and American jobs as it will lead to more plants being built here and a decline in our trade deficit over time. The winners and losers are clear and our portfolios are positioned accordingly.
4.) Even though the ECB meaningfully raised its economic growth targets, too, it did not raise its inflation forecasts nor did it alter its revised QE program buying 30 billion euros of debt per month at least thru next September. Draghi reiterated that the ECB would continue its aggressive QE until inflation breaches that magic 2% level.
Where do we stand now and what are the investment implications of all that is happening?
It remains clear that the global economy will continue to accelerate as we enter 2018 with the U.S. possibly leading the way at the margin after falling behind for much of 2017. Growth in China is still likely to exceed 6.3% in 2018, as exports will accelerate complementing continued strong growth in consumer demand. The emerging markets economies will do well, too, as they are tied to growth in the industrialized nations, as exports are the key driver in those markets.
The bottom line is the investing environment for 2018 looks excellent at this time. North Korea remains a key risk as well as monetary bodies moving faster, if growth and inflation are stronger than currently anticipated. We will watch all of this carefully.
We continue to emphasize the financials, the global industrials, low-cost industrial commodity companies, capital goods companies, domestic steel and aluminum companies, beneficiaries of U.S. tax reform, technology at a fair price to growth and special situations including Disney. We bought it when it got hit a few months ago below $100. We love its management and content. The deal with Fox was not too bad. Great management makes for a great investment. Again, patience is needed.
At this time, we want to thank our investors for the faith and support that they have continued to give us and to you, our friends, for your comments as they push us to think out of the box. It truly has been a wonderful period for Paix et Prospérité since we began in 2013. We had a thesis to prove – that a well-managed global hedge fund could still outperform all indices. Frankly, we have achieved it and went beyond our vision. We know our best is yet to come.
So remember to pause, review the facts, reflect and consider any emerging mindset shifts; always look at your asset composition along with risk controls; do independent research and…
Paix et Prospérité LLC