Shot Heard Around The World

Trump’s “pre-empted” announcement of 25% steel and 10% aluminum tariffs underlined his “America First” message that the U.S. will no longer tolerate unfair, illegal trade practices from abroad.

We would have preferred a more targeted approach to illegal dumping of aluminum and steel into the states and still hope that he will throttle it back next week allaying concerns from our closet allies, especially Canada.

Let’s state a few facts: the U.S. runs a $566 billion dollar trade deficit with the world, $375 billion with China alone, which penalizes our economic growth, jobs and balance of payments. The only trade area that we run surpluses in is services, which includes intellectual property currently under review as it is being pirated away from abroad, mainly China. Another fact is that the WTO is really ineffective, like the UN, in resolving conflicts. So, what options were really left to do and be effective? Take unilateral action. But how much?

We all want open and fair trade, not trade wars. The western world is comprised of capitalists with a profit motive. But some of our trade partners—socialists and/or communists—have different objectives, primarily to create jobs.

No one disputes that China and others are subsidizing many industries including steel and aluminum. No one disputes that China transships to other countries to circumvent rules. We all know that steel and aluminum made in China finds its way into many, many countries including Canada, Europe and Mexico with the U.S. as its final destination point.

So what are we to do to end illegal dumping? Nothing tangible has ever happened as our trade deficit just grows and grows as abuses get more and more. Could it be done with a scalpel rather than a hammer? Perhaps. But, Trump’s announcement was clearly a shot heard around the world. And it caught everyone’s attention. It’s time to walk the walk rather than talk the talk. Maybe it’s worth taking some short-term pain for long-term gains.  After all, we are running a near $600 billion trade deficit and energy is not the main culprit as in years past. Who has the most to gain and who has the most to lose from fair and open trade? Think about it!

A surge in capital spending in the U.S. is one of our major investment themes. The change in tax regulation, especially the immediate write-off of capital spending; reduced regulations and red tape to get projects approved; and finally Trump’s trade policies will all contribute to a surge in capital spending in the states by both domestic and foreign companies over many years to come.

For example, Alcoa will shift some of its production from Canada to the states restarting previously closed facilities and Nucor will finally reap the benefits of having sustained its capital spending plans over the last five years entering new markets and reducing costs while other companies cut back. Don’t you think that Alcoa and Nucor are pretty good long term investments boosted by this move? There are many more direct and indirect beneficiaries of this trend where we have invested. We expect these companies not only to grow earnings at accelerating rates with increasing returns but also to be revalued as the new growth stocks in America. Not too bad! Imagine all the higher paying jobs that will be created too. And who will finance all of this? Our banks. Another one of our major investment themes.

Beside Trump’s huge trade announcement, Jerome Powell’s testimony last Tuesday and Thursday to Congress took center stage. It is amazing how analysts pour over every word he says trying to figure out if the Fed will be dovish or hawkish with raising rates 3 or 4 times this year. Powell did a great job in our opinion and was direct/honest with his responses to Congress.

It is clear that our economy is getting better. It is clear that the tax plan and spending plans will be add to growth from what it otherwise would be. It is clear that employment will continue to grow and that we are at or near full employment. We believe wage pressures and inflation will increase near term but productivity will increase as capital spending surges holding down unit labor costs over the next few years. Powell added that Fed policy would remain moderate to sustain the economic expansion but be enough to prevent the economy from over heating. The market did not like that comment, but we had no problem with it as that is their intent.

Interest rates rose on Powell’s testimony on Tuesday only to fall back after Trump’s comments on trade, raising the specter of a trade war which could penalize growth if it mushroomed out of control, which we do not expect.  Notwithstanding the Fed should sit back and see how events unfold before changing its current policy from moderate hikes in the funds rate this year and next. We expect 3 hikes this year and next beginning in March, a steepening yield curve and the 10-year treasury at 3.25-3.50% by year-end.

Virtually all  the economic statistics reported last week supported continuing strength in the global economy.  After decades of stagnation, Japan’s unemployment hit a 25-year low.  In fact, the head of the BOJ mentioned that excessive ease might end sometime in 2019. Good news is good news. While the numbers out of China last week pointed to a moderate slowdown, don’t bet on it as numbers reported just after the Chinese New Year are notoriously off the mark. Europe is doing just fine.  And finally, we expect U.S. first quarter GNP to exceed 3.0% followed by similar gains for the rest of the year.

Uncertainty creates opportunity for the investor with a time frame beyond the next day .The market remains undervalued today as global growth is accelerating; inflationary pressures, while building, remain muted; the yield curve is steepening for all the right reasons (worry if it inverts); and corporate profits, cash flow, dividends and buybacks are all accelerating. As Buffett says “you are buying businesses rather than pieces of paper and the outlook for investors has never seemed brighter than today.”

We continue to emphasize the financials, global capital goods and industrial companies; low cost, financially strong commodity companies including domestic steel and aluminum, technology companies selling at a fair price to growth and special situations implementing change that will be revalued over time. We remain short bonds.

Remember to review all the facts; step back, pause, reflect and consider mindset shifts; analyze you asset mix and risk controls; maintain excess liquidity at all times; do independent research and…

Invest Accordingly!

Bill Ehrman
Paix et Prospérité LLC

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