Stop Trading: The Trend Is Your Friend

Do you listen to what the pundits’ have to say day after day? They shift their view based on that day’s stock action rather than having any real sustainable, investable thoughts.

They need to pause, consider mindset shifts, do in-depth independent research and then invest accordingly. They need to stop trying to sound smart by over analyzing every move. I wish they would invest both long and short with at least a one-year time horizon rather than trying to trade on each piece of news. How many rich traders do you know? On the other hand, I know very rich investors. Warren Buffett comes to mind!

I will say it again. The global economy is accelerating; inflationary pressures are muted; earnings, operating margins and cash flow are improving faster than anticipated while interest rates remain extraordinarily low for this stage in an economic recovery. Sounds like a pretty darn good environment for investing. But remember, all markets and stocks are not equal so you must do the work to separate the winners from the losers. And equally as important, you must have patience to let it all play out.

Virtually every major data point reported this week supported our investment thesis:

  1. China continues to confound the pundits as recent economic data points support growth just a hair under 7% for the year. Both official and private purchasing manufacturers’ surveys revealed solid strength. Results over the next few weeks will confirm strong exports, strong industrial output, continued strength in fix investment and retail sales growth near 11%, similar to the prior month. Interesting to note is that the CPI is running up only 1.5% on an annualized rate while the PPI is up close to 5.5%. It is expected that bank lending declined to less that 800 billion yuan last month, the lowest level since last November. China is in fine shape.
  2. Eurozone economic activity accelerated as anticipated with a gain of 0.6% in the quarter or an annualized gain or 2.3%. Interestingly, Eurozone growth has outpaced the growth in the U.S. over the last 18 months. Despite the acceleration in growth, producer prices fell by 0.1% in June from May. As long as both the CPI and PPI remain weaker than the ECB has predicted, we expect monetary policy to remain accommodative for the foreseeable future. Earnings reports have been fine too.
  3. The United States had a series of strong economic data points last week: manufacturing activity continued very strong in July with an ISM reading over 56; the trade deficit declined to $43.6 billion as exports hit a 2 ½ high; service activity continued strong; and finally payrolls gain were 209,000 in the month, hourly wages accelerated to a 2.5% annual pace and the jobless rate fell to a 16 year low at 4.3%. It is virtually impossible to forecast a significant slowdown in U.S. growth for the remainder of the year with over 2 million new jobs created over the last twelve months.
  4. Reported corporate profits both here and abroad continue to exceed earlier expectations and most managements have at least raised the lower end of their forecasts for 2017. I am particularly struck by the strong margin and cash flow gains in the quarter.

Let’s review things.

The DOW breached 22,000 Thursday, rising for 8 straight days. Pessimism exists as money keeps leaving the stock market; the 10-year treasury rose to all of 2.27% on Friday on the heals of strong job data and earnings keep knocking the cover off the ball. It is pretty obvious to me why the market continues to rise on a wall of worry. But not all stocks are equal. Herein lies our strength. Paix et Prospérité continues to outperform all averages not only for this year but for the last few as well.

The political news out of DC continues to be negative on one hand but somewhat positive on the other. Clearly Trump and his inner circle have their hands full with the Russian investigation; but it is equally clear that the President’s new Chief of Staff, retired General John Kelly, is bringing some order and discipline to the White House.

As I mentioned last week, I am much more optimistic today that a tax overhaul bill will be passed this year than I have been for months. Gary Cohn’s commented Friday that he is shooting for a business tax rate now below 23%. I find that doable and passable this year with ample benefits to our economy and global competitive position. I also expect an individual tax cut with no direct gain for the wealthy although I continue to anticipate a favorable change to the capital gains rate but with a longer holding period, which I support for capital formation. I expect an infrastructure bill will follow tax reform, but it may be delayed until early 2018. You are already seeing the benefits of Trump’s trade policy, as a week does not go by without some foreign company announcing a major new plant to be built in the United States. I also see countries like China finally reducing excess capacity and raising prices in attempt to stay ahead of more punitive tariffs from DC. Finally Trump and his team continue to cut red tape offering regulatory relief across the board. Healthcare is another issue however and will have to wait until both the Democrats and Republicans realize that this has to be done on a bipartisan basis or not at all.

I want to make a brief comment on AIG, the huge insurance company that has had its problems since 9/11. There has been another management shake-up at the company and a former senior executive of the company. Brian Duperreault has returned and assembled a first-class team. Brian has an amazing record of success spanning his forty-year career accelerating growth in each company that he has led and creating huge shareholder value. On his first conference call after beating estimates for the second quarter, he announced that he wouldn’t give forecasts any longer as he is managing the company to create long-term value rather than short-term objectives. The analysts hated it but I just loved it as this is what is missing today. Management should not micro-manage the short term to please Wall Street but concentrate on creating long-term value. This perspective has not hurt Warren Buffett or Jeff Bezos. I am absolutely amazed by the reaction in the stock market if a company falls a penny or two short in its current earnings as long as the longer-term outlook has not shifted. That’s what creates opportunities to profit for investors like Paix et Prospérité. By the way, AIG sells at $65 per share with book value over $80 per share. We own it.

Let’s wrap this up.

It’s very hard to sell this market when the global economies are improving, earnings are accelerating and interest rates are so low. The 10-year treasury is 2.27%; the 10-year bond is 0.46%; the 10-year Brit is 1.18% and the 10-year JCB is all of 0.06%. Remember too that financial risk is declining as bank capital and liquidity ratios are rising. We still expect the yield curves to continue to steepen, as the financial authorities remain one step behind fearing deflation if the global economies stall more than inflation as the global economies pick up steam. Remember: the trend is your friend.

But all stocks and all markets are not equal. We continue to emphasize the financials, global industrials, low-cost industrial commodity companies (Rio Tinto’ earnings report was sensational and the future is bright indeed); technology; growth companies at a fair multiple and special situations. By the way, Huntsman completed the IPO for its commodity business at over a $3 billion enterprise value leaving the remaining HUN as a pure specialty chemical company that will merge with Clariant at the end of the year. Yes, we still like the stock today even though our cost is less than $15 per share, as the stand along company with or without the merger will be revalued over time and is worth in the mid 30’s at least over the next twelve months.

Lastly, we want to welcome Jim Myer to Paix et Prospérité as our Head of Business Development. Jim has a long and illustrious career in the financial services industry and we are looking forward to him being part of our team.

In closing, review all the facts; step back, pause and consider mindset shifts; look again at your asset mix and risk controls; do independent research and…

Invest Accordingly!

Bill Ehrman
Paix et Prospérité LLC

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