Suspended Animation

The financial markets are in a state of suspended animation pending resolution of the NAFTA and China trade negotiations and Trump’s meeting with Kim Jong-un to denuclearize the Korean peninsula.

The markets could break either way depending on the success or failure of any one of these negotiations. Buffett and Munger are looking “over the valley” and remains optimistic long-term despite all of the near-term risks. Their actions speak for themselves.

So, now the question for you to answer is whether you are an investor or a trader? If you find sufficient value at today’s prices recognizing the risks, why not be buyers? If you do not, maybe sell and raise cash until you see sufficient upside to justify the risks?

We look at our holdings all the time to assess whether the upside justifies the risk using a one-to-two year time horizon at the least. Many of our investable long-term trends take years to play out but the rewards are huge if we are right. Oh, did I mention we tend to be right many more times than we are wrong? Hence, our successful track record beating all indices. Our bogey on any long-term investment exceeds 25% per year including dividends. Shorts/hedges have different objectives. By the way, our long-term performance is close to that hurdle rate.

Another one of our key strengths is knowing when to hold ‘em and when to fold ‘em. Now is a time to hold them! We are nowhere near an economic peak or tight monetary policies here and abroad. But remember that all regions, industries and stocks are not equal. Active management is again beating passive management as not all boats are being lifted today, as over the last few years. It’s not all about excessive monetary ease any longer. Experience, an understanding of global political, economic and financial trends as well as good, independent research separates us from the pack.

Our outlook for continued global expansion with muted inflationary pressures remains on track. Increases in global employment, wages, profits and capital spending support our optimism that the future remains bright indeed. We still expect global growth around 3.9% for both 2018 and 2019. And 2020 will be another good year too.

But, change is occurring with new trends emerging. Trump’s pro-growth, pro-business; America First policies have altered the global investment landscape. Board decisions on where to expand are shifting with the US being a destination of choice after many years of neglect. Our portfolios continue to over weight those industries/companies that will benefit from this clear longer-term trend. It helps that these companies have pricing power, too, as known disruptors cannot hurt them. The combination of volume growth, pricing power, rising operating margins will lead to higher earnings, returns and free cash flow for many years. These companies will be the new growth stocks and receive higher relative valuations in the future than their historic ones. And the old winners are likely to be the new losers too!

Strength in the Euro and Yen over the 9 months has finally penalized growth in the Eurozone and Japan, which are heavily export dependent. Inflation remains muted and has been somewhat weaker of late in those regions putting downward pressure on interest rates. Growth in the US has picked up at the same time and is likely to exceed 3.5% in the second quarter. Our interest rates have risen recently due to accelerating growth, which is good news. The long end, nevertheless, is being held down from what it might be due to huge capital flows from abroad as the yield differential has widened once again. The dollar has strengthened as a result as we predicted. Strength in crude oil prices that are dollar dominated contributed too. Don’t forget that the Chinese Yuan is tied to the dollar for the most part thereby not influencing trade patterns.

So where does all of this lead us?

We continue to see great value in our market with multiples near the lower end of their historic range with interest rates ironically near historic lows too after seven years of economic growth. Financial ratios continue to improve as well, reducing the chance of systematic risk.

Finally, inflationary expectations remain muted although we see some rise in the months ahead before accelerating productivity gains kick in reducing unit wage pressures. We do expect input costs including industrial commodity prices to continue to rise. That is why we only own companies with pricing power.

So why is the market selling at these levels?

Skepticism and fear still exists that Trump and his team will screw up and lead us into a trade war or more. We disagree! While we would not be surprised to see some trade skirmishes pop up, we remain optimistic that it won’t mushroom into trade wars before there are agreements in place creating a more level playing field with closer reciprocal trade tariffs along with rules to protect IP. A win for Trump and America too!

Can you anticipate what the pundits and media will be saying then as the market rises to new high? While we remain optimistic that all of this will materialize over the next few months, we do invest for the longer term to permit our investable trends to play out. We always maintain excess liquidity to take advantage of market weakness if the unexpected occurs, which seems to happen all too often.

The financial markets remain in suspended animation waiting to see how all of these events play out. No one knows for sure what will happen or when but the market today is creating opportunities for those investors willing to look over the valley like Buffett, Munger and us. We invest like them in companies with strong financials, superior returns, great futures and, most importantly, with excellent managements. We buy them with an eye to own them for years. Our average holding period exceeds two years.

Our portfolios today include financials, capital goods and industrials, technology at a fair price to growth, industrial commodity companies including domestic steel and aluminum and, finally, special situations where internal developments including M & A, will lead to higher valuations down the road. By the way, sports betting is a new area of interest after the recent Supreme Court ruling. We remain short bonds and long the dollar too.

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

Invest Accordingly!

Bill Ehrman
Paix et Prospérité LLC

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