Sustained Growth and Prosperity

There is a certain irony that the world’s political, economic and financial leaders are coming together in Davos this week to discuss “creating a shared future in a fractured world”. The intention is to develop a shared perspective on political, economic and social topics aimed at embracing positive change globally. This is happening as U.S. government is shut down due to the continued inability of our political parties to put the country above themselves. What a shame.

Christine Lagarde, head of the IMF, will present an updated view of the world economic outlook, which undoubtedly will be very favorable showing building momentum as we enter 2018 with minimal inflationary pressures. She will touch upon concerns surrounding trade conflicts and the need for all governments to enact financial and social reforms to assure sustained growth in the years ahead.

Global economic statistics remain strong across the board. In fact, China’s economy exceeded all forecasts and grew by 6.9% last year. We expect growth to exceed 6.5% this year bolstered by strong exports benefiting from global economic strength and a sharp increase in domestic consumption despite tighter financial controls and efforts to further reduce pollution and zombie companies.

It will be interesting this week to hear President Xi Jinping of China and President Trump speak at Davos offering most likely different and opposing views of the future with one looking across a more connected world and the other looking inward toward his own country. I am for open, free and fair trade that is monitored by a world body with the capability to enforce change in a timely fashion when abuse is proven. I expect Trump to also announce that the U.S. is open for business with less red tape, a better, more competitive tax system and a willing and capable work force. Potential trade conflicts is an area that we are monitoring closely as it could be a thorn in sustaining the global expansion.

No one can argue that the global economy is expanding across the board with minimal inflationary pressures as we enter 2018 and that this will be a great year for corporate profits. Interest rates in Germany and Japan remain historically low with ten-year government bond yields near 0 with real rates negative despite resurgence in growth in 2017. The divide amongst the pundits and economists occurs when looking to 2019 and beyond.

Paix et Prospérité is in a minority, which we like, forecasting that the U.S. economy will expand for several more years bolstered by tax reform and a Fed that will remain one step behind as long as inflationary pressures remain subdued. The U.S. will again become the engine for global growth. We do expect both the BOJ and ECB to reduce their stimulus programs sooner than generally anticipated in 2018 as growth will stay above forecasts and inflation will pick up somewhat reducing deflationary concerns that remain in both regions. All monetary bodies remain incapable of admitting that the Philips curve no longer works nor does historic measurements of productivity. Global competitive forces and swift technological change led by the disruptors will keep a lid on inflationary pressures from what they otherwise would have been in past recoveries of this magnitude.

We recognize that this is an optimistic view, which differs from the consensus, which is more cautious about 2019 and beyond. We see areas of major change that will sustain growth for years to come. We believe that the U.S. has entered a major, multi-year capital spending cycle for several reasons:

  • Tax reform reduces the corporate tax rate and permits the immediate tax write off of capital expenditures boosting profits and cash flow
  • Repatriated foreign cash balances provides the added capital to boost spending above what it otherwise might be
  • Corporations under spent for the last 10 years therefore capacity utilizations rates are high just as volume growth is accelerating
  • New technology significantly lowers manufacturing costs by replacing older less efficient equipment
  • Reduced regulations and red tape accelerates the capital spending process
  • Fear of trade barriers along with tax reform has changed managements’ decision-making process regarding where the next plant will be built

Finally, we believe that the U.S. government will pass a trillion dollar infrastructure program before year end which will begin to kick in later in 2019. Higher capital spending will eventually lead to rising employment, which will bolster future consumer spending and reduce future government budget deficit despite the tax cuts. All good!

A major shift is occurring globally as U.S. capital spending accelerates. U.S. economic growth will be supported more by rising investment/production and a declining trade deficit rather than consumption while the reverse will occur elsewhere, especially in China. We are finding numerous long and short investments around the world that will be impacted by this longer-term trend.

The bottom line is if our politicians don’t do anything foolish, the U.S. has truly entered a period of sustained growth and prosperity. We have the tailwinds from tax reform; reduced regulations, a pro-growth, pro-business administration and a moderate Fed that will remain one step behind as long as inflationary forces remain muted. In addition, we are fast becoming the largest producer of crude and gas giving us a competitive advantage over most of the world, which reinforces us as a destination for new plants.

The investment implications are clear-cut. Our portfolios are concentrated in those companies that will benefit from these longer-term trends. We are emphasizing the financials that will benefit from loan growth and a steepening yield curve; global industrial and capital goods companies; technology at a fair price; low cost industrial commodity companies including domestic aluminum and steel; and special situations where managements are making major changes to improve their competitive advantage and future returns.

We recognize that the market is off with a strong start and there are always unforeseen risks; but our success has been based on our ability to recognize, invest and benefit from these longer-term trends. We maintain excess reserves at all times to be able to take advantage of hiccups along the way as long as we have not shifted our view. Listen to all the earnings conference calls as it will assist you in better understanding the future direction of the economy and how each company will participate or not.

Review all the facts; pause, reflect and consider mindset shifts; analyze you asset composition and risk controls; do independent research and…

Invest Accordingly!

Bill Ehrman
Paix et Prospérité LLC


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