Taking Away the Punch Bowl

Now that the global economies appear on sound footing as growth has accelerated nearly across the board, the discussion within the financial community, governments, businesses and the consumer is how and when the monetary authorities will begin to reduce excessive monetary stimulus without causing negative reactions to the financial markets and our economy.

The irony is that while economic growth has accelerated and employment risen, inflation remains subdued, which has perplexed most all of the monetary authorities. Unless inflation shows signs of picking up, it remains our contention that the monetary authorities will remain one step behind and would rather hold off meaningful moves fearing deflation more than inflation. Hence, we expect the yield curve to continue to steepen, which reinforces our investment conclusion of not owning bonds of any duration as well as buying reflation beneficiaries – most of all, the financial stocks.

It becomes clearer every day that global economic growth is accelerating. One of the key reasons for the recovery is that the global financial system is strong and is lending across the board. The last of the “problem” Italian banks was cleaned up last week such that we expect growth in Italy (one of my favorite countries to visit and do business in) to resume. The Greek banks appear in better shape too. Finally, and most importantly, China has successfully reduced shadow lending, and its financial system is moving to sounder grounds. The government deserves credit for managing the Yuan too.

Unfortunately Brexit is finally taking its toll on the British economy. Personally I think that there is a good chance that Britain may reverse or significantly modify its position on exiting and/or being a member of the Euroland before it finalizes its negotiations to fully exit.

The biggest positive global economic surprise last week was that growth in China, Europe and Japan appeared to accelerate meaningfully while the employment data in the U.S. was stronger than anticipated too. It is very hard to forecast a sluggish U.S. economy when it continues to create over 180,000 jobs per month as it has done over the last year. Yes, the wage data remain muted with average hourly earnings only up 2.5% year over year. All in all it was an excellent employment report and bodes well for the growth for the remainder of the year even without the benefit of any of Trump’s pro-growth, pro-business legislative agenda. But remember that his executive orders to reduce regulations and his ability to persuade domestic and foreign companies to build new plants here will go a long way to stimulate our economy. And finally unleashing our banks will help provide needed capital for corporations and individuals. All good!

On another note, Trump went abroad last week resulting in the negative press subsiding. A respite from the daily pounding against Trump and his administration! Trump had a great reception in Poland and gave what I felt was one of his best speeches about the need to unify and come together. I knew that he would have a chilly reception at the G-20 but felt that his meeting with Putin went as well as one could expect and maybe even better. I thoroughly understand why members of the Eurozone feel threatened by Trump’s fair trade policy as each country, most notably Germany, runs huge trade surpluses with the United States and therefore they want to maintain the status quo as long as possible. Threats to retaliate from any American trade sanctions against what are deemed unfair trade practices are humorous when you have most to lose. We need a transparent universal trade policy that is accepted by all and enforceable within a reasonable time period. Quite frankly if the United States changes its tax structure and reduces onerous regulations, U.S. and foreign multinational manufacturers will gladly build additional plants here to supply U.S. needs rather than import from abroad. That is the real crux of our huge trade deficit.

Global stocks are outperforming global bonds as the yield curve is finally steepening. I find it ironic that a month ago the pundits were recommending only growth stocks like the fabulous FANG four but now they have changed their tune and are recommending reflation beneficiaries (including the financials) and value stocks with good earnings growth selling at a discount to the market with above average yields. How fast the pundits change! And yet somehow they are always a step behind and a dollar short.

The bottom line is to stay the course. We do not expect the Fed or any other major monetary body to take the punch bowl away soon and end the proverbial party. In fact they all should really wait to see whether inflationary pressures are really building and are sustainable before they make major monetary policy changes. I strongly concur that they should continue to tell us that they are nearer the end to aggressive ease but any changes at this point would be minor although it is worth noting that the pendulum will start to swing back from aggressive ease the other way within the next nine to twelve months.

You want to only own stocks with earnings growth increasing far faster than the stock market multiple declines as rates rise. That takes us back to the reflation beneficiaries including multinational industrial companies, financials, tech and the best in breed industrial commodity producers with pristine balance sheets and low cost capacity. We also favor some domestic steel and aluminum companies as we do expect government action against proven dumping from abroad. There are also several special situations in our portfolio under going tremendous change that will lead significant revaluation over time.

Remember to review all the facts; step back, pause, reflect and consider mindset shifts; recalibrate your risk controls and asset allocation; do independent research on each investment and …

Invest Accordingly!

Bill Ehrman
Paix et Prospérité LLC

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