The Path Forward

The U.S. stock market hit new highs last week continuing to climb on a on a wall of worry while most other markets including China declined. It remains clear that both the U.S. and Chinese economies have accelerated while the economies of Europe and Japan remain stuck in the mud, in desperate need of reforms and trade deals.

We continue to be surprised that the pundits/experts believe that our market is fully valued selling at less than 17 times prospective earnings when the 10-year treasury is yielding 2.5% and bank capital/liquidity ratios are at new highs. The investment winds remain to our back with an accelerating economy with minimal inflationary pressures; low interest rates with an accommodative Fed; stronger than expected operating margins, profits and cash flow; and the prospects of trade deals on the horizon We continue to believe that the market is 10% undervalued today. But not all stocks will perform equally. There will be new winners and losers as the investment environment continues to change. Paix et Prospérité’s strength is staying one step ahead by identifying new trends/investments early and benefiting when they become apparent to all.  

Let’s look at the events of the week that support our outlook:

1.) The United States economy clearly accelerated as we moved through the winter with March as the as the strongest month in the quarter. We were not as enamored with the first-quarter GNP results reported Friday as the pundits since the vast majority of the 3.2% real growth reported came from inventory accumulation and a smaller trade deficit. In fact, we were disappointed that the consumer spending rose only 1.2% but were pleased that the PCE price index slowed to only a 1.3% increase, well below the Fed target of 2.0%. The government shutdown in January reduced growth in services by 0.3%. We are confident that the Fed will look through these numbers next week maintaining its current accommodative policy recognizing that reported growth will slow in the second quarter even though consumer spending is likely to accelerate.

Other stats reported last week included the consumer sentiment index which fell slightly in April from lofty levels to 97.2; existing housing sales fell 4.8% to an annualized rate of 5.21 million while new home sales actually rose 4.5% to 692,000 units in March and durable orders for business equipment increased to a 7-month high at $258.5 billion.

Our initial read is that second-quarter growth will slow to around 2%. We expect consumer spending to accelerate offset by a decline in inventories and a higher trade deficit as we return to more normal trading patterns that were altered by the threat of additional tariffs in January which never materialized. We look for an acceleration in growth in the third and fourth quarters bringing full year GNP gains near 2.7%.

Our confidence is increasing that trade deals will be reached with China and Japan over the next few months which will boost growth in 2020 and beyond.

2.) Economic prospects are clearly improving in China too. We are quite confident that all the monetary, fiscal and regulatory stimulus thrown at the economy has done the trick as first-quarter GNP came in stronger than anticipated at 6.4%; industrial production in March rose 8.5% from a year ago; retail sales rose a healthy 8.7%; exports most recently surged 14.2%. and industrial profits rebounded 13.9% from a year earlier.

We paid special attention to comments from Chinese President Xi Jinping at the Belt and Road forum in Beijing where he essentially supported many of the trade/intellectual property reforms demanded by the Trump administration in the trade talks as well as acknowledging that the yuan won’t be used to increase competitiveness. He also dialed back China’s control/dominance over countries participating in the Belt and Road initiative. Here again, he is bending to U.S. demands making a trade deal much more likely to be concluded over the next month. U.S. Trade Representative Lighthizer returns to Beijing this week.

3.) Europe continues to be a mess as we see little progress on the financial, regulatory and trade reforms so sorely needed to enhance the regions global competitiveness. For example, Germany’s IFO index fell again in April to 99.2 and French factory confidence fell to a four-year low. While French President Macron discussed plans to cut taxes, he failed on his plan to introduce regulatory reforms.

We remain very pessimistic on Europe’s prospects and continue to believe that it will be very difficult for them to reach a trade deal with the U.S. if they try to exclude agriculture as they say.

4.) While the economic stats out of Japan have deteriorated, we believe that the prospects of Japan and the U.S. reaching a trade deal near term has improved dramatically. Factory output fell 0.9% in March, the jobless rate increased 2.5% and food inflation pushed up overall inflation to 1.3%, the highest reading in 4 years. The BOJ maintained its short-term rate at minus 0.1% and that of long-term yields at 0% at its most recent meeting. It also lowered its current economic forecast while extending to the summer of 2020 its aggressive easing policy.

On the other hand, Prime Minister Shinzo Abe and President Trump appeared to have a very successful meeting in DC on trade and were both optimistic that a deal could be concluded over the next month or so when Trump visits Japan to meet the new emperor. Japan’s economy will clearly benefit from a U.S. trade deal with China and with themselves. We are getting more optimistic on Japan’s economic prospects.

Trade has moved to the forefront of our outlook over the foreseeable future. We are gaining more confidence that deals will be struck between the U.S. and China and then with Japan. A deal with Europe remains questionable as long as agriculture is not part of it. While trade deals will not alter our economic outlook for 2019, it will boost our global forecast for 2020 and beyond. But don’t forget that the financial markets will anticipate all the gains/changes well before they become reality.

Specifically, we would expect trade deals to boost global economic activity; increase inflationary expectations; steepen yield curves; weaken the dollar; increase commodity prices and have a favorable impact on corporate profits. But not all regions, industries, and companies will benefit equally. Herein lies our strength. We have been global investors for a majority of our 48-year career successfully managing money utilizing both a top-down and bottom-up approach understanding the inter- and intra-relationships amongst the variables. We are true active managers outperforming the averages by a wide margin while maintaining liquidity and controlling risk at all times.

As you know, we anticipated the change in market perception back in December and shifted our portfolios accordingly to reflect a stronger economic environment as the year progressed.

Our portfolios currently include global industrial and capital goods companies like EMR and HON; technology including CSCO and MSFT; U.S. domiciled global financials like BAC; low-cost industrial commodity companies generating enormous free cash flow like RIO; cable with content like Comcast and Disney; housing related like HD; and any special situations. We are flat the dollar expecting it to weaken on trade deals and own no bonds as we expect the yield curve to steepen. We remain fully invested owning the best in breeds with great managements, winning business plans and big free cash flow with above average dividend.

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

Invest Accordingly!

Bill Ehrman
Paix et Prospérité LLC

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