The Schizophrenic Market

The market pundits on CNBC, Bloomberg, Fox and other media networks swing back and forth day by day and sometimes hour to hour on virtually each and every one of their opinions of the global economy, financial markets and politics.

These “experts” are looking through the rear view mirror at current and past events rather than projecting the future which is what they should be are doing. After all, aren’t markets a discounting mechanism of future returns? These experts always accentuate the negative rather than giving equal weight to the positive occurring at the same time. Unfortunately, bad news sells better than good news. These so-called experts, including Cramer, do a disservice and should help their listeners think as investors rather than traders. Unfortunately, their listeners get whipsawed week after week following them as they are always one step behind. We only know successful, wealthy investors, not traders.

Their biggest fear this past week was rising interest rates as the 10-year treasury approached 3% whereas low rates and a flattening yield curve had been their overriding concern for weeks. These experts switched from fearing a weak economy and a flattening yield curve to fearing an overheating economy that would “force” the Fed to act 4 times this year rather than 3 as we still believe. Now the pundits want us to believe that the Fed will tighten policy quicker than earlier assumed leading to a flattening yield curve down the road and a recession within 18 months. We disagree! Our heads spin, as the experts shift their view daily, always looking at what just happened and then reacting rather than anticipating the future, which is our strength.

We have not altered our view.

We continue to believe in a strengthening economy throughout this year into 2019. We continue to expect the yield curve to steepen with the 10-year treasury breaching 3.25% this year and 3.75% in 2019. We also expect S & P earnings to easily exceed $150/share in 2018 (first-quarter results are so far exceeding even the most optimistic projections) and $165/share in 2019. By the way, the IMF reaffirmed their global growth forecast of 3.9% for 2018 and 2019 without inflationary pressures. We expect global competition, rapid technological advances, further penetration by disruptors and accelerating productivity gains to keep a lid on inflation for years to come. Don’t worry about rising commodity costs. Accelerating growth, much higher corporate earnings, muted inflationary pressure and rising bank capital ratios is a recipe for higher stocks prices. But not all regions, industries and companies are equal.

Change is everywhere and, as such, new investable trends are emerging. Look at government policy here and abroad to get an idea where the policy winds are to your back or in your face. For instance, we continue to invest in the production side of the US economy as Trump’s America First Policy complemented with tax and regulatory relief take hold rather than the consumption side of our economy such as consumer nondurables, housing and retailing. We expect a surge in capital spending by both domestic and foreign companies for many years to come. In addition, we are concerned about investing in social media companies with an advertising model. While Facebook is a great company, mandated changes in their business model may slow incremental returns. As the US government wants to spur overall economic activity, banks are a logical place to invest too as they benefit from loan growth and a steepening yield.

Our overseas investments, on the other hand, focus on consumer and technology industries rather than production industries as in the past. If our trade deficit is to decline, we win while our trading partners lose. Take a look at what we import and what we export to get leads where to invest. It appears that a new NAFTA deal will be announced in weeks; Mnuchin is headed to China to negotiate a better/fairer trade deal; and we may consider entering the TPP down the road or at least sign bilateral deals in the Pacific. China is a case in point as we shifted our investments there to those areas that their government wants to emphasize to sustain future growth such as the financial, consumer and technology industries rather than production industries such as steel and aluminum.

Again, it is good policy to invest in those areas with government support providing wind to your back and disinvest in those areas where the government is in your face. We expect new secular leadership to emerge here and abroad on the long and short sides of the markets. And stay short bonds everywhere. These are long term trends so be patient as they unfold, checking the boxes along the way and be open to change if events dictate.

A successful investor must have core beliefs acting as their True North. Unfortunately the media is bombarding us with sound bites every second of every day influencing those without core beliefs and/or have less information than the professional investor. Each week the experts are telling us why something happened rather than focusing on what will happen. Here again is why we believe that investing with an excellent manager with a proven record over many market cycles will outperform passive management over time. Paix et Prospérité has consistently outperformed all indices by leaps and bounds since we returned to active management in 2013. Management is our first decision in selecting a company to invest in so the same should go for you too in selecting a professional money manager. Our long-term record of success speaks for itself.

First-quarter earnings have been nothing short of sensational passing even the most optimistic forecasts. Listening to the conference calls gives us great confidence that we are only in the mid inning in the economic cycle with better days ahead. Change is indeed happening as management has really learned from past cycles so we doubt a boom/bust scenario will unfold down the road as in past cycles. Managements are controlling costs and capital spending so as to increase profitability and cash flow for years to come. Again not all industries and companies are alike. I would not want to be a consumer nondurable company like Colgate, Clorox and P & G as it is virtually impossible for them to raise prices as competition is so intense. However just the opposite is happening for Alcoa and Nucor, our domestic aluminum and steel investments. Demand is going through the roof; prices are strong and earnings growth/cash flow/returns are accelerating. The former companies valuations are going down while the latter ones are on the rise. These are examples of some new secular trends mentioned earlier which we correctly anticipated and invested accordingly!

The market pundits, whose views change daily, are a primary cause of market volatility! As you know there have been no changes in our core beliefs. Our investments in financials, global capital goods and industrials, technology at a fair price, industrial commodity companies including domestic steel and aluminum and special situations has paid off tremendously in April, as our performance has been far superior to the markets. We invest with a one to two year time frame, which is sufficient to let our core beliefs along with new trends emerge and be recognized by market participants. And we remain short bonds of all maturities.

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

Invest Accordingly!

Bill Ehrman
Paix et Prospérité LLC

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