There’s No Place Like Home

The U.S. stock market finished its best quarterly performance since 2009 rising by nearly 13% with the 10-year treasury bond ending at a breathtaking 2.4%. The pundits/experts have been fighting this every day, constantly calling for a market top anticipating an economic downturn or even a recession by year end due to the inverted yield. We disagree!  The turning point for the market and for us occurred when the Fed did an about face in December and was no longer going to be a threat to our economy. Interestingly, Larry Kudlow recently called for the Fed to reduce rates 50 basis points as an insurance policy to keep our economy going, fearing contagion from weakness abroad. We appreciate his position but would rather the Fed just remove the hike it made in December which was a mistake.

The U.S. economy is in fine shape. While we do not agree with the administration that growth will reach 3% this year, we are confident that our economy can expand by over 2.4% in 2019 and beyond for all the reasons stated last week: accommodative Fed; large growth in total employment and wages over the last year; highly stimulative fiscal policy including big tax cuts; large increases in technology spending resulting in accelerating productivity gains; and regulatory relief.  And if there are trade deals, our economy is likely to accelerate into 2020 due to declining trade deficits.

Clearly the United States is not only the current engine of the world but key to future global growth. While we are confident that China’s economy will do better moving forward due to all the domestic stimulus, we believe that a trade deal is essential for continued progress for China moving into 2020. Not so in the United States where trade is a much smaller share of GNP. And if there are no trade deals, the Eurozone, Emerging Markets and Japan will remain stuck in the mud doing well to stand still.

The bottom line is that we continue to find the U.S. markets undervalued with less risk than almost any other market. We are tired of hearing market pundits/experts say that our market is fully valued today at 17 times forecasted 2019 S&P earnings with a 10-year treasury yielding 2.4%, the Fed on hold for another year plus and bank capital/liquidity ratios at their highest levels in over 20 years. Do the math yourself. Ask Buffett what the appropriate stock yield/multiple should be relative to the bond yield? Why can’t the market easily sell at 19+ times earnings even if yields rose to 3.0% which won’t happen unless the global economy accelerates along with inflation. If so, earnings growth will accelerate offsetting any decline in multiple.

Let’s look at the recent data points that support our belief that there’s no place like home.

1.) Economic activity has picked up slightly in the United States: new home sales rose to an 11-month high in February; consumer sentiment rose to 98.4 in March; consumer spending increased modestly by 0.1% in January after a very weak December; personal income rose by 0.2% in February with a saving rate at a relatively high 7.5%; the Fed’s preferred inflation gauge tied to PCE actually fell 0.1% in January and is up only 1.4% year over year, the lowest number reported in 2 years; and the trade deficit fell to $51.15 billion in January as exports rose 0.9% from December whole imports fell 2.6% with the deficit with China declining 14% which we take with a grain of salt due to threats of added tariffs beginning January 1st boosting December exports from China. On the other hand, business saw some softness in February as the composite PMI Output Index fell to 54.3 from 55.5 in February. We have increased our estimate of first quarter GNP to slightly less than 1.8%, up 0.5% from a month ago.

There were three other worthwhile events that need to be mentioned as they play a pivotal role in our investment assessment and why we believe there is no place like home.  First, venture capital funding hit $99.5 billion in 2018, a level not seen since 2000. It is paramount that the U.S. remain at the forefront of technological change if we are to remain the dominant global economic force over the foreseeable future. Clearly protecting our IP is probably the key issue in our trade negotiations with China. It does not hurt that Lyft went public last week at a valuation of nearly $30 billion which only adds fuel to the fire for more venture capital funding as Lyft investors made a fortune. It is widely believed that this will be a record year for new issues of truly great companies disrupting markets and making a difference. Second, fourth-quarter stock buybacks set a 4th consecutive quarterly record hitting $233 billion and $806 billion for the year. We see no reason that corporations will slow their buybacks in 2019 out of free cash flow and additional repatriation of foreign retained earnings. And finally, the Mueller report came out clearing Trump and his aids from conspiring or coordinating with the Russian government’s 2016 election interference and reached no conclusion of obstruction of justice Attorney General Barr pronounced the President clear of committing any criminal offense. Basically, this report removes any threat that Trump will be impeached removing a possible impediment for the markets.

The U.S. is well-positioned to outperform the rest of the world over the foreseeable future. Trump’s apparent exoneration from the Mueller investigation will only invigorate him to push his agenda “To Make America Great Again.” While we continue to disagree with his tactics and social views, we do agree with most parts of his economic, financial, regulatory and trade agenda. We are sure that the Chinese, Europeans and Japanese negotiators appreciate his renewed strength/confidence after the Mueller report improving our odds at getting a favorable outcome in the trade negotiations. Not bad!

2.) We remain cautious at best as to the prospects for growth in the Eurozone and Japan without trade deals. The flash eurozone PMI Composite Output Index fell to 51.3 in March; the services PMI fell to 52.7; the manufacturers PMI Output Index fell to 47.7 and the Flash Eurozone Manufacturers PMI fell to 47.6, a 71-month low. The Flash Japan Manufacturers PMI index remains at 48.9 with further production cuts and weaker new order inflows. Business confidence continues to fall. Need we say more?

The Eurozone desperately needs financial, regulatory and trade reforms. Will it happen? We doubt it except for the possibility of a trade deal with the U.S. before year end. Then there are growing risks of a hard Brexit. Europe is really between a rock and a hard place. Japan is only slightly better off, but the country has no room for added domestic stimulus as its aggregate debt to GNP is out of slight already. Trade deals is their only possible salvation which we do expect by this fall.

3.) We continue to believe that China’s economy will respond favorably to all the domestic fiscal and monetary stimulus. While it is likely to boost growth for the rest of the year, we doubt that it will be sustainable without a trade deal with the U.S.. Little deals with Italy and France won’t push the needle in China to make a difference.

The bottom line? There’s no place like home.

In closing, we fully recognize that we live in volatile times. We have learned to stay true to our core beliefs; stay open-minded willing to change when/if any of the key variables shift; and be patient as change takes time. Listen to all of the company conference calls so that you can discern the differences in strategies and invest in only the strongest companies as successful investing is a marathon, not a sprint. Paix et Prospérité continues to outperform.

Our portfolios include drug companies benefitting from new product flow; global industrials and capital goods companies with unit growth 1.5X GNP; technology at a fair price to growth including semis; low-cost industrial commodity companies generating huge free cash flow; capital companies with content; and many special situations where managements have strategies to close the gap between current price and intrinsic value. We own no bonds and are flat the dollar.

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

Invest Accordingly!

Bill Ehrman
Paix et Prospérité LLC

 

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