What Lies Ahead?

The financial markets have recovered well over half the precipitous decline that occurred 10 days ago. It’s fascinating to watch and listen to those pundits who were telling us why the markets were in free-fall now reverse themselves and tell us why the markets recovered with better days ahead.

I say tune them out completely and invest based on your own analysis and core beliefs. We do! The pundits are typically one step behind – explaining why it happened looking in the rear view mirror rather than looking ahead through the windshield. Let’s face it, anyone can be a Monday morning quarterback.

Unfortunately, many investors are influenced by these commentators and get caught up in the emotion of the day. They do not pause, reflect and review the facts in order to make sage decisions. They forget to think as an investor and as a result act as a trader and wealth is not created as it could be.

Paix et Prospérité was able to take advantage of and profit from this overreaction in the markets. We added to some positions and reduced others to make room for new investments that really got slammed without reason. We always advise to maintain excess liquidity to take advantage when others are panicking. We also covered some of our bond short. Our funds are close to new highs for the year, clearly outperforming the averages. Truthfully, we like volatility as it separates the pros form the amateurs. It’s hard to differentiate ourselves when everything is rising indiscriminately.

The week ended on a high note for us as the U.S. Commerce Department called for tariffs on imported steel and aluminum. We have recommended for over a year owning domestic aluminum and steel companies for a numbers of reasons including our expectation that Trump would keep his promise to these industries and respond to illegal dumping from abroad. We expect the administration to take a measured approach here to avoid a major trade conflict; but that will be enough to boost profitability from current levels, which is pretty good already. Don’t forget that domestic demand for steel and aluminum will benefit from a surge in capital and infrastructure spending for years to come too. Stay invested with the highest quality, low-cost producers even though the weakest ones will have the most leverage.

Last week’s economic and financial statistics continue to support an accelerating global economy. It does appear, however, that inflation is finally picking up, which is the primary concern of the financial markets. How will all the monetary bodies around the world react? Will they take away the punch bowl prematurely slowing the recovery too soon leading to the next downturn? And if economies turn down, what tools are left for the monetary authorities to use to mitigate it?

Our take is that inflation will pick up near-term but that it will be capped due to the competitive impact of globalization and rapid technological change giving rise to disruptors everywhere. Here is one case in point: Trump’s stimulus plan is front-loaded boosting growth and near-term inflation. It is our view, however, that inflation will stay contained in the 2% area as new, more efficient capacity comes on stream later in the year and in the years ahead. Productivity will accelerate offsetting hourly wage gains.

The same perspective goes for the U.S. budget deficit, as the cost is front loaded while the benefits accrue over years. Look through that windshield! The bottom line is that we see both inflation and deficits accelerating near term but declining years out. Think as an investor. Of course, that view is open to change based on actions from monetary authorities, but we still believe that all of them will stay one step behind and let their economies run hot rather than risk a premature downturn.

So where does this all leave us?

The stock market continues to offer significant upside for the investor. But not all regions, asset classes, industries and companies will benefit.

We continue to emphasize: financials benefiting from loan growth; a steepening yield curve and further deregulation; global industrial and capital goods companies benefiting from global growth and an acceleration in corporate capital spending; industrial commodity companies as utilization rates and prices continue to increase; domestic aluminum and steel companies for all the reasons mentioned above; technology companies selling at a fair price to growth (eg. Cisco has been one of our largest positions for 2 years now), and special situations where managements are instituting significant change that will result in increasing volume growth, margin expansion and earnings/cash flow and dividends growth.

We expect the dollar to remain under pressure near term but improve later in the year as the benefits of tax reform can be seen by accelerating tax receipts leading to forecasts that the U.S. deficit will decline in the out years rather than continue to increase as most forecast today.

Review all the facts; pause, reflect and consider mindset shifts; analyze your capital allocation and risk controls; do independent fundamental research and..

Invest Accordingly!

Bill Ehrman
Paix et Prospérité LLC

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