From Rags to Riches
It is hard to believe that we went from the worst fourth quarter performance last year since 1931 to the best gain for the year in 2019 since 2013. We believe that there are more gains to be made in 2020 as the global economies recover after a sluggish performance this year bolstered by continued monetary stimulus, some fiscal stimulus and less trade tensions. The pundits/experts have remained one step behind, looking in the rear-view mirror as traders, rather than over the valley as investors, which is our strength. Did you notice how all of them were bullish last week? A little late, don’t you think?!
Let’s go back in time and look at what we were saying just one year ago around this time of year during the worst December that any of us can remember. On December 16th our blog was entitled “Christmas Sales Have Begun”. We mentioned that adversity creates opportunities for investors with more than a one-second time frame. We commented on all that was bothering the markets including: “record flow outflows (huge tax selling), a global synchronous economic downturn; trade problems, consumer and business confidence falling, rising fears of deflation, and monetary authorities had it wrong (they were tightening)”. Systematic trading was dominating the marketplace putting undue pressure on the averages.” Fortunately, we had raised a lot of cash in October, so we started to nibble away at defensive, high yielding stocks.
The following blog dated December 23rd was titled “It’s Always Darkest Before the Dawn” where we discussed that “a perfect storm hit the financial markets as the Fed raised rates, signaled two more rates hikes in 2019; maintained their $50 billion per month runoff of their balance sheet; the ECB ended its bond purchases; the trade war with China over stolen IP escalated; there was a partial shutdown in our government; Trump’s administration was in disarray; and investors were liquidating stocks at a record pace.” We predicted that the global economy would slow without any inflationary pressures in 2019 and that the next move by all monetary authorities would be to ease big time.” We believed that the stock market was still undervalued, so we continued buying only defensive stocks like healthcare, consumer non-durables, cable with content, utilities and the like with above average dividend yields.
The last blog of year was entitled “Wake-up Call” where we sat back, looked over the valley and discussed what was needed to be done to right the ship to avoid a global recession with rising deflationary forces in 2019. We felt that clearer heads would prevail as the alternative had such negative connotations for the global economy and rising deflationary pressures. We began commenting in this blog that the stock market multiple would trend up to 20 times earnings, higher than the historical range, as interest rates were 300-500 basis points lower than the historic norm while bank capital/liquidity ratios were moving to all time highs. We added that the Philips curve was dead, and the Fed had no reason to fear inflationary pressures as unemployment fell. We recommended adding to defensive stocks, U.S based, with above average yields as our economy would outperform all others as the consumer was 75% of GNP.
Now let’s fast forward to December 2019 and, once again, look at the key issues first and foremost in the minds of investors throughout the year which have all done a 180 degree turn since a year ago: trade, monetary policy, Brexit and Trump:
Trade: Presidents Trump and Xi had a phone conversation Friday confirming that the signing of Phase 1 of a trade deal would happen the beginning of 2020. China confirmed that it was also postponing any additional tariffs on U.S goods just like we did on the proposed December tariffs. It was confirmed that China will buy at least $40 billion of agricultural products and over $200 billion of other U.S goods over the next two years. Finally, it became clear that President Xi has concluded that it was better to deal with Trump than run the risk of dealing with a left-wing Democrat.
The House finally passed the North American trade pact with bipartisan support. This deal to us was far more important to conclude than Phase 1 of a trade deal with China. We are confident that this deal will boost U.S. GDP over the next two years.
Finally, Trump decided yesterday not to impose tariffs on Brazilian steel and aluminum. The bottom line is that trade will most likely not be an issue in 2020 which should lead to less uncertainty in the business community and a turnaround in global trade.
Monetary policy: Could it get any more accommodative than now? Several key voting members of the Fed came out last week and mentioned that there will be no change in rates in 2020; the Fed injected nearly $58 billion into the financial system; Sweden ended negative rates which has been the wrong policy choice; the BOJ kept policy steady leaning on Abe’s $120 billion stimulus plan to boost Japan’s economy; and finally China added the most cash into the open market since January.
Brexit: Prime Minister Johnson, with his newfound majority in Parliament, forced through a bill which puts the country on course to leave the EU by January 31, period. His intent is to force the EU to conclude a deal now. We agree with him as the EU is acting like a bully even though their economies are at far more risk if a hard Brexit occurs than the U.K.
Trump: Trump clearly has a winning hand going into 2020 to win the Presidential elections. Even his impeachment may turn in his favor as Pelosi delays moving it to the Senate who will clearly exonerate him. We are confident that Trump will propose the following next year: major tax cuts for the middle/lower classes; a new Healthcare bill; and propose a major infrastructure program painting the Democrats into a corner as obstructionists.
Here’s how we are ending the year: investors are adding to equities as they are underweighted the asset class and there is minimal tax selling as all asset classes are up; the global economy is bottoming out and 2020 looks like a much better year; trade deals are being concluded lowering tensions and boosting business/consumer confidence; monetary authorities everywhere are easing providing more liquidity than is needed by the real economy thus pushing investors out on the risk curve; the stock market multiple is moving up as investors final acknowledge, like the monetary authorities, that low inflation is not transitory; and Trump looks like a winner.
Clearly, we went from rags in 2018 to riches at the end of 2019.
Paix et Prospérité became fully invested while shifting its portfolio months ago to more economically sensitive companies with superior managements and strong cash flow selling at recession valuations while reducing the defensive holding selling at record high valuations as we became more confident that the global economy had reached an inflection point and 2020 would be a far better year economically. Technology was and remains the largest portion of our portfolios. Our overriding core belief was that the monetary authorities would remain overly accommodative through 2020 providing wind to our backs while reducing risk. We also felt that Trump would do everything in his power to get re-elected which is quite a lot, as we have seen.
Our objective for the S & P next year remains 3400+ based on S&P earnings of $170+/share with a stock market multiple of 20-ish. We are riding the trend in place, as Soros would do, as long as all the key issues that we factored into our analysis remain intact. So far, so good!
Let’s take a brief look at the most recent global economic data points as we look over the valley rather than in the rear-view mirror
United States: All of the most recent data points keep turning up positive such that we have raised our fourth quarter GNP estimate to over 2%: personal income increased 0.5% in November; real DPI rose 0.4% while real PCE increased 0.4%; the PCE price index rose only 0.1% excluding food and energy; third quarter GNP was unrevised increasing 2.1% with higher consumer spending offset by a decline in inventories; consumer sentiment rose to 99.3 in December from 96.8 in November (great for holiday sales); existing home sales picked up increasing 2.7% in November; leading indicators were unchanged; coincident indicators rose 0.4% and lagging indicators increased 0.5%; Fannie Mae increased its 2020 forecast significantly; industrial production rose 1.1% in November and 0.5% excluding autos (GM strike); home builder confidence increased to a 20 year high to 76 in December; and job openings edged up to an amazing 7.3 million jobs.
Pretty great set of numbers for sure.
Finally, President Trump signed yesterday an astonishing $1.4 trillion-dollar spending bill.
The bottom line is that we believe that 2020 real GNP will be above the consensus exceeding 2.2% with inflation holding beneath 2%.
China: While the government is currently forecasting 6% growth next year, we actually believe that it could be higher based on the huge amount of monetary and fiscal stimulus now being plowed into their economy. The trade deal, too, will remove a huge uncertainty boosting business/consumer confidence such that we expect a rebuilding in inventories which have been reduced during the fourth quarter.
Finally, November stats came in stronger than anticipated with production jumping 6.2% from a year ago; fixed asset spending accelerating to a 5.2% gain over the first 11 months and retail sales climbing 8%. China’s large purchase of U.S. agricultural products will go a long way to taming their high inflation rate.
The Eurozone/U.K.: While we remain pessimistic on the long-term prospects of the Eurozone without fiscal, trade and regulatory reforms, next year could clearly be better than 2019 as global trade tensions are reduced and a deal with the U.K. on Brexit is finally reached. Recent data points have come off the bottom like the composite Purchasing Manufacturers and Services Indices but none of them are worth bragging about. Maybe Merkel has to leave office before any real change can occur in Germany and then the rest of the Eurozone.
Japan: The government recently came out with small upgrade in its 2020 economic forecast now projected 1.4% for the year. We do expect that the fiscal stimulus package along with trade deals may make these numbers conservative for the first time in our memory.
We see no reason to alter our current view that 2020 global economic growth will accelerate from disappointing 2019 results. It is clear that all the monetary authorities will stay on hold with their aggressive easing policies until inflation stays above 2% for a sustained period which is not likely anytime soon.
Our investment conclusion is to continue to move to more economically sensitive companies like global industrials, capital goods and machinery companies. Also, we are maintaining very large financial holdings as we expect yield curves to steepen as short rates are not increased by the monetary authorities as global growth improves. We continue to add to well financed, low cost industrial commodity companies with strong cash flows as we expect prices to rise from increased demand and a lower dollar. Technology remains the largest sector of our portfolios for obvious reasons as buyers get a quick, high return on these investments in addition to their need to remain competitive. Special situations remain the second largest sector in our holdings as long as managements are intent on closing the gap between their current price and intrinsic value.
Clearly, we are not long bonds nor the dollar anymore.
We want to wish all of you a sensational holiday season. We hope that our weekly blogs have made a difference and have helped you in some manner. Feel free to email or call us if we can do more to help you out.
Our initial tag line was “the creation of wealth to help mankind.” We are all so blessed and need to give back whatever and wherever we can.
Our weekly Investment webinar will be held on Monday, December 23rd at 8:30 am EST. You can join by typing https://zoom.us/j/9179217852 into your browser.
Remember to review all the facts; pause, reflect and consider mindset shifts; turn off the pundits/so called experts; look at your asset mix with risk controls; do independent research and…
Paix et Prospérité LLC