Investing in a VUCA Global Environment 

The key to successful investing in a VUCA (volatile, uncertain, complex, ambiguous) global environment is the ability to maintain your focus on the long term despite being bombarded constantly by sound bites. The key is to stay hold the vision despite tweets that set the quants off in one direction or another without regard to basic fundamentals.

 

We at Paix et Prospérité are fundamentalists. We combine a top-down global economic view with a bottom-up research-driven fundamental analysis that leads to investing in companies selling well beneath their intrinsic value. We also sell short companies we deem significantly overvalued. Yes, we are value investors a la Buffett. Successful investing takes patience which is far from easy in our VUCA environment. You have to stay open-minded and be willing to shift if core beliefs change from your baseline thesis.

 

Last week was absolutely incredible. We had Trump and other government leaders speaking at the UN; the Democrats began impeachment proceeding against Trump due to his “inappropriate” interaction with the President of Ukraine; China purchased agricultural products as a prelude to the big October trade meeting in DC; the failure of another high profile IPO; and, finally the word that the Trump administration was studying whether to limit U.S portfolio flows into China.

 

We believe in the benefits of globalization but recognize the need for fair and open trade without subsidies and, most importantly, the need to protect IP. This is the twenty-first century and no country should be an island unto itself without regard for mankind. While Trump makes many good and fair points, his delivery and combative nature just turns everyone, including ourselves, off. As an example, he is right that China no longer needs and deserves special status at the WTO.

 

The Democrats have been trying to take Trump down since he came into office. While the House/Democrats have every right to investigate the administration if inappropriate actions are perceived, it should be done with the highest regard for the office of the President with full recognition of the longer-term consequences of their actions. Will all President’s discussions with other leaders be open to review and interpretation by others now? Should we get rid of/limit executive privilege? Think about it!

 

We remain optimistic that the U.S and China will have positive discussions on trade next month. While we do not expect a final, all inconclusive trade deal to be reached, we do expect progress to be made; China to make additional purchases; additional tariffs to be postponed and a timeline to be agreed upon for further talks leading to multiple additional trade agreements including protecting IP. Use the US and Japan trade announcement last week as a guideline of what may happen when the initial step toward a large trade deal was agreed upon with other agreements to follow. Both Trump and XI need a deal.

 

We believe that the failure of another high-profile IPO, Peloton, was a good thing as it brought the new issue market down to the real world of sane valuation. This is not a question about how great all of these disruptors are but what are they worth today, still generating huge losses with the prospects of profitability many years down the road. It has been like the Emperor had no clothes. Greed was all over the IPO market, but no longer.

 

Finally, Bloomberg came out Friday with a story that the U.S was considering blocking Chinese companies from listing on U.S exchanges for failure to provide proper documentation including all financial/regulatory filings in accordance with our requirements. We believe that no company, no matter where domiciled, should be able to list here without it. What is wrong with that?

 

Our focus remains on the global economy, monetary policy, fiscal actions, and trade negotiations. The U.S remains the best house on the block to invest in as our economy is doing quite well bolstered by the consumer along with aggressive fiscal spending; monetary policy is easing with interest rates pushed lower than they deserve to be due to strong capital flows from abroad, and earnings are doing better than expected. Remember that Trump needs, even more, today than ever before a strong economy and stock market to be reelected which most likely means a positive resolution on trade with China. The bottom line is the U.S market remains the best and safest market to invest in today.

 

Let’s look at the most recent economic data that supports/detracts from our view that the U.S. economy is well-positioned to sustain 2+% real growth while weakness will persist in China, the Eurozone, and Japan:

 

The United States

The outlook for sustained above-average consumer spending, which is over 70% of our GNP, was supported by recent data points: the September index of consumer sentiment rose to 93.2; current economic conditions increased to 108.5 while the index of consumer expected rose to 83.4. All great numbers that were supported by a 0.4% increase in personal income in August; personal consumption rising 0.7% and the all-important PCE, excluding food and energy, increasing at an annualized rate of only 1.6%. We were pleased to see the saving rate rising to 8.1% from the prior month too. The decline in mortgage rates is supporting higher home sales which rose 1.6% in August. Interestingly, there remains a shortage of low-cost affordable housing.

 

There was some good news in the manufacturing sector for a change as new orders for durable goods increased by 0.2% in August; shipments rose 0.1% after a weak July; unfilled orders increased 0.1% and inventories rose 0.3% reflecting a car build anticipating a car strike which has occurred. The flash composite output index increased to 51.0, a two-month high; the services index increased to 50.9, also a two-month high; and the manufacturing PMI and output indices rose to over 51.0, 5-month highs.

 

We continue to believe that the U.S economy can sustain 2+% real growth for the foreseeable future led by the consumer along with huge fiscal stimulus. The outlook could change depending on what happens in the upcoming trade talks with China. Stay tuned.

 

China

China’s economy has continued to deteriorate despite the significant ease in monetary policy; the increase in fiscal spending (over $280 billion) at all levels; and the decline in the yuan. Profits at China’s industrial firms fell 2% in August as industrial production fell to a 17½ year low while exports tumbled. China’s Beige Book released Wednesday showed that growth slowed meaningfully in the third quarter while debt levels soared. Still, think that China does not need a trade deal? China sorely needs our agricultural products as well as our energy.

 

The Eurozone

We are maintaining our pessimistic outlook for the Eurozone until we see some movement on fiscal and trade fronts. European confidence fell to a four-year low as Germany is on the brink of a full-fledged recession and other countries in the region are close behind. Deflationary fears are rising too as inflationary expectations fell to a multi-year low. The potential for a hard Brexit still remains, too.

If you want to invest in this region, buy only consumer staples, healthcare and service companies with above-average dividend yields.

 

Japan

While we were pleased to see the U.S. and Japan reach an initial trade agreement, it won’t do anything to stimulate the Japanese economy. In fact, the economic data has only continued to deteriorate: the flash Japan Manufacturers PMI fell to 48.9 in September; factory orders and output fell for the ninth straight month; and inflation rose only 0.5% from a year ago, the slowest pace in 16 months.

 

It is hard to believe that the government will increase the retail sales tax to 10% on October 1. Not good! Invest in only the consumer staples, healthcare and service industries here as ell…

 

Let’s wrap this up.

 

We realize how difficult it is to stay focused on sound investing in a VUCA environment when bombarded by so many sound bites/tweets during the day that can play havoc short term in the marketplace. However, that is just what you must do. The basic drop back for profitable investing remains present today: the economy is doing well; the supply of capital being provided by the monetary authorities exceeds the demands of the real economy thus boosting the value of risk assets; inflationary pressures are weak; interest rates are at ridiculously low levels; bank capital and liquidity ratios are at new highs; corporations/individuals are refinancing their debt savings billions in interest costs while extending terms; the consumer is strong with record employment and rising hourly wages; and so on and so forth.

 

We fully recognize the risks too including trade conflicts could spiral out of control; debt levels are high; Europe/Japan, as well as many other countries, need major fiscal and regulatory relief; middle east energy fields are vulnerable to attack; Trump is in trouble and far-left Democratic Presidential candidates are on the rise.

 

We continue to believe that the U.S stock market is undervalued with interest rates so low and bank capital/liquidity ratios so high. Interest rate spreads are small, and risks of systemic risks are low. The key for outperformance begins with asset allocation and ends with stock selection. We focus on only owning the best, highest quality companies with excellent, proven management teams; winning long term strategies to succeed regardless of the environment; positive earnings, cash flow, and free cash flow growth; and selling well beneath intrinsic value.

 

Our portfolios are concentrated in technology; consumer staples; cable with content; global capital goods/industrials/machinery; retail including a focus on housing; airlines; financials and many special situations. We own no bonds and remain flat the dollar.

 

Our weekly Investment Committee meeting will be held Monday morning, September 30th, at 8:30, am EST. You can join the webinar by typing https://zoom.us/j/9179217852 in your browser.

 

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

 

Invest Accordingly!

 

Bill Ehrman

Paix et Prospérité LLC

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