Money Makes the World Go ‘Round

Financial markets worldwide have risen a tremendous amount this year, led by the U.S.  Offsetting global economic weakness, monetary policy been excessively accommodative as inflation has been running well beneath their 2% threshold that most monetary authorities have targeted as a long-term objective. Therefore, interest rates have been ridiculously low, even negative in many parts of the world, such that investors have been forced to move out on the risk curve buying equities with, in the most case, dividend yields far in excess of 10 government-issued bonds.

 

We have argued consistently over the last 9 + months, that the pundits/experts were wrong stating that our market should top out at 17 times earnings, the high end of the historical range. We analyzed that the market should sell at 20 times earnings even with the 10-year treasury at 2.50% (1.7% today) which would still be 3 – 400 basis points below their historic range.  We see no reason to alter that view today as even the Fed now believes that low inflation is not transitory. Don’t forget, too, that bank capital/liquidity ratios are hitting new highs which bodes well for a low market risk factor.

 

It’s not that we believe that there is a clear runway ahead for the financial markets without risks. Many still exist—in trade, Brexit, Trump and the global economy. We remain convinced, however, that all of the global monetary authorities will maintain overly accommodative policies for the foreseeable future which will support the markets as “money makes the world go ‘round.”

If stock markets were so overvalued as the pundits/experts say, why would M & A thus far in 2019 be the sixth-best year in the last 20?  Also, isn’t it ironic that our market is hitting all-time highs when investors have shunned stocks for bonds at a historic pace over the last four years? Over $1 trillion has been added to bond funds since November 2015 while over $100 billion has been liquidated in stock funds. That is the primary reason why we would not be surprised to see an upside blow-off as investors just start returning to historic asset mixes norms. It’s also helpful that the new issue market has all but shut down for only the best of the best companies with a clear path to profitability since the We Work disaster. Finally, we want to mention that over $2.4 trillion of bonds worldwide have been issued this year at ridiculously low rates paying off higher-cost debt, lengthening terms, increasing cash flow and boosting cash on hand. And that does not include the consumer who is refinancing mortgage debt at a record clip saving thousands of dollars each per year. Not too bad!

 

The bottom line is that the stock market advance is far from over.

 

Before we review what is happening economically/financially in the key regions, let’s review the key issues impacting the markets daily: trade, monetary policy, Brexit and Trump:

 

Trade: While we were surprised that Trump signed the U.S legislation supporting Hong Kong to the dismay/objection from China so soon, it may have been a smart move as he sent a message to the leadership of China that he is committed to correcting our relationship with them on many fronts. It is more evident each day that China needs a trade deal much more than the U.S. While we expect Phase 1 of a series of trade deals to get completed, we really are not concerned if Trump takes his time to extract the best deal possible as China is eating most of the tariffs and corporations continue to rush out of China at a record pace putting China 2025 in doubt. We were pleasantly pleased to see China raise penalties on IP theft last week hoping to gain favor with Trump.

 

Also, it was good news to hear that the Democrats are finally moving to pass the USMCA without issue. The truth is that they had no choice or be called obstructionist entering the 2020 election year.  Finally, can you believe that the EU approved increased U.S beef imports last week in an attempt to ease trade tensions between our two regions. Not a bad starting point on the all-important agriculture issue between us.

 

The bottom line is that there are several positive things occurring to reduce trade tensions globally that can only boost worldwide growth next year.

 

Monetary Policy: Fed Chairman Powell gave a speech last week in Providence, R.I. where he indicated that interest rates are unlikely to rise anytime soon, and the Fed remains firmly committed to its 2% inflation goal which means that low rates are here to stay. He acknowledged that the Fed has hit its employment objectives while finally emphasizing that inflation is also in focus as one of their two mandates. While it remains a possibility that the Fed could lower rates over the next twelve months if needed, we do not believe that the Fed can raise rates during a Presidential election year without tremendous flack.

 

Both the ECB and BOJ continued to support their policies of aggressive monetary ease until inflation reaches their 2% goal. Don’t hold your breath for it to happen anytime soon.

 

Brexit: It now appears that Boris Johnson will get a 68-seat majority at the December 12 national election according to YouGov poll. If so, Johnson vows to get the Brexit deal through by Christmas. He also pledged not to raise income taxes, value-added taxes or national insurance rates.

 

Trump: We believe that Trump is feeling more confident by the day that he can win the election next year due to the strength of the economy, the stock market, and his winning position against China. Notwithstanding, he is paranoid enough not to shoot himself in the foot unless he has alternative plans to solve the issues ready to go. Don’t forget that he has the power of the Presidency going into elections that can only boost his re-election chances. It appears to us that Biden will be his opponent, as both Warren and Sanders are faltering, which is good by us as he is much more of a centrist than the other Democratic nominees and he is a capitalist at heart.

Now let’s take a quick tour by country/region that either support or detract from our view that the U.S remains the best house on the block although we do believe that the others key regions have entered or past inflection points such that growth will be better worldwide in 2020 than this year:

 

The United States. The vast majority of economic data points last week support our view that the U.S economy will sustain growth around 2% for the foreseeable future bolstered by strong consumer demand along with huge amounts of fiscal stimulus at all levels. The Beige Book saw a slight acceleration in the U.S economy just ahead of the holiday season; U.S. GDP growth was revised UPWARD in the third quarter to 2.1% bolstered by strong consumer spending and a positive revision to inventory investment while the PCE rose only 1.5%; consumer spending rose 0.3% in October; new orders for durable goods increased 0.6% last month while shipments were virtually flat; booking for business equipment sales rose a surprisingly strong 1.2% in October while shipments increased 0.8%; home prices were strong last month while retail sales are still increasing at a 4+% clip and finally, the U.S posted the first month in 20 years as a Net Exporter of petroleum products which gives us a tremendous competitive advantage longer term.

 

China. The general consensus is that China will grow at only 6% this year falling to 5.8% in 2020. There were articles last week that China’s financial warnings signs are flashing almost everywhere while the industrial side is decelerating rapidly as profits shrank at their fastest pace this year falling 9.9% on a year over year basis. Interestingly, the official manufacturing purchasing managers’ index rose to 50.2 in November while the non-manufacturing gauge was 54.4, the highest reading since March. All we can say for sure is that corporations are exiting China as fast as possible diversifying their supply base. China needs a trade to buy some time to further adjust their economy from exports/production to consumption.

 

Eurozone/Britain. While some of the economic data points were marginally better last week such as Germany ‘s unemployment falling and a slight tick up in inflation to 1.3%, the economic outlook looks bleak without a major round of fiscal stimulus, regulatory reforms and trade deals. Hope springs eternal!

 

Japan. No change in our cautious view on Japan as monetary policy remains as accommodative as possible and the government has no ammo to increase fiscal spending. Clearly their hopes rest on an end to global trade conflicts. Fingers crossed!

 

India. Growth continues to slow in the world’s fifth-largest economy which is disappointing for sure. The country has grown well above 7% for many years now but has slowed to under 5% in the most recent quarter as consumer demand was unusually weak. We are still confident that Modi’s economic plan will work but it won’t happen overnight.

 

Investment Conclusion

 

We remain constructive on all financial markets.  After all, “money makes the world go ‘round.” The monetary authorities remain far more accommodative than the global economy needs to sustain itself thus the excess capital continues to find its way into financial assets as investors move further on the risk curve buying equities, especially those with dividend yields above risk-free 10-year bonds.  In addition, we are more confident by the day that 2020 will be a better year economically bolstered by huge monetary stimulus and passing the one-year anniversary of tariffs making year over year comparisons easy to surpass. Finally, we do expect the U.S/China to conclude Phase 1 of a trade deal lowering trade tensions around the world although this won’t be the panacea for corporations to open their pocketbooks in a meaningful way until long term solutions are in place for trade, fiscal policy, regulatory relief, and IP protection.

 

Our portfolios, which continue to beat the averages, remain concentrated in technology, especially semis; global industrial, capital goods, and machinery companies; financials; retailers that are going through significant positive change; low cost, high yielding industrial commodity companies; cable with content and many, many special situations. We own no bonds expecting the yield curve to steepen nor are we long the dollar any longer expecting it to weaken as growth overseas begins to bottom out/improve in 2020.

 

Our weekly Investment Committee webinar will be held on Monday, December 2nd at 8:30 am EST. You can join by typing https://zoom.us/j/9179217852 in your browser.

 

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

 

Bill Ehrman

Paix et Prospérité LLC