Running Toward Daylight

Since markets bottom on extreme pessimism, rise on a wall of worry, and peak on over-exuberance, we were pleased to read in Barron’s yesterday that their fall 2019 Big Money Poll showed that only 27% of money managers were bullish, the lowest reading in more than 20 years.

 

According to Morningstar, the net outflow in stock funds in the third quarter of 2019 was the largest since 2009. How amazing that our market is within 1% of an all-time high with such pessimism. No surprise to us as the key data points we have been watching are only getting more positive. While we have recently gotten even more confident that the stock market will rise to new highs, we have changed the composition of our holdings as we expect the next leg to be led by more economically sensitive stocks rather than those considered defensive which are now selling near-record valuations.

 

Let’s look at the key issues that are really influencing the markets:

 

Monetary Indicators: Global monetary conditions continue to be extremely accommodative and clearly more money is being created by all monetary authorities than needed by the real economy pushing investors further out on the risk curve. While we are not sure whether the Fed will cut rates again this week or wait until December misses the point that the Fed has been accommodative since December lowering rates a few times and is now also buying Treasuries adding liquidity to the system which is also favorable for financial asset valuation.  Mario Draghi, at his farewell conference call as the head of the ECB, talked about the virtues of his past policies and the need for governments to pick up the torch to stimulate their economies by easing fiscal policy. Lagarde, the incoming head of the ECB, was not hesitant to point the finger at Germany’s need to lead here and also the importance in China/U. S reaching a trade deal. We respect her!

 

Trade: It was announced Friday that the U.S and China were close to finalizing key parts of the Phase 1 trade pact and that it appears almost certain that both leaders will sign the agreement next month when they meet. We expect Trump to formally back off from additional tariffs in December as China formally begins buying agricultural products and agrees to additional deals on currency manipulation and IP protection.

 

Brexit: It appears more likely than ever that a deal will be reached over the next few months preventing a hard Brexit. We don’t even think that Britain will have to go to an election in December to get it done. Clearly, the ECB, including Macron, wants a deal as the economic risks of a hard Brexit would be too much to fathom as Europe skates near a recession.

 

The markets have not been blind to these events and despite continued global economic weakness, we appear to have reached an inflection point. Finally, there appears to be a light at the end of the tunnel and investors have begun to run towards daylight. Isn’t it ironic as the polls show excessive bearishness with markets so close to new highs? What happens if money finally flows out of bond funds into stocks which is highly likely? Could there be an upside blow off?

 

Let’s take a look at the most recent data points that confirm/detract from our view that the U.S economy is still the best house on the block and that bad new will turn into good news forcing other industrialized nations to add substantial fiscal stimulus and make regulatory reforms as well as to make trade deals:

 

U.S.

 

We were pleased that the UAW ratified the new labor pact with GM on Friday as the economy really would have suffered if the strike continued much longer. Expect next week’s employment numbers to be reduced by around 40,000 jobs because of the strike. Consumer spending and large/growing fiscal stimulus will remain the main drivers supporting U.S growth around 2% for the foreseeable future. The Federal government’s gap has increased by 26% in the last twelve months to $984 billion and will continue to widen over the next several years based on the recent reconciliation bill approved by both parties and signed by the President. That’s a huge amount of added stimulus on top of strong consumer spending.

 

We were surprised that the manufacturing PMI rose to 51.5 in October, the Service PMI increased to 51 and the composite PMI ticked up to 51.2. Residential single-family house sales fell slightly last month but were still up over 15% from a year ago. New orders/shipments for manufacturers durable goods continue to soften which is no surprise at all.

 

We are not certain whether the Fed will cut rates again next week or wait a while longer to see the impact on our economy from the trade ceasefire with China. Clearly, the Fed can justify cutting again as the global economy is weak and inflation is continuing to run well beneath their 2% threshold.  We can make a case for pausing too as our economy is doing just fine, the GM strike was settled, rates have begun to lift and the dollar has finally weakened. Will Powell decide on cutting to keep the positive momentum going in the marketplace? Probably! Remember that the Fed has begun injecting over $60 billion/month into our financial system. That may be enough added stimulus at this time.

 

Finally, no one is watching our economic stats and markets closer than Trump. Clearly, he knows all too well that he needs both moving up for him to have any chance of winning next year’s election. Never underestimate the power of the Presidency.

 

China

 

We were bemused by Pence’s comments about China last week and their rebuttal on October 25. Both were talking to their bases more than anything else. Watch what is done rather than what is said. It was far more important to us that both sides have apparently agreed to the text on many parts of Phase 1 trade deal and China has publicly agreed to buy over $20 billion of agricultural goods over the next year. We believe that Trump will postpone the proposed December tariffs for additional trade concessions.

 

Eurozone

 

The Eurozone economy remains on the cusp of a recession. While there were some positive indicators last week like a slight uptick in German business expectations, both business climate and current assessment indicators continued to fall. The IHS Markit Composite PMI held at just 50.2 in October.

 

It is clear that both England and the Eurozone want a deal on Brexit. A deal will add some certainty to business which is a clear positive and a no deal, hard Brexit could lead to another leg down in both the economies of England and Europe.

 

It’s time for Germany to stand up and lead Europe by adding some real fiscal stimulus, besides spending on clean air, and free other countries throughout Europe to do the same. Europe needs regulatory reforms and a trade deal too. Hopefully, more bad news will turn into good news as governments act rather than falling deeper into the abyss. We expect so!

 

Japan

 

Japan’s economy continues to wither on the vine as evidenced by a drop-in export for the tenth straight month. Shipments abroad fell 5.2% in September to the lowest level in over 3 years. The Composite PMI fell to 49.8 from 51.8 the previous month which included a 3-point decline even in the Services PMI. We really don’t know what the BOJ can do more when it meets this week. Japan’s economy relies on an improvement in global growth which we do expect to begin sometime next year.

 

Investment Conclusions

 

We expect continued growth in the U.S and an improvement in growth in China once trade deals are signed to lead to an improvement in global growth next year. We are pleased that almost all of the monetary bodies are acknowledging that monetary policy has done about all it can do to stimulate growth and it’s time for governments to step up to the plate by finally adding fiscal stimulus, regulatory reforms, and trade deals to the formula. We expect that to happen over the next year as the failure to do so has dire consequences to growth and a rise in deflationary forces.

 

We are growing more confident by the week that we have reached an inflection point and that global growth will improve next year after a very disappointing 2019.  We finally are seeing some daylight. It is time to look at investing in those companies that will, directly and indirectly, benefit from fiscal stimulus as most of them are selling at recession valuations without any upside expectations. On the other hand, the defensive stocks are all selling at valuations not seen in generations. Technology continues to be the wave of the future and needs to be a core part of any portfolio.

 

The bottom line is that we are gaining more confidence in the global economy and markets when investors have gotten more cautious as evidenced by the lowest levels of bulls in 20 years along with record liquidations in stock funds over the last three months. The key to outperformance will be proper asset allocation and stock selection.

 

Our portfolios are concentrated in technology; financials; global capital goods/industrials/machinery; retail with a housing bent; cable with content; industrial commodities; healthcare with new products and many special situations including ag-related. We now expect the yield curve to steepen, the dollar to weaken and industrial commodity prices to rise over the foreseeable future.

 

The weekly Investment Committee webinar will be held on Monday morning October 28th at 8;30 am Eastern Standard Time. You can join the webinar by typing https://zoom.us/j/9179217852 into your browser,

 

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

 

Invest Accordingly!

 

Bill Ehrman

Paix et Prospérité LLC

Leave a Reply

Your email address will not be published. Required fields are marked *