Stick to the Plan

Global stocks continued their march upwards as bond prices and the dollar fell. Investors are sensing better days ahead inspiring a shift away from bonds/cash to stocks. While we remain focused on monetary policy, trade, and Brexit, we are beginning to factor in how the political winds are blowing as we look over the valley.  Many of the Democratic nominees for the Presidency are preaching a sharp move to the far-left abandoning capitalism for socialistic policies that go far beyond just income/wealth redistribution.

 

We stand with Lee Cooperman and others who are out their arguing that the American dream /capitalism made our country great while also recognizing the need to support policies to further assist the lower and middle classes, improve healthcare and make education affordable for all by increasing the progressiveness of the tax code and getting rid of tax loopholes, including carried interest, and other non-essential tax breaks that benefit only  the wealthy. We were pleased to see Michael Bloomberg enter the Presidential race and feel that he would make a great President. We would vote for him, or even Biden over Trump. It’s time we moved back to centrist policies.

 

We remain optimistic that global growth is bottoming out and that 2020 will be a better year economically. We mentioned weeks ago to watch global interest rates as a forerunner of a change in investor sentiment away from the safety of bonds to stocks. Rates have risen materially everywhere!  Remember that investors are wildly overweighted bonds from historic norms and underweighted stocks. Yes, we could see a melt up in stocks as investors shift their asset allocations. Also, stocks are seasonally strong between November and year end.

 

In addition, we continue to believe that our stock market remains undervalued today as the stock market multiple could increase to 19+ times earnings even with the 10-year treasury at 2.5%. While we have focused on investing here, we recently added exposure to global industrials, capital good and machinery stocks as well as low cost, cash generating industrial commodity companies that will benefit from a pick-up in global growth and a weakening dollar. Technology remains the largest portion of our portfolios.  At the same time, we reduced our exposure to defensive stocks including consumer non-durables, restaurants and utilities.

 

Before we review the most recent data points in the U.S, China, Europe and Japan, we will update our views on monetary policy, trade, Brexit and Trump:

 

Monetary policy: It remains clear that all of the major monetary bodies will maintain an overly accommodative stance until there is a meaningful pick-up in growth and inflation. The irony here is that we do expect global growth to accelerate but not inflationary pressures. We have long discussed that global competitive pressures, technological advancements and the rise of disruptors will all support keeping a lid on prices. It just came out this week that Chinese factories are exporting lower prices around the world. Supply line shifts will only serve to double down on competitive price pressures. The bottom line is that global money growth will continue to exceed the demand for funds pushing investors further out on the risk curve to stocks.

 

Trade: While we remain very optimistic that the U.S and China will shortly finalize Phase 1 of a series of trade deals,  we do not expect any roll back in any existing tariffs until both sides see that they are adhering to the first agreement and are progressing toward Phase 2 of a trade deal. On the other hand, we do not expect Trump to impose tariffs in December, as currently planned, as it would be political suicide. We heard many important comments last week that led us to believe that the U.S and China are serious about resolving their trade conflict. Specifically, Commerce Secretary Ross expressed optimism that licenses would be forthcoming for U.S company’s ability to work with Huawei, and that China/U. S. were working together to crack down on fentanyl smuggling. The bottom line is that we expect the trade war ceasefire to hold at least until after election next year.

 

Brexit: We don’t know whether the British snap election on December 12th will resolve whether Brexit will go smoothly or not. The simple truth is that it would be harder to stop Brexit than to let it go through next year. We firmly believe that all parties, including those in the Europe, do not want a hard Brexit as the economic damage to all could be serious when their economies are flailing already.

 

Trump: We are more convinced each day that Trump realizes that his only path to the Presidency is a strong domestic economy along with higher stock prices. The Republican election setbacks in Kentucky and Virginia were a reminder to him of his potential vulnerability next year which is good. We expect Trump to fully use the power of the Presidency as an incumbent to help his cause next year which will most likely include proposals to cut taxes on the lower/middle classes; close tax loopholes for the wealthy; propose a huge infrastructure plan financed with 50+ year duration bonds; and a plan to reduce healthcare costs.

 

The net of all of these updates is that we are sticking to our game plan which includes remaining long equities; yields to rise; the dollar to fall; and industrial commodity prices to rise. Global growth is bottoming out and we expect 2020 to be a better year.

 

Let’s review some of the most recent data points which support/detract from our view that the U.S economy remains the best house on the block while seeds of a recovery are finally showing up elsewhere:

 

The U.S

 

The vast majority of economic data points support our view that the U.S economy will continue to grow around 2.0% for the foreseeable future led by consumer demand and huge fiscal stimulus: the October Non-manufacturing PMI was at 54.7; business activity/production at 57; new orders at 55.6; the employment index at 53.7; consumer sentiment at 96.0; current conditions at 113.2; consumer expectations at 84.2; the Markit services index at 50.6; the PMI composite at 50.9 and the early November read on consumer sentiment rose to 95.7. By the way, job openings remain around 7 million.  Not too shabby!

 

On the other hand, manufacturing remains weak as factory orders fell 0.6% in September as shipments declined 0.2%. We were disappointed that U.S productivity fell at an annualized rate of 0.3% in the third quarter, but we really do not believe the numbers as the government has a hard time measuring gains due to technological improvements.

 

We see no reason to alter our game plan through next year which includes a good economy led by the consumer and strong fiscal spending along with a President who will pull out all stops to win the election which should translate into higher stock prices at least to the Democratic convention.

 

China

 

We are more convinced each day that China realizes that they have a losing hand on trade as corporations continue to shift their supply chains to other countries while domestic growth continues to slow. On the other hand, China realizes that Trump cannot escalate the trade conflict without shooting himself in the foot. That is why we expect a series of deals over the next year with a subsequent reduction in existing tariffs creating a win/win/win for China, the U.S and the rest of the world as global trade/growth resumes.

 

China’s exports declined less than expected In October while imports fell for the sixth straight month. Their services sector expanded at its slowest pace in eight months in October as new orders slowed and business confidence hit a 15-month low.

 

The chances of China and the U. S reaching a series of deals looks good. Don’t listen to the daily rhetoric on TV or in the papers. Watch the deeds and listen closely when President Xi speaks. Last week he said that China was committed to economic openness and global trade. He means it, as he needs it, to achieve China 2025.

 

The Eurozone

 

Bad news is good news as it will force governments, most importantly Germany, to introduce major fiscal stimulus and regulatory reforms. Trade deals are a necessity! While the EU cuts its growth forecast for the Eurozone once again, we believe that the bottom may be in sight as the prospects of China and the U.S reaching a deal have risen significantly and Lagarde seems to have government officials finally listening to her pleas for fiscal relief. Hopefully the huge move up in rates last week are for real and is predictive of future events.

 

Japan

 

Japan’s economy will benefit from its trade deal with the U.S especially after the U.S/China sign off on Phase 1 of a trade deal including a cessation of future tariff hikes. The country is also counting on the huge Asia Pacific trade deal boosting its economy once it is signed next year. Maybe higher rates in Japan is pointing the way that the bottom has been reached and a better year is ahead in 2020. We think so!

 

Investment Conclusions

 

We are sticking to our game plan that global growth is reaching an inflection point and 2020 will be a better year for all. As such we have shifted our portfolios from defensive to offensive selling off the old winners and adding more economically sensitive stocks that were selling at recession valuations. We have also added to our technology holding especially beefing up our semi stocks that have significant market share gains ahead. We added to our foreign holdings by buying global capital goods, industrials and machinery stocks as well as industrial commodity companies with significant free cash flow and low-cost positions. Banks also make up a key portion of our portfolios as we expect the yield curve to steepen and loan growth to improve next. We are maintaining some retail holdings, too, as we expect a bang-up Christmas. Finally, we own a number of special situations where managements have plans to close the gap between the current stock price and their intrinsic value. We own no bonds and expect the dollar to weaken.

 

The weekly Investment Committee webinar will be held on Monday morning  November 11th 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; look at your asset mix with risk controls; do independent research including listening to earnings calls and …

 

Invest Accordingly!

 

Bill Ehrman

Paix et Prospérité LLC

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