The Sky is Falling…Not!

The death of the U.S. economy and the stock market have been greatly exaggerated.

 

Our biggest concern remains business and consumer confidence. They both could be hurt by the dire predictions made by pundits/media bombarding us with negative sound bites 24/7 despite the majority of data pointing to the contrary!  Yes, the U.S economy has slowed, but don’t forget our economy is being hit by a GM strike, Boeing’s Max disruption, trade conflicts and politics.

 

Don’t listen to Chicken Little. The sky is not falling.  Focus instead on the preponderance of data points that support continued, albeit slower growth, for the quarters ahead. We recognize how difficult it is to invest successfully in a VUCA (volatile, uncertain, complex, and ambiguous) global environment but focus instead on long term investing in great companies with superior leadership selling below long-term intrinsic value.  Stop trading on every sound bite as that is the recipe for failure.

 

It was amazing how quickly the pundits began predicting a recession in the U.S next year after the September Manufacturing Report came out October 1. Is anyone really surprised that our manufacturing sector has continued to weaken? Don’t fret as the manufacturing sector is only 10% of U.S GNP while the consumer/government comprise nearly 90%.  We have been hearing for months how the slowdown in manufacturing and trade will hurt hiring. Yes, it has, but to a small degree as we added over 136,000 new jobs in September; average hourly earnings are still increasing near 3% with inflation running beneath 2%; the unemployment rate continues to drop especially amongst minorities; the average workweek and overtime have not changed; and there remains over 7 million, yes 7 million, job opening in the U.S. Does that sound like a bad backdrop for continued growth in consumer spending in the months ahead? And add the fact that governments will increase spending over the next two years by several hundred billion dollars and we have a very accommodative Fed.  Does that sound like a formula for a recession?

 

We have seen no reason to change our thesis that the U.S economy will slow over the next year but still grow around 2% in real terms. That is not a recession!

 

On the other hand, we are maintaining a pessimistic view towards growth outside the U.S, including a sharp slowdown in China, unless there are major changes in fiscal, trade and regulatory policies. The WTO lowered its forecast for global trade again last week to only 1.2% in 2019, down from its forecast of 2.6% in April. We believe that their prediction of a pick-up in growth in 2020 to 2.7% is way too high without any trade deals, fiscal stimuluses and regulatory reforms. We continue to avoid investing in countries where exports/manufacturing are the keys to growth. However, we will look at the consumer, healthcare and services sectors, on the other hand, in these countries where there are earnings growth and substantial dividends. Remember that there are negative interest rates in many of these regions/countries like the Eurozone and Japan.

 

The bottom line is that we still find the U.S market undervalued today. We used the market weakness last week to upgrade the quality of our holdings, as all stocks got hit indiscriminately, without changing our net exposure.

Let’s look at the key data points reported last week that support/detract from our view that the U.S economy is in fine shape while weakness continues abroad:

 

The United States

Clearly, the key set of numbers that we looked at last week revolved around the consumer which is the key factor supporting our view that the U.S economy will sustain growth near 2%. We already mentioned the employment report which clearly paints a goldilocks picture as the numbers were not great, but just about right to support continued easing by the Fed over the foreseeable future. Lower interest rates will help the interest sectors of our economy namely autos and housing which continue to do better than expected. In fact, the auto industry is still running at a 17 million annualized rate while housing has picked up and could do even better if there was more supply. Nothing wrong with being supply-constrained.

Investors focused last week on the weakness in the September Manufacturing ISM report and slowdown in the services gauge. Specifically, the Manufacturers PMI fell to 47.8, down 1.3 points from August; new orders index rose slightly to 47.3; the production index declined to 47.3; the employment index fell to 46.3; the inventories index declined to 46.9, and the exports index fell slightly while the import index rose. Clearly demand contracted, consumption fell and inputs were weak. Global trade was mentioned as the single key factor hurting manufacturing, A strong dollar is NOT helping.

While the more important services index did fall to a 3-year low in September, it still stood at 52.6, which means positive growth. The HIS Markit services index also remained above 50 in September. Chain store retail sales have accelerated to a near 6% gain in September.

While we do not expect the impeachment proceeding against Trump to go anywhere, clearly it has stopped the government from moving forward on any legislation which unfortunately could include the trade deal with Canada and Mexico. Throw all the bums out unless they put the people of this country ahead of themselves. Bernie Sanders heart issues clearly help Elizabeth Warren, which in turn, may help Trump’s reelection chances. Don’t forget that Trump needs a strong economy and stock market to get re-elected.  Stay tuned to this key event which will impact investing next year.

 

China

President Xi’s speech last Tuesday commemorating the 70thanniversary of the Chinese Communist Party’s rule was no surprise as he mentioned many times that no force could sway China’s future development, peacefully. Clearly, he considers Hong Kong and Macao part of China forever.

We remain hopeful that China and the U.S can reach a trade truce next week postponing any additional tariffs. If so, an initial deal will include major purchases by China of our agricultural products along with a schedule for additional meetings to resolve issue by issue.  Don’t forget the more time it takes to reach a trade deal; the more time companies have to shift their supply lines outside of China damaging the potential of China 2025.

 

The Eurozone

Europe’s manufacturing sector continues to spiral downward as the September PMI fell to 45.7 indicating the steepest downturn in manufacturing in over seven years. The region’s downturn was led by deteriorating conditions in Germany where the PMI hit a 10-year low. Clearly, concerns over Brexit, the effects on trade by the U.S- China trade war and the inability to reach a trade deal with the U.S all weigh against business/consumer confidence in the region. Eurozone CPI slowed to less than 1% in September raising fears of deflation.

It’s hard to fathom why Germany has not loosened its own purse strings yet while also not permitting other countries in the Eurozone to do the same. The WTO ruling against Airbus does not help the situation. Hopefully, there will be progress on a trade deal with the U.S when both sides meet next month. Stay tuned!

 

Japan

Can you believe that Japan went forward raising the retail sales tax to 10% from 8% on October 1s? It’s hard to fathom even though the government tried to partially offset the added tax by increasing domestic stimulus by $18.55 billion. The Japanese Manufacturing PMI contracted to 48.9 in September, a new low for the year. The slowdown in global trade has hit Japan hard and future prospects remain bleak.

 

India

India’s Reserve Bank is forecasting that India will grow around 6% in 2019, a multi-year low. We believe that this forecast is overly-optimistic as it means that growth will accelerate to around 7% in the second half of the year which is unlikely as overall demand only rose marginally in September hurt by almost no growth in exports and employment. The government has added fiscal stimulus by cutting taxes and boosting spending while repo rates have been cut too. Hopefully, these moves will stimulate growth later in the year into 2020.

 

Investment Conclusions

We are maintaining our view that there is no place like home. The U.S advantage over the rest of the world is that our economy is dominated by consumer and government spending, not manufacturing and trade. The dollar has remained strong as the interest rate differential has only widened over the last few weeks such the inbound capital flows remain huge. Our Fed has more arrows left in its quiver to lower rates and begin enlarging its balance sheet, unlike the ECB and BOJ which are virtually frozen to do more at this time. While Japan has little leeway to increase fiscal stimulus due to its huge debt to GNP ratio, Germany and the rest of the Eurozone can loosen its purse strings to stimulate growth. How much worse can their economic outlook get before they act?  We expect some movement in the Eurozone on fiscal stimulus, trade, and regulatory reform before year-end as the consequences of not moving are too dire for them. China still has room to move but no trade deal will be a bigger and bigger drag on growth the longer the conflict goes on.

Clearly, the sky is not falling in the United States as the experts/pundits/Democrats may want you to think. Our market continues to fight against a wall of worry creating tremendous investment opportunities for the patient investor. Don’t forget that well over 65% of the S & P companies are yielding above the 10-year treasury with the prospects of additional dividend hikes ahead as corporations are generating record free cash flow. By the way, corporate and individual refinancing now exceed $1 billion over the last 3 weeks and is growing rapidly putting more cash into the consumers’ pockets and reducing interest costs/boosting profits and cash flow for corporations. Not bad!

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

As always, the weekly Investment Committee webinar will be held on Monday morning, October 7, at 8:30 am EST. You can join the webinar by typing https://zoom.us/j/9179217852into your browser or dialing +1 408 638 0968 or +1 646 558 8656

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

 

Invest Accordingly!

 

Bill Ehrman

Paix et Prospérité LLC

 

 

 

 

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