Think as An Investor

We were thrilled to hear the experts/pundits speak on Friday as well as Barron’s most recent roundtable of 10 experts write on Saturday about how cautious/pessimistic they are about the prospects for the financial markets in 2020. There clearly is no over-exuberance or froth in the marketplace yet. Just the start of a rotation back into equities, which have been liquidated over the last few years, such that its allocation is well below their historical norm, while reducing bonds and cash positions, which have been the preferred asset classes, and are now over-weighted well above  their historic norms in most portfolios.

 

While we acknowledge that there could be a correction in the marketplace any time, we see substantial gains for investors over the next year and possibly longer especially if you are correctly positioned. Think as an investor rather than as a trader. Think like Buffett whose record for successful investing longer term is unparalleled. How many rich traders do you know?  Does it make sense to sell positions that you like longer term if you are only looking for a small correction short term? Hell no!

 

It was very important that tensions between the United States and Iran subsided somewhat last week. We were surprised and pleased that Iranian officials reached out to Iraq and American counterparts warning them of their missile strikes in Iraq beforehand such that no one would be killed. Since no American was killed in the attack, which is Trump’s red line, he did not retaliate. Rather he spoke in a somewhat conciliatory manner about both sides lowering tensions in the region. Trump also asked our NATO partners to work with us against terrorism which is something that we mentioned last week.  NATO’s Secretary-General Stoltenberg responded favorably and said that he was pleased with the formation of such an alliance. It did not hurt Trump’s position against Iran/terrorism when Iran took full responsibility yesterday for bringing down a Ukrainian airplane killing 176 innocent people including many Canadians.

 

Let’s go back and look, once again, at the key variables impacting stock prices today

 

Monetary policy: It is crystal clear that virtually all of the major monetary bodies—BOJ, Bank of China, ECB and our Fed—have overly accommodative policies that will not reverse anytime soon and that means at least for 2020. Again, if more money is being created than needed by the real economy, the excess funds finds its way into financial/risk assets including stocks, bonds and commodities. Basically, it is risk on!  Remember that our stock market multiple is priced off of bond yields, normally 10-year treasuries, plus some risk premium. Bond yields are incredibly low as there is no inflation and risk premiums are down as there is so much excess liquidity/capital in the system as evidenced by low bond yield spreads. We continue to be surprised that all the experts think that the market is fully valued at 18-19 times earnings which was the high end of the historic range when interest rates were at least 300-500 basis points higher than now. Besides keeping all short-term interest rates down, most monetary bodies, including our Fed, are increasing their balance sheets, too, which keeps downward pressure on longer term rates. We see no reason that our stock market multiple cannot reach 20 times earnings even if the 10-year treasury yields increase to 2.5% from slightly under 2% today.

 

Trade: It is hard to believe that Phase 1 of a trade deal between the U.S and China will finally be signed this week in D.C. with the Chinese delegation led by Vice Premier Liu. We continue to be surprised by the positive rhetoric out of Beijing and DC about Phase 2 of a trade deal which talks will commence shortly; China state media touts the trade deal as a sign of coexistence; and the U.S and China agreed yesterday to hold semi-annual talks on reforms. Maybe it is true that China would rather negotiate trade deals with Trump than running the risk of dealing with a Democrat President who would take a much harder line, especially on pollution. Finally, the Senate Finance Committee voted 25 to 3 to back the U.S.-Mexico-Canada trade agreement. We fully expect global trade to improve as we move through 2020 into 2021 boosting global growth.

 

Brexit: We remain confident that U.K Prime Minister Boris Johnson and the EU will finally reach a deal on Brexit this year. The cost of not reaching is deal is so punitive to both sides such that we expect cooler heads to prevail and a deal to be finalized. IF the economic cost of Brexit has already hit Britain by $170 billion and counting, we could only imagine the penalty borne by the EU so far, too.

 

Trump: Since strength in the U.S economy and stock market appear to be the key factors boosting Trump’s chances for re-election, we are confident that he will do all in his power as incumbent President to increase his odds for victory. That will include introducing new tax legislation to lower taxes on the middle to lower classes while penalizing the wealthy; new healthcare legislation to reduce costs, especially for medicine; an infrastructure bill and further reducing regulations/red tape holding back our economy. Protecting our country and trade policy will remain at the forefront of his legislative agenda, too.

 

The bottom line is that we remain confident/optimistic that the global economy will do better in 2020/2021 than 2019. We were amused that the World Bank trimmed its global growth forecast last week for 2019 and 2020 basically looking in the rearview mirror rather than through the windshield. They had no idea that Phase I of a trade deal between the U.S and China would finally be signed, nor the completion of the USMCA, as well as Johnson winning his election in Britain.  We expect global growth to build sequentially as we move through 2020. We do not expect a growth spurt at the beginning of the year. After all, trade deals are just being finalized; fiscal stimulus is just beginning to be implemented in many nations; and finally, it takes at least 6 to 8 months for monetary ease to kick in. Also, it will take time for business/consumer confidence to build until reality/certainty sets in that all of this is for real.  But it will as the year progresses.

 

Here are some brief comments on the most recent data points by country:

 

United States: We fully expect fourth quarter real GNP to exceed 2% and growth in 2020 to build sequentially bolstered by continued strength in strong consumer spending and a slow but steady improvement in manufacturing/capital spending as the year progresses as global trade improves. The employment data reported Friday was just fine as 145,000 new jobs were created while hourly earnings slowed to a 2.9% year over year gain which still exceeds the inflation rate by a wide margin.  Our economy created over 2.11 million new jobs in 2019 which is nothing to sneeze in spite of slowing global growth. We were pleased that Trump reversed his position and now supports the U.S. Export-Import Bank which is helpful to U.S manufacturers.

 

China: Fourth quarter GNP was apparently stronger than anticipated such that economic growth for 2019 will fall well within the government target of 6-6.5% growth. We now believe that China may even exceed 6% growth in 2020 as it benefits from the U.S trade deal, fiscal stimulus and aggressive monetary ease. China will easily be the fastest growing major industrialized country in 2020. And inflation will moderate as U.S exports of ag products finally begin arriving in size.

 

Europe/Britain: There is nothing reported that looks good economically in Europe/Britain. One can only hope that global trade will improve as 2020 progresses which will benefit Europe and that Brexit is reached reducing corporate/consumer uncertainty. Europe is clearly the problem child region of the world.

 

Japan: We expect the Japanese economy to pick up sequentially through 2020 too, as global trade improves and fiscal stimulus kicks in supported by continued monetary ease.

 

Investment Conclusions

 

We expect global growth to pick up sequentially as we move through 2020 benefitting from increased trade, fiscal stimulus and continued monetary ease.  The U.S will certainly benefit disproportionately as we institute Phase 1 of a trade deal with China boosting our exports big time over the next few years; the USMCA is finally passed supporting trade growth between our neighbors; additional fiscal stimulus kicks in federally as well as locally; monetary policy remains very easy (let it rip!) including the Fed injecting billions into the financial system; regulatory relief; and Trump doing whatever else he can do to boost the economy and our stock market.

 

While we have already discussed why a 20-market multiple is supported even if 10-year treasuries rise in yield. We have not discussed our forecast for S & P earnings which we still estimate at $170 per share for 2020, vs. an estimated $163/share in 2019, but with a run rate closer to $180 p/s by the end of the year. Don’t forget that the huge equity shrink continues at amazingly high levels that boosts reported eps. Just ask Apple owners what it has meant to them!

 

The bottom line is that our market could easily exceed 3400 this year with the potential of hitting 3600 which is not our forecast at this time. The key to outperformance will be stock selection. While technology, especially semis, has remained the largest portion of our portfolios, we have reduced the more defensive sectors adding to the more economically sensitive sectors such as financials, expecting the yield curve to steepen and loan growth to accelerate; global industrial, capital goods and machinery companies which will benefit from accelerating global growth and increased capital spending; low cost, free cash generating industrial commodity companies as expect both volume and pricing to improve; defense companies for obvious reasons; some retailers who have adapted to a changing marketplace and are gaining market share; agricultural companies who will benefit from recent trade deals; and many special situations selling well beneath intrinsic value. We own no bonds and expect the dollar to weaken over time.

 

Unfortunately, we are unable to hold our weekly investment webinar this week due to a prior commitment but feel free to email us questions which we will respond to as promptly as possible.

 

Remember to review all the facts; pause, reflect and consider mindset shifts; be open to shift your asset mix with risk controls as necessitated by the environment; listen to the upcoming earnings calls focusing on the future rather than the past; do independent research and …

 

Invest Accordingly!

 

Bill Ehrman

Paix et Prospérité LLC

Bill.ehrman@prosperitefund.com

 

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