Time To Recalibrate

A successful investor must have a global perspective. Last week we talked about the Fed having to broaden its mandate to consider the impact of its policy decisions not just on the US economy but also on the global economy. For instance, the Fed has commenced a return to interest rate normalization when other monetary bodies such as the BOJ, ECB, and Bank of China have maintained excessive ease. Our rates have risen across the curve such that the dollar has soared as money has been flowing in from abroad pressuring foreign rates and dollar-dominated debt just at the wrong time putting added pressure on foreign economies and inflation too. Tension from trade and geopolitical issues have contributed to the global slowdown.

Living in an unusually VUCA (volatile, uncertain, complex, ambiguous) environment today has created a decline in investor, business and consumer confidence over the last nine months. Our primary concern remains a synchronous downturn unless the Fed wakes up; acts with prudence and patience with a global perspective and pauses after December. What is the Fed worried about anyway? Inflationary pressures are declining as we discussed last week. Not only does a successful investor need a thorough understanding of the global political, economic and financial landscape, they must understand the internal and external impacts (the domino effect) from one region and country to another.

Change in future Fed policy may be in the air!

We listened intently to both Fed Chairman Powell and Vice Fed Chairman Clarida last week and noticed a marked change in tone from recent hawkish comments about being far from rate normalization. Both mentioned the strength on the dollar, weaknesses overseas and a deceleration in domestic capital spending. Don’t forget that the Fed was predicting US economic growth decelerating to a gain of 2.5% in 2019 anyway from near 3.0% this year. The Fed, BOJ and ECB still don’t fully appreciate the impact of global competitiveness, technology and disruptors pushing down inflationary pressures. Again, deflation, rather than inflation, is still a greater risk to the global economies if we have a synchronized downturn in global economic activity once/if the Fed goes too far raising rates next year. Hopefully, the Fed finally gets it. We think so!

We now expect the Fed to raise rates in December and then pause, emphasizing that it will be data dependent on future hikes. This decision should take pressure off the dollar and let foreign economies breath easier. Hopefully, trade deals will be reached with Europe, Japan, Australia and India over the next several months further reducing uncertainty boosting foreign growth which will help foreign currencies too. If US economic growth continues above trend and trade deals are reached, which is our base case, we would expect at least one more hike in the Federal Funds rate next year keeping real rates at historic lows.

Trade concerns remain in the forefront of investors’ minds. While Trump made noises of potentially reaching a deal with China last week, we are less optimistic that something will happen quickly as it now appears that the “real”  issues between our two countries transcend trade. It really is about global influence and power. Just read President’s Xi’s and Vice President Pence’s speeches at the Asia-Pacific Economic Conference this past weekend. It remains our expectation that the US will make deals with Europe, Japan, Australia and India first and then jointly negotiate a broad trade deal with China including IP. This won’t happen overnight but really is the proper course of action for the US and our allies. Patience is a necessity.

Will Trump pause on implementing another round of trade tariffs next year? Possibly if he gets a substantial down payment from Xi upfront immediately reducing our trade deficit and making some concessions on IP protection. We are hopeful but far from certain that this will happen. Clearly China has more to risk without a trade deal especially if Trump is smart enough to conclude deals with Europe, Japan, India and Australia isolating China.  

Let’s wrap this up.

Growth in China, the Eurozone and Japan are decelerating while fourth-quarter real growth led by the consumer will be close to 3% in the US. Businesses and consumers are more cautious across the board concerned about global geopolitical and trade issues. Clearly the economic glass has shifted from half full to half empty. Fed and trade policy are playing havoc across the world too with the US siphoning billions from abroad reaching for our higher yields putting pressure on foreign rates and currencies exasperating foreign policy, trade and economic growth.

Hopefully the Fed will look through the windshield recognizing its impact on global growth and pause after its most likely December Federal Funds rate hike. If so, there will be a huge sigh of relief, the dollar will fall, commodity prices will lift and global economies will resume growth. If not, there is risk of a synchronized slow down now including the US.

We fully expect the Fed to pause after its December rate hike mentioning that it will be data dependent on future rate hikes acknowledging downside risks are greater than an upside inflationary blow off.

Trade is another issue. Clearly global growth is suffering and economic stats including inflation are being impacted by buying in anticipation of possibly higher tariffs down the road. Have you noticed the volume at our ports and tanker rates? We fully expect the US to reach trade deals with Europe, Japan, Australia and India in the foreseeable future, boosting growth quickly in those regions. We are hopeful that Trump and Xi will reach a temporary ceasefire when the meet later this month but are less sanguine that a full trade deal, including IP, will occur until later next year after our allies join in.

The bottom line is that we are investing looking over the valley anticipating that the Fed will pause, trade deals will be reached and then negotiations will begin in earnest with China. Once the Fed pauses we expect the dollar to weaken, growth prospects abroad will improve and commodity prices to rise. If not, global growth will slow further while deflationary risks rise.

We have created a win/win portfolio owning best in class with superior managements and long-term winning strategies; rising volume with pricing power; growing net income, cash flow and free cash flow; above average and growing dividends with large stock buybacks in place from free cash flow.

Our portfolios own large global financial ala Buffett; healthcare; cable with content; airlines; capital goods and industrials; domestic steel and aluminum; industrial commodities; technology at a fair price to growth; and special situations where internal actions will significantly add to long-term valuation.

Patience is a necessity as well as maintaining excess liquidity at all times to take advantage of sharp computer-driven market declines. We are flat bonds and the dollar although near term it will remain the currency of choice.

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

Invest Accordingly!

Bill Ehrman
Paix et Prospérité LLC


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