The Trend is your Friend

George Soros’ (a former partner for 9 plus years) unparalleled success was predicated on his uncanny ability to recognize a new trend before anyone else; add to his position over time often using leverage as long as he believed it was not fully recognized by others, and then selling the position when it was recognized by others and selling at full value.  Naturally, he was quick to reverse his view if he felt he was wrong.

 

We, at Paix et Prospérité, have the same philosophy however we are primarily stock investors rather than buying/selling futures/options on stocks indices, currencies and commodities as George did. We combine both a top-down global perspective analyzing economic, monetary, fiscal, trade and regulatory policies by region combined with a bottom up stock specific approach to investing utilizing our independent research. We do hedge our portfolios if we deem it prudent. And, as we have said before, our long-term record of outperformance speaks for itself.

 

As you know we turned bearish last year when the Fed tightened policy way too much jeopardizing our economy while Trump was tweeting incessantly about trade tariffs against any country, most notably China, that was not trading on a level playing field with us and stealing our IP. However, we shifted our stance at the end of last December after the Fed finally reversed its monetary stance easing policy, lowering rates, and acknowledging that it would do all in its power to sustain the economic expansion while trying to raise the inflation rate up to its 2% target. We wrote many times this year that all monetary authorities globally were now overly accommodative providing more liquidity to the system than was needed by the global economy such that the excess liquidity would move into financial assets thereby increasing prices for stocks and bonds while forcing investors further out on the risk curve. We recognize that there is a lag time between monetary authorities easing policy and the global economy responding by expanding once again. This was further complicated by a sharp slowdown in global trade such that the countries relying on exports/production, like China, Germany and Japan, suffered much more than the countries, like the U.S, who were much more reliant on consumption. It also helped the U.S that Trump added tremendous fiscal stimulus and regulatory reforms to our economy whereas Germany and Japan had refused to budge. China’s economy was hurt the most as its economy was so reliant on production/exports and the shift to consumption was just in its early years. Our portfolios were concentrated domestically in defensive stocks with yields far above the 10 and even 30-year Treasury rates. The U.S was by far the best/safest house on the block to invest in.

 

We began to shift our view 8 weeks ago when we recognized that the global economy was nearing an inflection point such that growth was finally basing and would begin to accelerate as we entered 2020. Therefore, we slowly began to transition our portfolios to more economically sensitive stocks domiciled in the U.S selling at recession valuations with above average yields generating significant free cash flow while also shrinking their market capitalizations. Technology was then and remains today the largest area of concentration in our portfolios as corporations would invest in it earning a significant return on their tech investments while enhancing their competitive position.

 

Beside our view that all this excess monetary creation would find its way into financial/risk assets, we held firmly to our belief that the stock market multiple would trend up over time to 20 times earnings moving above the historic trend of 13 to 17 times earnings as interest rates were 300-600 basis points below their historic norm while bank capital/liquidity ratios(risk) were moving well above historic highs, too. We eventually became far less concerned about trade tariffs/conflicts recognizing that most of the tariffs were eaten by the overseas manufacturers, the strength of the dollar and supply chain movements.

 

These trends/core beliefs were and remain our friend as we are more convinced today that:

 

  • The global economy is bottoming out and 2020 will be a better year;
  • Trade is far less a problem to the U.S than perceived with China at risk as its economy continues to weaken thereby jeopardizing China 2025 putting the U.S in the driver’s seat due to the inherent strength of our economy bolstered by strong consumer demand and tremendous fiscal stimulus;
  • Global monetary policy remaining overly accommodative in excess of economic needs therefore boosting the value of financial assets while forcing investors further out on the risk curve;
  • Low inflation is not transitory due to global competition, technological advancements and disruptors everywhere;
  • Stocks market multiples will trend higher over time as the Fed/ investors become more convinced that low inflation is here to stay such that interest rates will remain 300-600 basis points below their historic norms with bank capital/liquidity ratios remaining at all-time highs
  • Most corporations are running lean and mean with dividend yields above the 10- and 30-year government bond rates while generating large amounts of free cash flow;
  • Investors are significantly over-weighted bonds just as the yield curve has begun to steepen and under-weighted equities even after the 20+% advance this year

 

Let’s take a look again at the four key issues that investors are focused on: trade, monetary policy, Brexit and Trump.

Trade: We believe that the odds of a Phase 1 trade deal continue to increase as evidenced by both the comments and actions out of the U.S and China last week. China began the process Friday of waiving tariffs on imports of U.S pork, soybeans, cotton, corn, and sorghum. Let’s be clear that China needs our agricultural goods as food inflation has risen out of sight. Trump, on the other hand, realizes that the U.S is in the catbird seat such that the President said at the NATO conference that he may be willing to wait until after elections to finalize a trade deal with China. In our opinion, China cannot afford to wait running the risk that companies will only accelerate their supply line shifts elsewhere and the Democrats, if elected, may take a more aggressive stance against China especially for environmental reasons (coal).

Trump also showed that he is more than willing to use tariffs to combat trade issues. He proposed duties of $2.4 billion against French products in retaliation to a French tax against U. S tech companies and he also reinstituted tariffs on steel and aluminum from Argentina and Brazil as he criticized them for cheapening their currencies to the detriment of U.S farmers.

 

Japan’s Parliament approved the trade deal with the U.S.

 

Monetary Policy: All of the major monetary bodies continue to support overly accommodative policies. ECB President Christine Lagarde joined Fed Chairman Powell stating that the ECB will be “resolute” on hitting its 2% inflation mandate. Good luck! By the way, the Fed pumped another $70.1 billion liquidity into the markets last week.

 

Brexit: It appears that Johnson will receive a mandate at this week’s upcoming election on 12/10 to pass his Brexit bill. If not successful, we still do not expect a hard Brexit as it would hurt both the British and European economies which both can ill afford.

 

Trump: We continue to believe that Trump recognizes that he needs a strong economy and stock market to win the election, therefore, it is doubtful that he will do anything that would jeopardize his chances to win. We expect him to propose a new round of tax cuts benefitting the lower and middle classes and pay for it by closing loopholes that benefit only the wealthy, an infrastructure plan, and a healthcare/drug pricing plan.

 

Now, let’s take a brief look at the most recent data points that confirm that the U.S is doing just fine while other economies continue to struggle. However, they appear to be bottoming out especially if, as we expect, global trade picks up after Phase 1 of a trade deal is reached between China and the U.S, and we pass the one-year anniversary of tariffs making year over year comparisons easier.

 

United States: The economic data points reported last week were overwhelmingly positive supporting our view that the U.S economy can sustain 2+% growth in 2020 and, even more if a Phase 1 of a trade deal is reached and if the U.S/Canada/Mexico trade deal is passed; U.S consumer sentiment hit a seven-month high of 99.2; the index of buying conditions rose to the highest level in a year; longer term inflation expectations fell to a record low of 2.3%; consumer credit increased to $18.9 billion in October which is up to a  5.5% annualized rate; wholesale inventories rose slightly after falling 0.7% in September; the trade gap fell to $47.2 billion as both imports and exports fell; the consumer confidence index rose to 61.7; factory orders rebounded 0.3% led by a surge in capital goods orders sans aircraft (Boeing issue); the IHS Services Index rose to 51.6 in November; the new orders index rose to 57.1 and the employment index was at 55.5%.

 

On the other hand, the IHS Manufacturing Index fell to the lowest level in a decade at 48.1; new orders were at 46.7 and employment at 46.6. We firmly believe corporations are reducing their inventories at a record clip which may present an upside surprise early next year.

 

The big shocker reported last Friday was the employment data: payrolls rose 266,000 after a 41,000 positive revision to the prior two months; the GM strike ending only added 41,300 to the numbers; the jobless rate dipped to 3.5%, the lowest level since 1969; and wages rose at a 3.1% annualized clip beating inflation. The U.S has added over 2 million jobs this year boosting annual incomes by over $600 billion. Some slowdown!

 

China: No real changes in our view that their economy continues to decelerate with financial risks rising without a trade deal. China’s default rate is about to break a record exceeding $17 billion this year. China needs a deal and fast.

 

Eurozone: Germany’s economy continues to slide as evidenced by a 0.4% decline in orders and industrial output due to weak demand. We cannot fathom why this country does not institute a huge fiscal stimulus program to offset rising deflationary pressures. We were pleased to see that Merkel’s party is losing elections. Change is needed here and fast!

 

Japan: We were pleasantly surprised to see Japan’s government pass a $120 billion fiscal stimulus plan funded by selling bonds. Thank heaven the interest cost will be so low that it won’t hurt the country’s budget. Are you listening Germany, France, India?

 

Investment Summary

 

We see no reason to alter our current investment view/ portfolio structure since all the trends/core beliefs that we saw 8 weeks ago are still progressing as we had anticipated. Our portfolios are concentrated in technology, especially semis; global capital goods, industrials and machinery companies; housing related retailers as well as other retailers who have successfully transformed themselves and will be revalued over time; financials; low cost, cash flow positive industrial commodity companies; some healthcare companies with major new product introductions; and many special situations where management is focused on closing the gap between current valuation and intrinsic value. We do not own bonds as we expect the yield curve to steepen nor are we long the dollar any longer.

 

Our Investment Committee webinar will be held on Monday morning, December 9th at 8:30 am EST. You can join 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 and…

 

Invest Accordingly!

 

Bill Ehrman

Paix et Prospérité LLC

 

 

 

 

 

 

 

 

 

 

 

 

 

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