Trump Tweets While the World Burns
Trump and his team just don’t get it! It’s their trade policy that is responsible for grinding global growth to a halt. Can you imagine business-planning: capital spending, hiring, and the like, when a tweet could change the environment in a second?
Managing money is impacted by Trump’s tweets, too. So far we have navigated successfully. We are outperforming the markets, investing in mostly domestic companies tied to the consumer and/or with technological domination, with strong management teams, winning long and short term strategies, strong earnings, cash flow and free cash flow with dividend yields, above the 30-year Treasury bond yield, that will grow each year. Also, we own gold stocks as a hedge against monetary/currency and political instability in today’s VUCA (volatile, uncertain, complex, ambiguous) global environment.
How do we navigate in a VUCA environment? With clarity, order, simplicity, and steadiness (COSS). The antidote to volatility is steadiness. The remedy for uncertainty is order. The treatment for complexity is simplicity. The cure for ambiguity is clarity.
Our mantra says it all. Review all the facts; pause, reflect and consider mindset shifts; always look at your asset mix with risk controls; do independent research and invest accordingly! We synthesize all the data taking a global approach to formulate a macro view then merge that with a bottom-up analysis doing firsthand research to find undervalued companies going through a positive incremental change that will outperform over time despite the VUCA environment. Look at Target last week, one of our largest holdings as is Home Depot.
It remains clear that all of the major monetary bodies: The Fed, ECB, BOJ and the Bank of China, realize that monetary policy is not the panacea for what ails their economy. Global trade has slowed dramatically due primarily to the trade conflicts initiated by Trump that have spread throughout the world. Business sentiment/spending/hiring have declined precipitously for obvious reasons. While the U.S is best positioned today as trade is not the driver of our growth, our big fear is that the decline in business sentiment here and abroad could negatively impact hiring and wage growth which will hurt consumer sentiment and spending. Yes, the slowdown that we are forecasting could turn into a recession within two years. But that is not our current forecast. Why?
First of all, our Fed has more arrows in its quiver to stabilize and stimulate growth than all other monetary bodies. Second, we are already running huge fiscal deficits that will only get larger which stimulate growth. It won’t be easy for the Eurozone and Japan to pass major fiscal stimulus programs quickly even though they may want to. China can and will. Third, we have a President who wants to be re-elected and realizes that he needs a strong economy and stock market to win. There are things that he can do to offset the negative impact of tariffs on the consumer. We still believe that Trump may cut withholding taxes on the lower and middle class equal to the tariffs received by our government. Not a bad idea, is it?
Before we go further, we want to reiterate that we agree with Trump that the United States has gotten the short end of the stick on reciprocal trade with China, Europe, and Japan. China has stolen our IP for many years, but U.S. companies permitted it because they wanted to enter China. They share part of the blame here. These companies also agreed to joint ventures in China. So, Trump is asking now for a level playing field, for China to change its ways. Not so easy nor should it be. How would we react if it was the other way around?
Things should change in dealing with China. China can easily purchase much more from the U.S reducing the trade imbalance: agricultural products for sure and end stealing our IP. Then there is Europe. Here again, the Eurozone can buy much more from the U.S by simply reducing tariffs and subsidies and leveling the playing field. Where’s the beef? And finally, there is Japan. Same here. Japan can buy much more from us, including agricultural products, to reduce its trade imbalance
The bottom line is that it is hard to change trade patterns that have existed for so long. Trump cannot do it with a tweet and a sledgehammer. Our partners must deal more fairly with us. What is wrong with removing all tariffs and subsidies? But it takes time and patience. which Trump does not have. He prefers to tweet without much thought of the consequences not only to us but to our long-standing relationships. While the world is getting more global, Trump is thinking as an isolationist. Trump needs to take a longer view and a more global view of what he is doing; have a timeline that all agree to for actionable events like trade deals, and hold everyone’s feet to the fire to deliver as committed.
There is a reason why our yield curve has inverted: investors from around the world are shifting their money here buying our bonds which have positive interest rates when their rates are negative. Does that mean that we are entering a recession or that they are already in one? Maybe that explains dollar strength too. Look at the flow of funds.
The U.S stock market is clearly undervalued selling at less than 17 times earnings with the 10-year yield hovering around 1.5%, the thirty-year bond yield near 2.0% and bank capital/liquidity ratios at an all-time high. Think as an investor with a longer-term time frame as we move a difficult, VUCA, period where change is occurring to global trade patterns which has caused geopolitical risks to rise too. Unusual opportunities come during periods of stress for those who stick to their disciplines. Now, is such a time.
Let’s take a look at the key data points of the week that support/detract from our view that the United States is the only place to invest unless/until there are trade deficits:
The U.S economy continues to chug along sustaining growth above 2% so far in the third quarter. We were pleased to see that the Conference Board Leading Economic Indicators increased 0.8% in July to 112.2 which suggests continued growth in the second half of the year. Both the coincident and lagging indicators of growth increased too despite continued weakness in the manufacturing sector. Housing activity has finally picked up too benefitting from lower mortgage rates. Don’t underestimate the positive impact on consumer spending as homeowners refinance their mortgages at much lower rates too. E-commerce sales are growing by nearly 14% year over year and now account for 10% of retail sales.
Business activity did weaken further in August with the U.S Composite Output Index at 50.9; the services index at 50.9; the manufacturers’ index at 49.9 and the manufacturers’ output index at 50.6. Businesses commented on the weakness in spending due to trade concerns.
It is clear from both the Beige Book and all the Fed comments, including from Chairman Powell, at their annual Jackson Hole symposium last week that the Fed is more concerned about the global slowdown including the impact of tariffs and weak inflation data than any perceived problems in the U.S economy. The general belief is that our yield curve has flattened/inverted due to huge money flows from abroad reaching for positive yields when their yields are negative. We still believe that the Fed will cut by at least another 50 basis points before year-end.
The CBO increased the anticipated size of the U.S deficit in 2019 by $63 billion due to the new budget deal. Expect an even larger increase in the deficit next year. All of this is highly stimulative. Also, we would not be surprised if Trump reduced taxes on the lower and middle classes to offset the new, higher tariffs and introduced another program to aid the farmers.
While we recognize that risks have risen as the trade war escalates, we still believe that our economy will continue to expand by 2+% over the next several quarters led by the consumer and increased government spending.
Growth in China will continue to slow in the second half of year tied primarily to the trade conflict with the U.S. While Trump’s tweet last Friday ordering U.S corporations to begin exiting China was ridiculous, the truth is many are leaving at an accelerated rate. The trade war with the U.S has cost China almost 2 million industrial jobs so far and that was before the most recent increase in U.S tariffs. Don’t believe the rhetoric that China can offset the trade war with domestic growth and new markets. Growth will fall and stay below 6% for the foreseeable future without a trade deal. China is cutting off their noise raising tariffs on soybeans and oil, both sorely needed. China is banking that Trump will need a deal before elections next year. But maybe not, if Trump cuts taxes equal to the tariff hike.
Growth in the Eurozone continued to moderate although we were encouraged that both the Eurozone Composite Output Index rose to 51.8 in August and the Services Index increased to 53.4. On the other hand, both the manufacturers’ output indices remained below 48. The German Manufacturing PMI came in at 43.6 in August and was considered better than expected.
While we expect the ECB to reduce rates again while increasing the number of asset purchases next month, don’t expect growth to be rekindled without trade deals and major local fiscal stimulus. Let’s see if Germany can pass a $55 billion stimulus plan. It was hard to fathom that Germany could sell 30-year bonds last week with negative yields. That says it all!
We are monitoring closely whether there will be a hard Brexit or not in October and whether the U.S and Eurozone can move closer to a trade deal. We remain very pessimistic on the prospects of Europe. And so do the Europeans who are all moving their money here reaching for any positive yield.
Japan’s manufacturing data shrank for the last four months as export orders fell. Factory output and new orders continue to weaken too which does not bode well for the balance of the year. Inflation rose 0.6% from a year ago. Here again, there is not much more than the BOJ can do to stimulate growth and the government has little wiggle room to introduce a major fiscal package. Why invest here?
Trump is holding global trade and growth hostage as he is fighting battles on all fronts at once. He must make some deals fast as the risks of a more pronounced global downturn are rising. While there is no place like home, the risks of contagion hitting our borders over the next two years are rising. So is the fear of rising deflationary forces and currency battles. The bottom line is that we are maintaining our defensive posture. While we remain optimistic that Trump will make the needed changes to win the election next year, he is turning the screws tighter on China and Europe right now. That will give him the ability to snatch victory next year before elections. But China knows that too. Look for a major tax package funded by the tariffs within the next few months to reduce/mitigate/eliminate the hit on the lower and middle class.
Our portfolios are concentrated in consumer non-durable companies; technology companies not exposed to China; housing-related retailers; specialty retailers; healthcare; utilities; cable with content; airlines; telecommunications; and many special situations. Our cash levels are elevated, we own no bonds and are flat the dollar. We are still working on an options strategy to move more cyclical if/when trade deals are reached.
Remember to review all the facts; pause, reflect and consider mindset shifts; look at your asset mix with risk controls; do independent research and …
Paix et Prospérité LLC