Global Events Create A Two Way Market

by: Bill Ehrman

What has become abundantly clear is that we live in a VUCA (volatile, uncertain, complex and ambiguous) environment with no sign of rapid change abating. So it is imperative for all investors to stay on their toes, poised to make changes to their core beliefs if need be.

These days, market psychology shifts on a dime. Unless you have core beliefs guiding your strategy you will be whipsawed at every turn, losing money along the way. That's why I emphasize that true investing is the only real way to create wealth as trading is a commission and loss generator.

There are contradictory comments day to day about the global economy, inflation, interest rates, and currency valuations. The conflicting data makes a challenging task even harder and explains why most institutional investors trying to be smart look so dumb. As I said in a Bloomberg interview a few years ago "the problem in investing today is that there is too much news." I stand by those words today. News travels quickly over many venues and trading takes place instantaneously from your phone, iPad, or computer in a nanosecond. No wonder we experience excessive market volatility. Remember the days of calling trading desks to execute and when volume was 10 million shares a day?

So, how do I continue to outperform all the major market indexes in this world? It is by having well thought-out and time tested core beliefs, monitoring economic and global statistics, understanding the inter-relationship between all the variables and being able to synthesize these findings. The result is a portfolio with the proper asset allocation. The bottoms up part of the portfolio is created through in-depth research, choosing one investment at a time within the confines of the overall schema, and controlling risk at every step. I recognize and take advantage of change everywhere, especially, how its impacts valuations and company performance. And finally, I know how to leverage the rule of compounding which begins with minimizing losses.

Most of the noise influencing the global stock markets came out of the United States beginning with Janet Yellen's speech on Tuesday ending with the unemployment data reported Friday. After her speech, I made a comment issuing a mid week blog. It is in "Yellen Says that the Fed Should Proceed Cautiously" where I responded that Yellen took a very dovish view, which we anticipated as, it was consistent with the Fed meeting the prior week.

The conclusion of the piece was that our core beliefs remain intact and all the damage caused by comments by some Fed Governors the prior week would be reversed, as predicted. I want to add that she emphasized in her comments weakness overseas and a slowdown in domestic growth since December as the driving points in the more cautious Fed view and policy.

The employment data Friday was consistent with our view of an improving domestic economy: payrolls rose by 215, 000 in March; the unemployment rate rose to 5% as over 300,000 people entered the labor force (a key data point as nearly 3 million have entered the labor force over the past year pressuring wages); average hourly earnings rose 7 cents and are up 2.3% year over year; the average workweek held at 34.4 hours; the labor participation rate rose to 63%, a 6 month high; and job growth has averaged 209,000 in the first quarter, down slightly from last years average monthly gain. This was a very decent report supporting our view of continued economic growth in 2016 in the 2-2.5% annual rate of gain.

Other U.S. data points reported last week were: consumer confidence rose to 96.2; the S & P/Case-Shiller Home Price Index rose 5.4% in the 12 months ending January; Rebook sales exceeded expectations rising 1.5% year over year; pending home sales increased 3.5% in February, the highest level in 7 months; consumer spending increased only 0.1% in February, the third sluggish month in a row, while personal incomes rose 0.2% boosting the savings rate and finally the ISM manufacturing index increased to 51.8 in March from 49.5 in February.

All in all, it's hard to be bearish on the U.S. economy. Matter of fact, the outlook for the U.S. economy is pretty darn good. My concern lies with the Presidential race and the failure of any of the candidates to articulate a cogent plan to improve the U.S. economy and to enhance U.S. stature overseas. For example, rather than focusing on tax inversion, the candidates should focus on the reasons behind it as well as discuss the needed changes to our outdated tax policy created for another generation.

The other area of focus for the financial markets remains energy. I find it interesting to note that low energy prices are really healthier for the global economy than not but somehow rising energy prices today is a sign of stabilization and better times. The market wants for some reason higher prices whereas I would be satisfied if energy prices held in the $35-$45 dollar per barrel range as that would be the best of all worlds. Expect a lot of posturing between now and the Energy conference in Qatari in a few weeks.

In truth, don't react to what they say but react to what they do and listen very carefully to every word. For instance, the Saudis said Friday that they would freeze production only if Iran and other major producers agree to curb theirs. The key word is CURB, not freeze. I still expect a deal with the major global producers agreeing to freeze production at January levels while permitting Iran to increase their production closer to where it was prior to sanctions.

By the way here are some interesting stats: U.S. rig count stands at 450 currently down 578 rigs from a year ago; Canadian rig count stands at 49 down 51 from a year ago; and international rigs stand at 1018 down 257 from a year ago. As I have mentioned last week, I would not be short energy going into the oil producers' conference in a few weeks.

Let's quickly look at key data points in some of the largest regions: China's PMI showed some life in March increasing to 53.8 along with an improvement in the Caxin manufacturing survey which rose to 49.7; Japan remains in a quagmire as negative rates has boosted the yen hurting the competitive ability to export and all PM Abe can do at this juncture is to front load some spending in the fiscal 2016 budget; and then there is the stats out of the Eurozone: the PMI rose to 51.6; bank lending rose 0.9% year over year; consumer prices actually fell 0.1% in March fueling deflationary fears and the Euro rose after dovish comments out of Yellen this week.

I remain favorably inclined toward China and cautious/negative toward Japan and the Eurozone.

Let's put it all in perspective.

The U.S. economy clearly showed some improvement recently and strength in the employment numbers over the last year assures continued expansion in 2016. Remember the consumer is 67% of GNP. Beside the growth in aggregate employment and hourly earnings, energy costs are still down 50% year over year, which benefits consumer disposable income. While a good portion of that gain may go into savings, the majority of it will be spent on goods and services.

Now let's take a look at interest rates. Who would have predicted that the 10-year bond would be below 2% at this point in time with the economy still expanding 2+%. We have lowered our year-end forecast for the 10-year bond to 2.35% from 2.75% previously.

Now let's look at earnings. The dollar has retreated by 4% since year-end against the euro and yen for reasons discussed in previous pieces. A lower dollar means that translation losses for the quarter will most likely be less than anticipated by corporations who made their forecasts three months ago. Lower translation losses means higher reported earnings.

Finally, higher earnings combined with lower interest rates means that our target price for the S&P moves up 5% from our previous forecasts. Naturally companies with a greater composition of their earnings abroad will benefit more than the average S&P Company. Again, we invest in stocks, not the market. First, we want to know if the wind is behind our backs when investing and that issue is part of our capital allocation and risk control decision process.

Then we do intense research searching for the greatest values with a three-year time frame. The largest percentage of our long portfolio is comprised of companies going through positive change, which we expect will result in higher valuations over time. Our shorts have the opposite characteristics of our longs. We remain 95% net long in our portfolios.

So remember to carefully review all the facts, pause to reflect, consider the proper asset allocation and risk controls, finally do in-depth bottom up research on each investment idea and…

Invest Accordingly!