Seeking Alpha
Bill Ehrman
Long/short equity, growth at reasonable price

Remember the axiom "when it appears on the cover of Barron's do the opposite?" The headline story in this week's Barron's was Lights Out for Stocks. Why not Prepare for the Next Up Leg as we discussed last week?

The focus of most investors/pundits remains that the sky is about to fall, believing that the bull market is long in the tooth and that it is time to circle the wagons and protect what you've made over the years. Nonetheless, the path of least resistance remains up. Remember, too, that there is nothing in the market for any of Trump's pro-growth, pro-business agenda, so what if it is passed?

The simple truth is that the global economies have just begun expanding in unison; inflation and interest rates have never been so low at this stage in an economic recovery, and earnings growth is accelerating led by the multinationals. No one, including myself, forecasted that the 10-year treasury bond would be less than 2.20% today nor the 10-year German bund would be 0.3% and the 10-year Japanese government bond at -0.02%. Yes, that was a minus sign!

At the same time, bank/financial liquidity and capital ratios have increased meaningfully over the years reducing systematic risk. Finally, all monetary authorities remain in an overly accommodative stance and will stay one step behind until inflation begins rising up to that magical 2% level. But that may take more time than expected due to the downward pressure on inflation resulting from globalization and the disruptors.

Can you imagine that we are shooting for 2% inflation when I remember all too well when the Fed was tightening to reduce inflationary pressures below 4 or 5%? What a different world we live in today and still the pundits look at the rear view mirror. It is imperative to recognize that the past is not a prologue for the future. Hear me Barron's!

Let's take a look at what was reported last week around the globe to see if it supports our investment thesis:

  1. The preponderance of data reported last week in the U.S was strong: the Bloomberg consumer comfort index rose to 53.3 from 52.8 last week while the Conference Board measure of consumer confidence rose to a 17 year high at 122.9; the Chicago ISM stood at a strong 58.9; consumer spending rose 0.3% in July while personal income increased 0.4%, the biggest gain in 6 months; the PCE price index rose only 0.1% in the month, a key gauge watched by the Fed; second quarter GDP was revised to up to 3% gain with upward revisions to consumption, business investment and profits; home prices accelerated to a 5.8% year over year gain in June; the August PMI rose to 58.8 with new orders, production and employment indices all accelerating; and finally U.S. employers added 156,00 jobs in August which included a 30,000 decline in government employment; wages rose only 0.1% from the prior month and are up 2.5% over the year and the unemployment rate stood at 4.5%. Wow, pretty good numbers! There were two other key points from the week. First, Hurricane Harvey was far more devastating than initially thought and the estimated cost to rebuild the area rose to over $150 billion, which clearly will be a boost to the economy over the next year. As an example, it is believed that 500,000 cars will need to be replaced. We expect the administration to tie an emergency funding bill for the region to the continuing budget resolution to prevent a government shutdown as many feared. Secondly, Gary Cohn, Chief White House economic adviser, said on Friday that the administration tax plan is ready to go and it won't benefit the wealthy at all. Pretty important stuff!
  2. Eurozone manufacturing activity rose to 57.4 in August, a 6-year high with output and backlog all increasing meaningfully; core inflation rose at only a 1.2% rate in month which Draghi and the ECB watch closely; Eurozone business and consumer confidence rose to a 10-year in August at 111.9 and finally growth forecasts for the second quarter were lifted to 2.5%.
  3. China's official PMI rose to 51.7, which was much stronger than expected. Production, orders and business expectations were strong across the board and bode well for the foreseeable future. China will clearly exceed its 6.5% growth target for the year despite clamping down on financial excesses.
  4. India's economy grew by only 5.7% in the second quarter, which was disappointing, as the government's cash crackdown has hurt manufacturing. We still expect the country to exceed its 6% growth target for the year, which is still pretty good.
  5. Industrial commodity prices continued to rise last week, which is an indication of strong global growth and production restraint. Demand will benefit here too from rebuilding Texas due to the damage from Hurricane Harvey.

Let's wrap this up. The global economy continues to surprise on the upside. It appears, too, that Trump's pro-growth, pro-business agenda may gain some traction assisted by the need to rebuild Texas after the devastating damage inflicted by Harvey. We expect the monetary authorities to remain one step behind until inflation begins to move up to the 2% level, which may take longer than anyone thinks due to the competitive effect of globalization and the disruptors. Expect earnings of the U.S multinationals to get an earnings tail wind from the decline in the dollar this year.

On the other hand, a strong euro and yen will hurt the European and Japanese multinationals. North Korea remains a big problem so expect periodic pressure on the financial markets during periods of escalation like what has just occurred. China is the key to the solution in the region so expect more outside pressure on them to exert their influence on North Korea to stand down.

We continue to emphasize the large money center banks which will benefit from a steepening yield curve over time and from deregulation; the U.S global industrials; low cost industrial commodity producers including domestic steel and aluminum; technology at a fair price, and several special situations which include the now merged Dow (NYSE:DOW)-DuPont (NYSE:DD) who will split into three companies within 18 months creating significant added value.

Paix et Prospérité finished August outperforming all averages as we have for the last several years. We have a time-tested disciplined approach looking through the windshield, understanding mindset shifts and recognizing that the past is NOT prologued for the future. Change is everywhere and patience is needed to let it all unfold.

So remember to review the facts; pause, reflect and consider mindset shifts; adjust your asset composition and risk controls as needed; do independent research at all times and…Invest Accordingly!