The Markets Hate Uncertainty

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by: Bill Ehrman

The global economic recovery runs the risk of stalling out unless all the parties accept that there must be changes in trading patterns. They must reflect “real” open, fair and reciprocal tariffs and subsidies where Intellectual Property is protected for all, not just for the U.S.

Why is that so difficult to do? Who could really object, and on what grounds? Why not ask our trading partners?!

The truth is that all countries will benefit longer term from open trade, as global competition will occur on a more level playing field. Also, there will be a burst in capital spending for more efficient plant and equipment lowering costs; there will be a step up in technology spending while increasing capacity; research spending will accelerate; and more, but different, jobs will be created in total as global growth accelerates. If all of this occurs, not only will global growth benefit but inflation will be held down as new, more efficient plants come on line everywhere. And then there are the disruptors. Did you notice Amazon (NASDAQ:AMZN) entering the online pharmacy market and also home delivery last week? Imagine if retail drug costs are held down as well as delivery costs. Both are sources of rising inflation but that will change down the line. Just look at the impact on grocery prices since Amazon bought Whole Foods!

The global financial markets remained under extreme pressure last week especially in those regions where exports are a significant part of their economy. But no one is immune from fear of escalating trade tensions, as new tariffs will begin this week in response to Trump’s earlier moves introducing tariffs on foreign steel and aluminum. Will the U.S ratchet this up and announce a new round of tariffs? Possibly and that will most likely draw additional tariffs against us from abroad.

The markets hate uncertainty!

There are NO winners here but yes, we lose less than those economies where net exports are a far greater percentage of GNP. Declines in overseas markets far exceeded that of the U.S last week but is losing less a good objective for our government? NO!

While it is impossible to know what is happening behind scenes, it is time for Trump to sound more conciliatory with our trading partners in public for a change. By now we think that they all get his message. They can read Trump’s poll rating too, which continues to rise with his base and others.

Did you happen to see Trump last week at the opening of the huge Foxconn plant in Wisconsin? (We never saw him so happy). It is a 20 million square foot plant that will employ 13,000 people with an average wage exceeding $55,000 per year. Do you think other companies, domestic and foreign, get the hint? Remember we want to invest where the government is behind our back. It goes for corporations too! Just ask Harley-Davidson (NYSE:HOG)!

Right now corporations are acting fairly rationale and are taking a wait and see attitude most likely holding back on some spending and hiring plans until there is more clarity on what happens next. But is that the right decision or should they be planning for a more level trade playing field in the near future? After all, a new plant built here does not pop up in six months even with reduced regulations and red tape.

Just look at what Nucor (NYSE:NUE), a steel company, did over the last 5 years during an industry downturn. Management bought and built super efficient plant on the cheap and is finally beginning to reap the benefits. Earnings will reach record levels in 2018 with more to come. Of course, Nucor was profitable every year and generated free cash flow after all of its spending while still increasing its dividends.

What do you think Amazon, Apple (NASDAQ:AAPL), Honeywell (NYSE:HON), Salesforce (NYSE:CRM), Nvidia (NASDAQ:NVDA), Cisco (NASDAQ:CSCO) and other companies with foresight and a long-term vision will do during this period? Each will continue to expand adhering to the Buffett long-term investment horizon. Unusual opportunities to profit occur out of adversity.

It can be said for investors, too. Value and upside rewards are greatest when fear is the highest. Have you noticed that investor withdrawals from mutual stock funds are the highest ever? What a great contra-indicator! Stick with best in breed with superior management; strong financials and a great business plan to enhance shareholder value regardless of the environment.

Let us state categorically that change will only accelerate in the years ahead. The political environment continues to shift as populism is on the rise once again as evidenced in Italy, Mexico and Spain. Do you still think that Trump’s stance on immigration is so extreme? Just take a look at what the ECB approved this weekend.

So what are we to do now?

We fully recognize that growth in the ECB and Japan has slowed down appreciably while the U.S has accelerated. Even though there has been a recent slight downtick in economic growth in China, we still expect their GNP to expand over 6.5% this year so no need to cry for them. But what about the future? Who can best survive escalating trade skirmishes? Whose monetary bodies have the ammunition to fight against an economic slowdown while strengthening their financial systems? ECB banks and the Chinese financial system have a lot more risk than our banking system. Did you happen to see the final results of the Fed stress tests? Our major banks can return over $125 billion of its excess capital to its shareholders over the next year despite the most difficult stress test ever?

So who can best survive escalating trade tensions and the potential negative impact on growth? The United States. But is that what any of us really want? We continue to believe that trade issues will be handled before spiraling out of control. We fully expect that the world will begin a process of reducing tariffs move in line with what exists now entering the U. and intellectual property will be better protected. Borders will be opened wider than ever.

How are we positioned during this time?

We, like Buffett, own only the winners with great management who will not only survive but will thrive over the next several years. Many of our investments have more than one way of creating added value too due to internal M&A. For instance:

  • The banks that we own are thriving, selling at less than 10 times earnings and also have the ability due to the Fed stress test to hike their current dividend yields to an above average 3% yield while also shrinking their capitalizations by 6 to 10%.
  • The industrials that we own continue recreate themselves enhancing their global footprint, competitive position and future value. Each one sells at significant discount to the market despite above average returns.
  • The technology companies that we own continue to make huge internal changes to increase their competitive position, growth opportunities and returns. Each one sells at discounts to the market and has huge buybacks, too.
  • Industrial commodity companies including domestic steel and aluminum. Managements are using different playbooks this time and are continuing to generate huge excess cash flow and returns as we move deeper into the economic cycle. Each one has superior returns, above average yields, are shrinking their capitalizations and sell at huge discounts to the markets.
  • Our special situations all deal with internal M&A to increase shareholder value by 30% plus regardless of the overall global economic environment.

Finally, we want to mention that the Fed should take a time out pending resolution of potential trade skirmishes. Higher inflation caused by increased tariffs truly is transitory as it is a one-time event and may be reversed down the road.

We fully recognize the near term risks to global economic growth therefore we maintain excess liquidity at all times; have a yield on our portfolio greater than the 10-year treasury; each investment is selling beneath a market multiple with an above average return and each one has more than one way to create added shareholder value.

Remember that uncertainty creates opportunity!

Remember to review all the facts; pause, reflect and consider mindset shifts; consider your asset allocation with risk controls; do in-depth research and invest accordingly!