Markets Climb On Wall Of Worry

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by: Bill Ehrman

Don't you wake up each morning expecting the worst? Don't you expect Trump to put both feet in this his mouth twitting something nasty antagonizing someone? And at the end of the day after the market holds in, do you say, "I dodged another bullet?"

Markets tend to rise on a wall of worry and peak when optimism is highest. Who is optimistic now? Not the Baron's Roundtable who were universally optimistic six months ago. Another great contra indicator!

Now is the time to review all the facts; pause, reflect and consider mindset shifts; analyze your asset composition and risk controls; do in-depth fundamental research and invest accordingly! The keywords are "invest accordingly" with an eye toward the future factoring in all the changes that are occurring in the global economic, financial and political landscape. That's what we do best and sets Paix et Prospérité apart from other money managers.

Let's look at all the key issues facing us; put them in their proper perspective and analyze the longer-term implications of each:

  1. Has global economic growth peaked? We acknowledge that growth in the ECB and Japan has slowed recently however growth in the U.S has accelerated while growth in China remains strong. Global growth will continue to benefit from large increases in employment, higher wages and big increases in capital spending especially for new technology. Don't get overly concerned if growth slows slightly from recent levels, as it is still pretty darn good. U.S growth may reach 4% in the second quarter and average around 3% for the rest of the year and be close to that in 2019.
  2. Have inflationary pressures picked up? Inflationary pressures have increased for sure but have you noticed the recent decline in industrial commodity and agricultural prices and the further inroads of disruptors in key sectors? We expect future increases in the PPI to moderate, which will be a precursor for smaller increases in the CPI down the road. Increased tariffs will be considered one off events and monetary policy won't tighten due to it. Increases in capital spending will lead to higher productivity gains, which will reduce unit labor costs.
  3. Have global monetary policies tightened? Global monetary policy remains overly accommodative. The supply of global money continues to exceed the uses of capital, which is beneficial for financial assets. Note the recent shift in China to a more accommodative stance. We expect the Fed to stay one step behind fearing an inverted yield curve despite what they may say about it.
  4. Is earnings growth peaking? Not so! Listen to the earnings calls of the major banks. Each one states that economic growth is strengthening; capital spending is accelerating; inflationary pressures appear under control; and earnings will continue to increase. Of course, each one cautioned about potential trade conflicts inhibiting growth. The bank stocks are ridiculously cheap! The ones that we own have enough excess capital to raise their dividend yields over 3% and buy in over 6% of the shares outstanding over the next year with more in the out years. S&P earnings will be close to $160 per share in 2018, up over 20%, with further gains to over $172 per share expected in 2019.
  5. Will trade policies hurt global economic growth? Trade will be the major disruptor for years to come. Trump's call for lower tariffs and fair/open trade across the globe is difficult for our partners to refute. While it is difficult to predict the immediate future, it is just as clear to forecast where we are going over the next few years. Let us state once again that lower tariffs across the board will be good for global growth while putting a lid on future inflationary pressures. Deals will be reached to protect IP across the globe too. We expect a surge in global capital spending too to reduce the cost of goods and enhance one's global competitive position. ZTE is back in business in the U.S Actions speak louder than words and this decision by Trump and his administration sends a message to China that are willing to deal. Let's see.
  6. How did Trump's meeting with our NATO partners go? Trump's success at the NATO meeting last week was a watershed event. He succeeded in getting our partners to meaningfully increase their financial commitment despite past reservations. Their concessions may be a precursor of upcoming trade talks in DC next week. We think so! We also believe that Trump's meeting with May went well and we do expect to hear something positive out of his meeting with Putin. After all, what is the downside here?
  7. Was Judge Kavanaugh a good selection for the Supreme Court? The selection of Judge Kavanaugh to the Supreme Court has positive long-term implications for financial assets, as he is clearly pro-business, against excessive government involvement and too much regulation.
  8. Will mid term elections hurt the financial markets? Mid term elections are always difficult for the incumbent party. Nevertheless we expect the Republicans to hold the Senate so the worse result could be a stalemate in DC. Is that really bad? Not so! Trump has gotten the core of his pro-growth, pro-business agenda passed already. We don't need another tax cut now.
  9. Is the resurgence of populism a negative for the financial markets? Populism is on the rise once again. Just look at recent elections in Italy and Mexico. Also take a look at the Prime Minister's battle over Brexit. Immigration is a global problem as well as global competitiveness. Self-interest wins in the end.
  10. Is the U.S market overvalued? The U.S market sells at around 16.5 times projected 2018 earning and less than 15.5 times projected 2019 EPS. That is cheap when compared to 10-year treasuries yielding under 2.9% and bank liquidity at all time highs reducing financial risk in our system. Read the recent Fed stress test results to see what we mean that our banks are now over capitalized no matter what disasters may occur.

While it is sometimes difficult to step back and not be overly influenced by all the noise in the market place, we see no reason to alter our longer-term investment outlook at this time. In fact, we are taking advantage of many opportunities created by excessive market volatility to diversify our portfolio into some new sectors, which have been unnecessarily punished.

For instance, we recently added some healthcare names to our portfolios, which have unique growth opportunities and are somewhat immune to Trump's efforts to reduce pharmaceutical costs including drugs. Also we added some additional new names, both domestic and foreign, that have been overly hit by concerns over trade with China.

Boeing (NYSE:BA) is a perfect example here. Paix et Prospérité invests for the longer term like Buffett looking over the valley when most investors look in the rear view mirror overly concerned by daily performance. We are always focused on long-term performance over all market and economic cycles. We have successfully achieved this objective over our 40+ years managing money. Patience is a necessity, as it may not happen day-to-day or even month-to-month.

While we certainly don't think that all the clouds lifted over the financial markets last week, we do believe that progress was realized in several key areas. Again, we suggest that you listen to as many earnings conference calls as possible to get a sense of where managements believe that we are going over the next few months and years.

Clearly trade is on everyone's mind but we remain hopeful that the current skirmishes won't actually turn into full-blown trade wars. In any event, we only own best in class with the strongest management teams with clear strategies and financial strength to succeed for years to come regardless of the economic and political environment.

Our portfolios continue to concentrate in the financials, global industrial and capital goods companies, technology at a fair price to growth, industrial commodity companies including domestic steel and aluminum, and special situations where internal strategic plans will add significant added value over time. We do expect gains in the dollar to moderate over the remainder of the year and the yield curve to steepen as trade fears are lowered.

Longer term we believe that a reduction in tariffs around the world will lead to higher global growth and lower inflation. Review all the facts; pause, reflect and consider mindset shifts; analyze your asset composition with risk controls; do independent research and… Invest Accordingly!