We are increasingly living in a multipolar world aptly defined by the acronym VUCA: volatile, uncertain, complex, and ambiguous.
Volatility reflects the speed and turbulence of change. Uncertainty means that outcomes are less predictable. Complexity indicates the vastness of interdependencies in globally connected economies and societies. And ambiguity conveys the multitude of options and potential outcomes resulting from them.
Rarely, if ever, in our 40-plus years, have we invested in an environment with so much VUCA and attendant sound bites causing extreme volatility throughout each day. It also does not help that electronic trading has become disproportionate percentage of daily volume.
Our belief to remain successful is simple: A successful investor must stay above the fray. This means maintaining their core values despite the daily noise and taking the long view as does Buffett.
Change has been the overriding theme over the last several years. We are always encouraging investors to do as we do: stop looking to the past to inform the future! This thesis applies for: traditional economic tools and rules; the rise and impact of populism in politics; growing globalization resulting in trade shifts; rapid technological change forcing the need to protect IP; the role of disruptors everywhere; boardroom and management shifts in operational strategies and objectives; and the increasing importance of millennials in society, just a few areas we monitor closely.
Trump has been a huge game changer both here and abroad. He ran on a populist agenda that was pro-business, pro-growth and with America First. His overriding theme was to make America Great Again. While we continue to agree with the basic tenets of Trump's business agenda, we also find him his own worst enemy as his delivery turns friends off and hardens our foes. We acknowledge that he ran as the anti-politician, but there are better ways than bludgeoning your opponents into submission. It is time for him to recalibrate his bargaining techniques as he has already made his main points. Time to sit down, reach across the table and make a deal. Any deal is better than no deal and maintaining the status quo.
Herein lies everyone's dilemma. How do you sell a market when we all know trade deals will lead to an immediate 10% rise in the indices? By the way, that tells you how undervalued today's market is. And if there are trade deals, we expect a re-acceleration in global growth, stronger foreign currencies, higher interest rates, higher earnings, higher inflation, and much higher stock prices
In the midst of a VUCA environment, Paix et Prospérité is playing the long ball owning only those companies with excellent managements and winning strategies regardless of any potential outcome. Each company is growing revenues, earnings, cash flow and free cash flow such that dividends are increasing, our current yield is near the 10-year Treasury, and each company is buying back stocks. Buffett mentioned that Apple's (NASDAQ:AAPL) buyback offers downside support and lower prices give it the ability to shrink the cap even more. It can be said for each one of our investments too. Again, we are cognizant of the short term while really focusing on earning long-term, outsized gains, which are tax efficient. After all it is above after-tax returns that you can keep that counts most.
Let's take a brief look at what was reported last week that supports our views that the U.S. economy remains very strong while growth overseas continues to weaken. Trump has made his point, so let's move on and make a deal.
1. Growth in the United States has continued very strong in the third quarter and we still expect third-quarter real GNP to begin with a 3 handle. Fourth-quarter growth should be strong too supported by very strong Christmas sales.
August employment data reported was stronger than anticipated: the unemployment rate held at 3.9%; employees added 201,000 jobs; the labor participation rate fell slightly to 62.7%; U-2, the broadest measure of unemployment, fell to 7.4%; and hourly earnings rose a strong 2.9%, a number not hit in 9 years. The wage number spooked the market, but remember that productivity is increasing now by a similar amount, so there is no increase in real wages.
We continue to believe that we are at the beginning of a capital-spending boom that will last many years. Higher capital spending along with technological advances will lead to accelerating productivity gains, which will keep a lid on future inflation. We may not need two more rate hikes this year and next. Hear us, Fed!
The ISM Manufacturing Index hit a 14-year high. That means production is not keeping up with demand, which bodes well for future production and growth.
Finally the House Republicans are moving forward to lock in individual tax cuts set to expire in 2025. We wish that politicians focused on a huge infrastructure program instead, as it is most needed to maintain a global competitive position.
2. Trade remained at the forefront of investors' minds. Talks continue with Canada with dairy appearing to be the last sticking point. Japan is next up after Canada to be followed by the Eurozone.
Trump mentioned on Air Force One Friday that he is preparing tariffs on additional $267 billion of Chinese goods, which would mean that all Chinese imports would be penalized. We are most concerned by near-term disruptions in supply chains more than the incremental costs to the U.S. consumer from higher tariffs.
Don't be fooled by the August trade numbers with China, which widened to a $31.05 billion surplus. Part of it was due to a weaker yuan, nearly 9%, with the majority as a result of pre-buying ahead of potential tariffs. Once/if additional tariffs are enacted, watch the trade deficit with China fall rapidly.
3. China's manufacturing gauge ticked up in August to 51.3, which should have been no surprise once seeing the surge in exports mentioned above. However, we consider this number a false positive and expect it to come down once/if tariffs are enacted. Consumer demand will NOT fully offset less growth in domestic production and exports.
Growth in total employment is going to slow meaningfully as industrial production falters, which will eventually put a dent in long-term consumer demand, which is expected by the government to be the engine of future growth.
We continue to project second-half real growth in China at less than 6.5% and less again in 2019. Trump has put the light on Chinese policies limiting and controlling foreign companies' ability to expand in China. We would not be surprised to see many companies pulling up stakes in China and move elsewhere to supply China and other markets. Other companies will simply not build there and supply China from elsewhere.
China 2025 is at risk. Listen up President Xi Jinping!
4. Eurozone economic growth slowed in the second quarter at an annualized rate of 1.5%. The ECB has little wriggle room to begin its move toward normalization as inflation remains at 2%, penalized by a weak euro and higher energy costs.
The ECB clearly nears some certainty from a trade deal before economic growth will reaccelerate. Let's hope that one is concluded before year-end which is our current view.
The bottom line is that global growth is being held back over fears of escalating trade skirmishes into something much more. Imagine how difficult it is for managements to plan with so much uncertainty in the global economy. It is easiest right now for managements to maintain a conservative bias on spending and hiring plans. But if trade deals are reached, change will occur overnight and the floodgates will open. The question is not if it will occur, but when. Take advantage of market weakness, look over the valley! Invest accordingly!
Investors need to stay above the fray. Buying right is just as important as selling at the opportune time. No one will ring a bell and tell you in advance that trade deals have been concluded. Invest like Buffett, making a decision on each stock based on its long-term fundamentals and valuation. Management is key!
Paix et Prospérité continues to emphasize U.S. domiciled large global banks; industrial and capital goods companies; technology at a fair price to growth; low cost industrial commodity companies generating huge free cash flow; domestic steel and aluminum companies; consumer non-durable and healthcare companies with unit growth with margin improvement; and special situations where internal change will create added value. We do not own bonds; are flat the dollar; and are avoiding companies where the government is in their face. Our average dividend yield is close to the 10-year Treasury bond rate.
So remember to review all the facts; pause, reflect and consider mindset shifts; always look at your asset mix with risk controls; do independent research and…