Where Do We Go From Here?

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by: Bill Ehrman

The media is misinforming you about the real magnitude and impact of tariffs. For instance, a 10% tariff on $200 billion of Chinese goods is a $20 billion surcharge in a U.S economy that is nearly $20 trillion dollars. Just think that the estimated damage from Hurricane Florence is between $38 and $50 billion which will be recovered and spent over the next few years. Also, consumer net worth increased by a whopping $107 trillion in the second quarter alone. Do you really believe that $20 billion in additional tariffs will make a dent our economy? Let’s assume that Trump raises the ante and imposes 10% tariffs on all $500+ billions of Chinese imports. That’s $50 billion or less than 0.003% of our GNP assuming that no goods are sourced elsewhere at lower prices. Really, how worried can you be as tax cuts alone dwarf tariffs?

It is clear that there will be supply chain challenges/disruptions as corporations shift supply lines to China and from China to other regions in the world. Rather than view this as a problem, there will be new winners as China loses global market share. Herein lies China’s dilemma. Don’t believe the Chinese government rhetoric that they can fully offset the loss in exports/production by moving up the supply chain to higher valued goods and/or increase domestic infrastructure spending sufficiently to fully offset the loss of exports to other regions.

We have shifted our portfolio to benefit from these new emerging trends. Demand for industrial commodities and equipment will actually increase which goes against the general belief. We’ve invested accordingly.

The U.S. economy is humming along and it now appears that 3rd quarter GNP growth may exceed 3.5% as both businesses and consumers are in great shape. We expect a strong fourth quarter too with excellent Christmas sales. We expect the Fed to raise rates Wednesday and most likely once again after November elections. But here again don’t worry as the real rate will still be negative which means that it is still simulative. The Fed should pause as we enter 2019 to see if trade conflicts does impact growth and also to see if productivity gains continue to accelerate which will hold down inflationary pressures. We continue to expect the Fed to remain one step behind fearing a slowdown more than an accelerating economy. The U.S economy will remain strong next year too with growth currently projected slightly below 3% led by a further hike in business investment along with continued gains in consumer spending. Normalized inflation will be less than 2% as productivity gains offset wage increases and one-time tariff hikes. S& P earnings are likely to exceed $170 per share in 2019 and the 10-year treasury will breach 3.25% as the yield curve steepens.

China is really caught between a rock and a hard place. While the government wants to exude confidence that their economy can withstand Trump’s trade tariffs/tactics, the truth is that Trump has shone a light for all to see on the inequities in dealing with China and how IP has been stolen by them. Their standing in the world has suffered despite all the money that they are throwing around to other countries to work with them. China 2025 is in jeopardy. Don't believe the rhetoric that China can win a trade war as they have much more to lose than us. Corporations are looking to at least partially shift production from China to supply from elsewhere. There will be new winners as China loses if this trade battle gets extended way beyond our elections. China’s move to reduce import tariffs from other countries won’t do much to stimulate consumer demand if employment growth and wages increases more slowly than currently projected. We do expect a deal to be reached after elections as it is in the self-interest of China both near and longer term. Without a deal, we expect China to grow less than 6.4% for the remainder of this year and even less rapidly next year.

The big news out of the Eurozone last week was that the Brexit talks were failing. Clearly no deal would undermine the single market objective but the long-term impact would be minimal for the rest of the world. The sharp move down in the pound clearly indicates that England would be the near-term loser without a deal. It is far more important the Eurozone strikes a trade deal with the U.S than resolving Brexit. Without a deal, the European economies will go nowhere and the ECB will not able to begin a path toward normalization as so stated. Here again, the U.S is holding all the cards.

It appears that the U.S and Canada are still not able to reach a new trade deal as politics over farm subsidies are overwhelming the positives of a new NAFTA. Canada is the loser here. Notwithstanding, we do expect a deal to be reached after fall elections. Nonetheless, the U.S will move forward with its deal with Mexico.

We were pleased to see that Prime Minister Abe was elected to a new three-year term as ruling party President. Don’t believe that Japan will get closer to China at our expense as that is all about negotiating tactics. The BOJ met last week and reaffirmed extremely low rates and accommodative ease for an extended time. We expect Japan and the U.S to strike a trade deal within the next few months. Don’t forget that our negotiations with North Korea is one of Trump’s bargaining chips here.

Let’s wrap this up.

Despite impeding tariffs, the outlook for global economic growth for the remainder of this year and next is pretty good. The U.S will stand out at the margin as Trump’s economic agenda continues to positively impact our economy. While we do not agree with Trump’s tactics, we agree that there is no better time to focus on trade policy inequities than now as well as protecting our IP. If all tariffs and subsides are reduced, the entire world will benefit. We expect trade deals to be reached with our counterparts over the next three to nine months which will lead to a reacceleration in growth and increases in business/consumer confidence in those areas.

Continue to invest as you look over the valley and take advantage of periodic sharp moves down in the market caused by over-reactions to news snippets or Trump’s foolish tweets. We still believe that the Republicans will lose the House this fall but keep the Senate. Also, we expect Jude Kavanaugh to be appointed to the Supreme Court.

Our portfolios continue to emphasize the financials, capital goods and industrials, technology at a fair price to growth without the government in your face, health care, cable, transportation and special situations where management strategic moves enhance shareholder value. Focus on the best management teams with strategic plans to succeed generating huge cash and free cash flow.

Remember to review all the facts; pause, reflect and consider mindset shifts; look at your asset composition and risk controls; do first hand research and …

Invest Accordingly!