Events of the week support our view that global economic growth may indeed accelerate later in the year as the BOJ, Bank of China, ECB and the Fed pushed panic buttons responding to deteriorating growth and weak inflation. Simultaneously, we expect trade negotiations to heat up with some resolutions reached during the year. Finally, we are looking for fiscal policy changes to stimulate growth too.
It is irrefutable that global growth is in a synchronous slowdown with inflationary pressures ebbing. It is ironic that the Davos participants were so downbeat this year after being so upbeat and wrong last year. Maybe these experts/pundits are contrary indicators, too, like all the commentators that we listen to day in and day out. But the truth is that bad news is good news as it is a call to action literally across the world.
Wherever we look, change is in the air. Let's start first with all the key monetary authorities:
- The Fed embarked on a plan to normalize rates well over two years ago raising the Fed funds rate multiple times and also by running off its portfolio by now $50 billion/per month. While the Fed constantly said and believed that its policy was still accommodative, it clearly was not by the fourth quarter of 2018 as the yield curve flattened, the economy slowed and business/consumer sentiment fell portending more weakness ahead. The financial markets went into free fall concerned that the Fed would throw us into a recession by the end of this year. Fortunately, the Fed finally woke up a month ago and signaled that it would pause on any additional rate hikes but it did not alter its policy of reducing its bond portfolio by $50 billion/month which was also restrictive. The Fed went half-way but it is was enough such that the financial markets have rallied no longer fearing a recession in 2019. Now, it appears that the Fed will consider this week ending its bond portfolio runoff earlier than previously assumed. That would be great news as the Fed would be 100% out of the way such that business/consumer sentiment and spending would improve; economic growth would be extended out further than currently anticipated; the yield curve may steepen and earnings will continue to increase longer boosting stock prices.
- The BOJ has not needed to adjusted its policy as it remains very accommodative but it did lower its inflation forecast once again. The BOJ still believes that inflation will pick up down the road expecting wages and prices to increase. We disagree for all the reasons we have stated week after week. Global competition, technology and the rise of disruptors industry by industry will keep a lid on global inflation, including in Japan, for years to come especially if trade deals are reached lowering tariffs and subsidies. We see no change in the BOJ overly accommodative policy for years to come while we do expect government stimulus programs to support higher growth.
- The ECB met last week. While not changing its monetary policy yet, it mentioned that it no longer expected to begin raising rates later this year. Here too, the ECB acknowledged that economic growth and inflation will come in lower than expected in 2019 and 2020. ECB President Mario Draghi suggested that the next policy move, most likely in March, will be to ease further. Here again, a 180 degree change in policy. We also look for fiscal policy changes throughout Europe starting in Germany to stimulate growth.
- The Bank of China and the Chinese government are throwing everything it can to stimulate its economy. Fourth quarter economic growth slowed to its lowest rate in 30 years coming in at 6.4%. Inflation is much less than forecasted, too. Consumer demand and industrial production continue to slow rapidly as we enter 2019 such that we expect the Chinese economy to grow near or less than 6% for the year which would lead to rising unemployment rates. China really needs a trade deal as corporations continue to shift capacity out of China to other Asian countries.
What a huge shift in global monetary policy in just a few short months!
We are also anticipating that trade deals will be reached and fiscal policy changes will be adopted to stimulate global economic growth. While we do not expect an immediate acceleration in growth, we do expect growth to bottom out by mid-year and accelerate into 2020. As long as global monetary policy gets more accommodative as it now appears, economic growth will stabilize at lower levels reducing recessionary risks and rising fears of deflation.
It is important to watch how the trade talks progress next week between China and the United States. While we continue to believe that there will be no quick resolution between our two countries, we do expect the gap to be significantly narrowed such that the 90-day cooling off period will be extended another 90 days. It is clear that big differences remain over IP and China 2025 rather than simply trade imbalances which can be resolved rather easily.
At the same time, we are watching closely our trade negotiations with the ECB and Japan. We believe that reaching a deal with the ECB is more complicated than generally assumed but it is also clear that the ECB desperately needs a deal as business/consumer confidence is falling fast along with its economy. We are confident that a deal with Japan will be struck this year.
The bottom line is that a shift in global monetary policy will stabilize global growth at a minimum significantly lowering recessionary risks which will be good for financial markets. If and when trade deals are reached, we fully expect an acceleration in global growth that can last for a few years.
We significantly reduced our cash component and hedges over the last few weeks as we believe that the market is undervalued with the Fed out of the way. We fully expect that economic growth will continue at above average rates in 2019 into 2020; interest rates will stay contained as long as the Fed funds rate is not lowered; and corporate profits will surprise on the upside. While not fully factored into our forecasts, we believe that the odds of multiple trade deals have risen as the economic and political risks, if not, are unfathomable for foreign countries. Once trade deals are reached, global economic growth will accelerate.
The composition of our portfolios has shifted over the last few weeks from defensive stocks to those that will benefit from continued economic growth selling at recession valuations. We own healthcare companies with above average unit growth benefitting from new products; industrial and capital goods companies; industrial commodity companies; technology at a fair price to growth; domestic steel; and many special situations. The average dividend yield on our portfolio exceeds the 10-year treasury rate. We are flat the dollar although we believe that it has peaked; expect commodity prices to rise; own no bonds as we expect the yield curve to steepen later this year; and recommend selling inflated private equity deals and real estate.
Review all the facts; pause, reflect and consider mindset shifts; analyze your asset mix with risk controls; do independent research… and Invest Accordingly!