Monetary policy has passed the point of diminishing returns virtually everywhere in the world except the United States, and possibly China, which both have more room to run. Powell stated it correctly last week after the Fed lowered rates by an additional quarter a point. He said that monetary policy has its limitations and cannot alone change business sentiment/policy/spending, which has turned down, due to trade tensions/conflicts/tariffs. Thank heaven the consumer remains strong. Government actions, including fiscal and regulatory policies, are key ingredients in addition to trade policies that influence business and consumers too.
Don’t blame the monetary authorities for the global economy decelerating toward the weakest growth in a decade. The OECD cuts its most recent growth forecast to only 2.9% this year from 3.2% forecasted four months ago and to 3% in 2020 down from a former forecast of 3.4%. “The global growth outlook has become increasingly fragile and uncertain due to escalating trade tensions.” The OECD acknowledged that the key monetary bodies, including the Fed, ECB, BOJ, and Bank of China as well as others, have continued to ease to shore up demand while urging governments at the same time too boost fiscal stimulus, make trade deals and ease regulations. The OECD concluded that risks remain to the downside especially if there was a deeper slowdown in China and if there was no deal on Brexit.
Before we continue on this topic, we want to offer some comments on the bombing of the Saudi oil fields last weekend. We discussed the incident in our inaugural investment committee webinar last Monday. Here are some of the key facts to keep in mind: the world consumes approximately 100 million barrels per day; approximately 5.7 million barrels went offline due to the bombing; 2.7 million barrels were to be restored quickly, potentially leaving 3 million offline for a few months or 3% of world demand; Saudi Arabia had approximately 200 million barrels in strategic storage; the U.S had 640 million barrels in strategic storage; the U.S imported ONLY 260,000 barrels/day in July from Saudi Arabia, 2019; China imported 1.8 million barrels per day in July from Saudi Arabia; several million incremental production could come online from Russia and other countries in a relatively short time; and oil prices only spiked to levels reached earlier in the year.
We concluded that we would not chase energy stocks and we would add to our positions hit hard on the opening, as this too shall pass. But, we felt that the U.S global energy position had been enhanced and that China would take note of their dependence on Mid-East oil and need to diversify their supply chain, including from the U.S. Ironically, China put a tariff surcharge on U.S energy exports a few months ago. Think about this! Thankfully, all ended well as Saudi Arabia expects production to be fully restored by the end of September. The U.S will be sending troops and equipment to defend the oil fields at the behest of the Saudi government.
We have not altered our view that the U.S remains in an enviable position as our economy is doing well, growing 2% plus, led by the consumer; monetary policy is easing while the Fed has many arrows left in its quiver to ease much further if needed; fiscal policy is highly stimulative; and real incomes are rising as inflation remains low and productivity is increasing. It certainly helps that external money flows into our markets remains strong bolstering the dollar and keeping interest rates much lower than they should be. We were brought up that a strong dollar connoted a strong economy.
We continue to believe that our market remains undervalued selling at a 17 multiple with 10 treasuries yielding 1.72%, the 30-year treasury yielding 2.17%; and bank capital/liquidity ratios are new highs. We recognize the risks out there but still see tremendous value as many great companies selling at less than 10 times earnings generating huge free cash flow and have dividend yields far in excess of the 30- year treasury.
You need to think as an investor!
Let’s look at the most recent data points that support/detract from our view that there is no place like home:
The United States
The U.S economy keeps chugging along with the vast majority of data points supporting continued 2% real growth for the foreseeable future. If not for economic weakness abroad and the potential of escalating trade conflicts, we continue to believe that the Fed did NOT have to cut the funds rate last week. We also believe that if not for huge money flows from abroad that our long-term treasury yield would be closer to 3%.
The Fed meeting and follow-up conference call was really a nonevent. Powell was forthright in acknowledging that the Fed was totally data dependent on all of its future decisions as we live in a VUCA (volatile, uncertain, complex, and ambiguous) global environment where change can occur at any time, so don’t trust long term forecasts. The Fed will act accordingly as the data points dictate. Clearly the Fed is more concerned about potential downside risks to upside blow offs. We agree! The Fed has our backs while also recognizing its limitations to offset trade conflicts.
Some of the stats reported last week include housing starts rose to an annualized rate of 1.36 million units, a twelve-year high; industrial production rose 0.6% in August, much stronger than expected, while the ISM manufacturing index fell to a disappointing 49.1; holiday retail sales were forecasted to climb a strong 5% despite “unprecedented uncertainty;” the Conference Board index of leading indicators remained at a strong 112.reading and existing home sales rose 1.3% in August.
We were pleased to see that Trump granted tariff relief on more than 400 types of Chinese products including parts used for Apple products. We remain hopeful that China and the U.S can make enough progress next month on a trade deal such that additional tariffs now contemplated will be postponed. Remember that Trump needs a strong economy and stock market to get re-elected. His actions on all of this will be telling than his rhetoric and tweets.
China’s economy continues to worsen despite all of the comments from the government to the contrary. Industrial production, retail sales and fixed investment are all rising much less than the government forecasted jeopardizing the magic 6+% growth that the government want us to believe the country will grow this year and next. No surprise to us that China cut the new loan rate for the second month in a row while also freeing up significant bank reserves to be loaned out. No matter what you hear, China needs a deal. Even domestic producers are moving offshore in addition to the tremendous exodus of U.S producers. China 2025 is at risk for sure.
Week after week we report that the European data points are getting worse and worse. Last week was no exception as European auto sales plunged 8.4% in August. German index of economic sentiment was a negative 22.5 in September. Wow! Europe risks a hard Brexit, no trade deal and little fiscal relief. Why invest here?
We were pleased to see that Japan and the U.S finalized a trade deal last week although it really won’t boost either country’s economy that much, if at all. The BOJ held rates steady as we anticipated waiting to see the impact of the upcoming retail tax hike to 10% next month. Key stats for the week include August exports fell 8.2% from a year earlier and core inflation rose only 0.5% in August from a year ago, a 2-year low. Why invest here?
India announced a $20 billion fiscal stimulus plan to boost growth which has been very disappointing so far this year. That’s a good start but far more may be needed as trade is slowing here too big time.
The United States remains in an enviable economic position only enhanced by its newfound importance and strength in the global energy market. We all must thank Boone Pickens who led the charge for U.S energy independence. We remain favorably disposed to the U.S stock market as our economy remains relatively strong without much inflation; you have an accommodative Fed; more liquidity is being created by monetary bodies than needed by the real economy thus boosting the value of risk assets; debt refinancing at up over $300 billion in just 3 weeks lowering interest cost and boosting profits and/or disposable income; the market is selling at around 17 times earnings as it did years ago when interest rates were 4-500 basis points higher; and Trump wants to get re-elected.
Our portfolios continue to invest in technology at a reasonable multiple to growth; cable with content; financials going through positive change; airlines generating huge free flow; consumer product companies selling at reasonable valuations to growth; retail going through positive change including those housing related; low cost, free cash flow capital goods, industrial commodity and machinery companies and many special situations. We own no bonds and are flat the dollar.
Remember to review all the facts; pause, reflect and consider mindset shifts; analyze your asset mix with risk controls; do independent research and… Invest Accordingly!
Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.