The Global Economy Needs Some Certainty

The global economy will remain stuck in the mud longer- term UNLESS there are real certainties on trade, fiscal policies, Brexit, regulatory changes and the U.S Presidential elections. While the financial markets will breathe a sigh of relief and rally big time when/if Phase 1 of a trade deal is reached between China and the United States which we still expect, we doubt whether businesses and consumers will open their pockets in a meaningful way without long term solutions rather than band aids that kick the real problems down the road for another day. On the other hand, we remain convinced that monetary policy everywhere will remain overly accommodative as long as inflationary pressures remain muted which we expect for many years to come due to global competitive pressures, technological advances and the ever-increasing rise of disruptors in all sectors. Therefore, investors will have few options but to keep moving further out on the risk curve. 

We continue to emphasize investing in the United States over foreign markets as our economy is dominated big time by consumer and government spending whereas other regions are much more reliant on production/exports which are being penalized by trade conflicts and the lack of fiscal stimulus. When there were fears that Phase 1 of a trade deal was in jeopardy last week, did you notice which market outperformed all others- the USA. 

Let’s take a look at what occurred last week in the areas most in focus by the financial markets: trade, monetary policy, Brexit and Trump.

Trade: While rumors were running rampant that Phase 1 of a trade deal was in jeopardy last week, both China and the U.S went out of their way to dispel/dispute them commenting that both parties were working well together and hoped to conclude Phase 1 of a trade deal in a relatively short time frame. It was interesting to note that Congress passed legislation essentially supporting the rights of the protestors in Hong Kong which China did not like one bit while Trump’s administration granted Huawei more time to work with U.S companies as a sign of good faith before totally blacklisting.  It is important to note that Trump plans to hold off signing the Hong Kong legislation using it as a bargaining chip in the trade talks. 

We want to again state emphatically that China needs a trade deal much more than the U.S. Their economy is rapidly decelerating and inflation is rising due to much higher food costs while companies continue to move their supply lines elsewhere jeopardizing China 2025. On the other hand, Trump realizes that he has a winning hand as our economy is moving along at a 2% clip with low inflation while China/its producers are eating virtually all of the tariffs fearing loss of business. Our government collected only $7 bullion last month from all the tariffs now in place, which adds up to an $84 billion annualized in a $21+ trillion economy or only .004% penalty…not too much. 

Apple’s Tim Cook has provided Trump with a real solution on tariffs while “Making America Great Again.” Trump should offer companies a 12-18-month waiver on any tariffs if they commit to build new plants in the U.S shifting their supply chain from China. For example, Apple’s new plant in Austin will cost initially $1 billion and hire potentially 15,000 employees over the next few years while displacing Chinese production. Sounds like a win/win for the U.S while a total loss for China. Imagine the benefits to our economy if this is the model that Trump uses moving forward! 

Monetary Policy: The Beige Book came out last week with few, if any, surprises. The Fed is on hold as RISKS to the U.S economy are “elevated’ as the “outlook for global economic growth and international trade were still significant which would weigh down the domestic economy.” The Fed is on hold UNLESS there is a material change in their economic outlook. Global uncertainty here and abroad has caused corporations to hold back on spending. The Fed also mentioned their commitment to buy back $60 billion/month of treasuries expanding their balance sheet which, by the way, is additional monetary ease. Interestingly, the Fed added over $103 billion to the system last week. 

Christine Lagarde gave her first public speech last week as the new head of the ECB. She called on European governments to boost innovation and growth with higher rates of public investment as rising trade barriers triggered by the US/China trade war should serve as a warning to European governments to build a stronger internal market less reliant on foreign trade. Germany clearly has the most to lose from a reduction in foreign trade and must take the lead by increasing its domestic spending in a major way and encourage/permit other countries in the Eurozone to do the same. 

Finally, the Bank of China lowered key rates last week to dispel fears that higher inflation would cause them not to ease further to bolster their domestic economy. 

Global monetary policy will remain unusually accommodative for a very long-time due to below trend growth with minimal inflationary pressures. Investors will continue to move out on the risk curve which will benefit stocks over incredibly low interest rate bonds/cash equivalents. 

Brexit: We continue to doubt that there will be hard Brexit the end of January as both the Eurozone and British economies cannot afford another leg down in growth that clearly would take place without a deal. The British vote takes place now in less than 3 weeks. 

Trump: It is reinforced each day that the economy and stock market is how Trump gauges his success/failure such that we are convinced that he will not shoot himself in the head by making  foolish moves without  alternate plans ready to go to bolster his chances for reelection. Apple head, Tim Cook, has turned into a surprisingly ally and appears to be giving good advice on how best to deal with tariffs that would strengthen America and set off a domestic spending boom. It now appears to us that Biden will be the Democratic nominee as Warren/Sander’s policies have hurt their party already.

While we still expect China/US to reach a Phase 1 of a trade deal, we have become less concerned if one is not reached as tariffs have not really filtered down to the consumer nearly as much as assumed and has clearly hurt China much more than us as companies shift their supply lines at an accelerating rate. China needs a deal and soon. The United States economy and stock market remain the best house of the block with far less risk than investing abroad. We still expect the global economy to perform better next year than this year as all the monetary ease kicks in and we pass the one-year anniversary of tariffs making year over year comparisons easier. 

Let’s take a brief looking at the data points that were reported last week that support/detract from our view that the U.S is doing just fine while the rest of the world remains stuck in the mud.  We DO NOT expect to see real long-lasting improvement in the global economy WITHOUT real certainty on trade, fiscal policy, Brexit and regulatory reforms. Notwithstanding global growth will be better next year than in 2019.

The USA

The vast majority of economic data points reported last week showed surprising strength: the composite PMI came in at 51.9 versus an expectation of 51.2 which was reported last month; the actual Manufacturing PMI hit 52.2 vs 51.5; the Services PMI was 51.6 vs 51.0; the Index of Consumer Sentiment rose to 96.8 from 95.5; the index of Consumer Expectations increased to 87.3 from 84.2; the Conference Board of Leading Indicators was 111.7; Coincident Indicators were 106.5 while lagging Indicators increased to 108.1; and finally, existing Home sales ran at an annualized rate of 5.460 million while building permits increased 5.0% from September to a seasonally adjusted 1.461 million units.  Pretty good numbers for sure!

While we have mentioned week after week about the huge amount of added Fed fiscal stimulus, we need to add that states have increased their spending at the fastest rate since the end of the Great Recession. State budgets have swelled to about $2.1 trillion, up nearly 4% from a year ago. 

Finally, we want to mention that the huge shrink in stock  outstanding continues at a torrid pace. Stock buybacks is estimated at $570 billion next year down from an estimated $670 billion this year and $748 billion in 2018. That adds up to nearly 7% of all stocks retired in just 3 years. WOW!

China

The Chinese economy continues to decelerate at an alarming pace as production, investment and consumption are all weakening while inflation is accelerating. Don’t believe that China will be fine without a trade deal as no other country/region consumes like us. Trump really does have them if he plays his cards right and offer companies a 12-18 tariff waiver if they build here.

The Eurozone/Britain

Both economies are continuing to slow down without any turn in sight. When will Germany finally blink and use their financial strength to ease fiscally and permit other countries in the region to do the same? Brexit must be solved or kicked down the road as a hard Brexit would cause another leg down economically throughout the region. Clearly any trade deals will be viewed positively but we need long term certainty on many fronts before we declare an “All clear.”

Japan

Japan’s exports fell at their fastest pace in three years in October threatening to tip their economy into a recession. Exports fell 9.2% year over year while imports sank 14.8%. The country, interestingly, is still running a trade surplus. Japan’ lower house, ratified the limited trade deal with the U.S last week. Why invest here?

Investment Conclusions

We have not shifted our view that our market remains undervalued as the US economy is in fine shape; corporate earnings are better than expected; interest rates will remain surprisingly low for years to come as low inflation is NOT transitory; and bank capital/liquidity ratios are really strong. Even though the market has had a strong run of late, the average investor remains underweighted equities and still over weighted in bonds.

Our big change in view over the last few weeks is that we have become more confident that tariffs have not and will not stop the US economy from growing. Phase 1 of a trade deal will certainly lead to higher stock prices near-term but IS NOT the long-term solution for what ails the global economy. Consumers/Businesses need certainty that trade deals are here to stay so they can plan accordingly with confidence that is sorely missing today. The U.S is in an enviable position to be dominated by consumer and fiscal spending whereas the vast majority of the industrialized world depends on production/trade. Notwithstanding, we expect global growth to be stronger next year as monetary ease kicks in and we pass the one-year anniversary of trade conflicts. 

Our portfolios continue to emphasize technology including the semis; global industrials, machinery and capital goods companies domiciled here; financials; cable with content; some retail stocks like TGT which have benefitted from new/innovative management; low cost industrial commodity companies with strong cash flow and above average rising dividends/buybacks; and many special situations where we expect managements to close the gap between current stock prices and their intrinsic values. We own no bonds and are flat the dollar.

Happy Thanksgiving to all. We have so much to be grateful for. 

The weekly Investment Committee webinar will be held on Monday November 25th at 8:30 a.m. Eastern Standard Time. You can join by typing https://zoom.us/j/9179217852 into your browser. 

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

Invest Accordingly!

Bill Ehrman

Paix et Prospérité LLC