We have discussed the accordion-like movements in U.S. economy for a number of years. One good quarter has been followed by a slower one and vice versa. The financial markets have followed a similar pattern, too. Both the bulls and the bears have been frustrated, the pundits have been one step behind, trading has been a failure, and most managers including hedge funds have performed poorly.
It may surprise you but the economy and financial markets have actually continued to grudgingly move to new highs with fits and starts over the last few years. Most people feel that we have been in a recession and a bear market. The Trump and Sanders supporters would certainly agree and will certainly change the dynamics of this year's Presidential election. The "career" politicians are on the ropes. Change is in the air. It can't get much worse in Washington, can it? We need leadership and the willingness to adapt new policies, as the old ones are outdated and certainly haven't worked for years. Have you been monitoring events in Saudi Arabia? It really is out with the old and in with the new. Bringing Aramco public has major implications for the energy market and M & A activity.
I wrote a blog last Wednesday titled "The Demise of the Market is Greatly Exaggerated," a theme that I wrote about a few months ago, too. I discussed that an overwhelming number of speakers at the Milken and Sohn conferences last week were bearish, market tops are caused by over exuberance, bottoms by excess pessimism, the market was still undervalued and there were many great investment opportunities out there in companies going through positive strategic change. I mentioned that I was not overly ebullient but nonetheless money was to be made on the long side and short side too. I am not a Pollyanna. I fully understand and control the risks, which I weigh against the rewards. My portfolio still has a current yield over 3% and the dividends will continue to increase this year. I finished my blog by saying, "Don't follow the pack!"
Don't follow any one data point but look for an underlying trend. Did you see the markets reaction to a slight, and I mean slight, downtick in economic activity in China last month as reported Tuesday. There was a slight giveback in two economic numbers from a very strong March, which was probably overstated in the first place. It did not stop the commodities markets for reversing course violently. But is that the underlying trend? Not in my opinion! I see the dynamics of supply and demand changing which will assist pricing. It has not hurt that the dollar has remained weak.
The bottom line is that China will grow 6-6.5% this year which is faster than any other major industrial nation except India but the financial and commodity markets are acting as if China was in a recession. China's leadership is on the right path for stable, albeit less, growth than in the past, of around 5.5-6.0% for many more years led by the consumer rather than the producer. I might add the pundits' fear that China would eat through its currency reserves supporting the Yuan has proven false as foreign currency reserves have risen for the second straight month and now total $3.22 trillion while the Yuan has risen vs. the dollar.
Look too, at the initial reaction to "only" a 160,000 gain in April employment." The pundits were quickly predicting that future employment gains will continue to moderate, the economy will remain weak, the fed was out of the picture for the rest of the year and the U.S would be on hold until the elections were over.
There was another side to the employment data: wages accelerated to a 0.3% gain (2.5% year over year), the average workweek expanded to 34.5 hours, more people continue to re-enter the labor force and job opening hit a multi year high.
Don't forget that the U.S economy has added over 3 million jobs over the last year, wages are up, and disposable income is rising as inflation is low. I still believe that the Fed is done for the year as written in a prior blog 'One and Done," the economy will expand by 2-2.5% in 2016 bolstered by the consumer, the 10 year bond will remain below 2.25% for the year, corporate earnings will be higher than previously anticipated due a weaker than projected dollar and the market is statistically undervalued.
The dollar remained weak this past week and is off approximately 6% from its high. A weaker dollar has bolstered commodity prices, especially oil, and will help our trade picture and the U.S economy over the next few months as the markets adjust. A weak dollar is a plus for our economy that needs to be factored in to growth forecasts here as well as the negative impact on some of our trading partners. Remember that you need to think globally and dynamically. The Chinese Yuan has lifted too as it is now part of an international basket of currencies including the euro and yen which has important implications for all markets too.
I still remain cautious on investing in the Eurozone and in Japan. Negative rates have had negative implications across the board and investors are taking risk off which has unfortunately boosted their own currencies penalizing their global competitive position. There is shortage of end demand in the world, not money, therefore there is little that the ECB and BOJ can do to stimulate economic growth, as that needs to be done by the politicians and regulators. While Japan is stuck with huge debt overhangs, which precludes additional spending and lower taxes to stimulate demand, the ECB countries do have the capacity to shift policies. However Germany remains the stumbling block. The truth is that Germany would like to remove Draghi too as President of the ECB.
So where does this leave us?
First and foremost there have been virtually no changes in our core beliefs. One exception is the dollar, which has been weaker than we anticipated at the beginning of the year but we saw the shift with the move to negative rates in Japan and the Eurozone and changed our view accordingly. A weaker dollar boosts U.S multinational earnings and also commodity prices including oil, which are dollar denominated. The second change in our core beliefs was that we covered our energy short over 10 weeks ago when we saw white flags raised by major producers and a large reduction in production in the U.S offsetting increases in production by Iran. The supply/demand for oil had changed and so, our view.
We remain positive on the U.S stock market, as it is statistically undervalued. But we do not buy the market; we buy stocks in companies that are strategically changing to thrive in this slow growth, globally competitive market. And we short those companies unwilling or financially unable to make the right strategic shifts to survive and thrive. Opportunities are everywhere to make money but you need to do the work, maintain excess liquidity and be patient to let events unfold. Ride the trend whichever way it is going. And remember to invest in stocks, not markets as there are differences as you look under the hood.
The political landscape has gotten clear now that Donald Trump is the presumed Republican nominee along with Hillary Clinton on the Democratic side. While I don't agree with most of Bernie Sander's platform, I want to thank him for awakening the consciousness on this country. We need change and we need it badly to grow this economy so that all our citizens can benefit. And I like that the Republican establishment continues to resist Trump as it plays into his hands that politicians' are more concerned with their own interests than the people that they represent.
Change is also abound in Washington which is GREAT!
So remember to review all the facts; step back, pause and reflect; consider the proper asset allocation while controlling risk; do in-depth independent research on each idea and...
William A. Ehrman is managing partner at Paix et Prosperite LLC.