Whatever the G-20 partners are doing to stimulate growth clearly is not working. So, it is time to push back against the status quo as attempted by Prime Minister Abe at the meeting of the G-7 leaders last week and by Presidential nominee Donald Trump and Democratic hopeful Bernie Sanders.
Is there anyone who disagrees that the global economy is stuck in a rut and monetary policy has done about all in its power to jump-start the worldwide economies but has failed? So, what's next? Either maintain the status quo or effect real fiscal, regulatory and tax policy changes coordinated across the globe to right the ship.
There is a reason that populism is on the rise here and abroad. Our politicians have failed us by being more concerned about political infighting and themselves rather than implementing real and substantive policy changes that would help the nation.
Negative interest rates were considered radical, weren't they? Let's give the BOJ and ECB some credit for thinking out of the box although it is not working as businesses and consumers both just don't trust the system and have hunkered down instead.
The market pundits had it wrong, yet once again, last week: the stock market had its best performance in 3 months; the slope of the yield curve rose; the dollar strengthened; gold, which everyone loves, fell dramatically and energy prices rose above $50/barrel. The markets clearly climbed a wall of worry!
So what's next? Let's look at the challenges the financial markets face and see if there are any changes in our global core beliefs, asset allocation, risk controls and stock selection.
The world leaders met in Japan this past week to discuss the global political, economic and financial challenges that we all face. Unfortunately, once again the same old things were repeated but there was little unity, if any, on implementing solutions, which are as obvious as the problems.
Prime Minister Abe of Japan called for joint stimulus by the G-7 members warning that risks were rising for the global economy but unfortunately G-7 members concluded that each country had its own economic agenda and would act independently. Not surprisingly, Germany was the most vocal against any action. All members agreed that Brexit was a bad thing-but for whom? Bottom line; don't count on any coordinated action to stimulate growth but rather watch country by country for any change. The G-7 kicked the can down the road once again!
Economic data out of the U.S continued to support a bounce-back in economic growth in the second quarter: consumer sentiment rose to 94.7, an 11 month high; pending home sales rose to a 10-year high while inventory of new homes fell to a one year low; durable goods orders rose 3.4% in April boosted by transportation and finally house prices are up nearly 6% in the last year boosting the wealth index.
The most important number to come out last week was that corporate profits were revised upwards in the first quarter from being down to now up1.8% after tax without inventory and capital consumption adjustments. After-tax personal incomes adjusted for inflation was also revised upward to a 4 percent annualized gain and the savings rate hit 5.7%, the highest level in 4 years. We boosted our forecast for S & P earnings by 6% over a month ago due to a weaker than anticipated dollar and better operating results than earlier estimated. Looks good!
The U.S, led by its consumer, truly is the engine of global growth at the moment. It remains clear that second quarter GNP will bounce back to at least a 2.5% gain from a slightly revised lower improvement of 0.8% in the first quarter. Economic growth of 2+% remains in the cards for 2016.
It was not surprising that Janet Yellen confirmed in a panel discussion at Harvard this past Friday that the Fed could raise rates "in the coming months." What else would you expect her to say-that higher rates are totally off the table? We need a mindset change that a return to normalcy is a good thing and reflects that the economy has healed and is on solid footing once again.
Economic news was scant in the rest of the world last week. It is clear that economic growth in the Eurozone has slowed down from its rate of gain in the first quarter as evidenced by a weak April PMI which fell to a 16 month low of 52.9. However, consumer confidence rose to -5.7, yes that is a negative sign. France's President Holland has met with stiff resistance by the unions to any changes in the labor laws, which are sorely needed. No surprise here! China appears set for a Fed rate increase and permitted the Yuan to weaken to its lowest level in 5 years although it is still above the level hit this past January. And finally, Japanese Prime Minister Abe hinted that he would delay the sales tax increase set for next year by another one to three years and also add additional fiscal stimulus. Good decision! Remember that an economy that is expanding will increase government revenues and reduce deficits over time. That is a far better strategy at this moment than no growth and reducing deficits by cutting spending.
It is ironic how most experts and "pundits" are no longer bearish on the price of energy. How fast sentiment changes! It's like the weather. We covered our 3-year energy short this past January when oil was under $30 per barrel. Unfortunately, we never went long it as we felt that the oversupply imbalances would continue for most of the year and reach balance next year and risk/reward necessitated our move. However, supply disruptions and a faster decline in U.S production has shifted the near term fundamentals and oil this past week rose past $50 per barrel. Saudi Arabia is taking victory laps as its strategy to increase/hold production would lead to a further price break, thereby reducing production in other regions where it became uneconomic to continue. Just look at a reduction in U.S production to less than 9 million barrels/day from 9.7 million a year ago. However this shut-in production becomes economic again once oil prices exceed $55/barrel. Hence that is our top range for energy prices for the next year. U.S crude imports are averaging 7.6 million barrels/day, up 10.9% vs. last year.
Hilary Clinton clearly had a setback last week when the State Department Inspector General's Report came out and said that she had knowingly violated department policies on emails, was obsessive and refused to be interviewed during the investigation. On the other hand, Presumptive Republican nominee Donald Trump is out there talking about less government regulation in the energy area. Energy independence must be a goal of our country. Excessive regulation and red tape clearly has held back our economy. Economic growth creates jobs, higher wages and prosperity for all of us. Trump has this right. Bravo!
Let's wrap this up.
The stock market remains statistically undervalued by 6%; monetary policy here and abroad remains easy thereby boosting the value of financial assets over hard assets; the 10 year bond yields remain below 2% here and lower abroad which supports a stronger dollar over time; M & A activity remains very strong as corporations shift strategies to excel in a slow-growth highly competitive global economy was evidenced by the Computer Sciences/HP deal and Bayer's attempted acquisition of Monsanto; private equity valuations have declined and IPO activity remains non-existent which clearly indicates no investor exuberance; a conservative mindset remains at all levels which will extend the economic cycle longer than believed although rates of growth will remain slow by historical standards; corporate profits will continue to surprise on the upside and the bear market in energy prices is over but the increase will be limited as shut-in production begins to come on stream as oil rises above $55 per barrel; opportunities both on the long and short side of all markets here and abroad are pervasive as CHANGE IS EVERYWHERE.
Hedge funds are not dead as an asset class. Management of a company in any industry, including wealth management, who underperforms for an extended period should be questioned and possibly removed. There are many great hedge fund managers but I do question those that have grown too large to perform simply due to the rules of compounding.
So remember to review all of the facts; step back, pause and reflect; decide on your proper asset allocation with risk controls; understand changes in mindset at all levels; do in-depth, independent research on each investment and...
William A. Ehrman is managing partner at Paix et Prosperite LLC.