The other area of focus for the financial markets remains energy. I find it interesting to note that low energy prices are really healthier for the global economy than not but somehow rising energy prices today is a sign of stabilization and better times. The market wants for some reason higher prices whereas I would be satisfied if energy prices held in the $35-$45 dollar per barrel range as that would be the best of all worlds. Expect a lot of posturing between now and the Energy conference in Qatari in a few weeks. In truth don't react to what they say but react to what they do and listen very carefully to every word. For instance, the Saudis said Friday that they would freeze production only if Iran and other major producers agree to curb theirs. The key word is CURB, not freeze. I still expect a deal with the major global producers agreeing to freeze production at January levels while permitting Iran to increase their production closer to where it was prior to sanctions. By the way here is some interesting stats: U.S. rig count stands at 450 currently down 578 rigs from a year ago; Canadian rig count stands at 49 down 51 from a year ago; and international rigs stand at 1018 down 257 from a year ago. As I have mentioned last week, I would not be short energy going into the oil producers' conference in a few weeks.
Let's quickly look at key data points in some of the largest regions: China's PMI showed some life in March increasing to 53.8 along with an improvement in the Caxin manufacturing survey which rose to 49.7; Japan remains in a quagmire as negative rates has boosted the yen hurting the competitive ability to export and all PM Abe can do at this juncture is to front load some spending in the fiscal 2016 budget; and then there is the stats out of the Eurozone: the PMI rose to 51.6; bank lending rose 0.9% year over year; consumer prices actually fell 0.1% in March fueling deflationary fears and the Euro rose after dovish comments out of Yellen this week.
I remain favorably inclined toward China and cautious/negative toward Japan and the Eurozone.
Let's put it all in perspective.
The U.S. economy clearly showed some improvement recently and strength in the employment numbers over the last year assures continued expansion in 2016. Remember the consumer is 67% of GNP. Beside the growth in aggregate employment and hourly earnings, energy costs are still down 50% year over year, which benefits consumer disposable income. While a good portion of that gain may go into savings, the majority of it will be spent on goods and services.
Now let's take a look at interest rates. Who would have predicted that the 10-year bond would be below 2% at this point in time with the economy still expanding 2+%. We have lowered our year-end forecast for the 10-year bond to 2.35% from 2.75% previously.
Now let's look at earnings. The dollar has retreated by 4% since year-end against the euro and yen for reasons discussed in previous pieces. A lower dollar means that translation losses for the quarter will most likely be less than anticipated by corporations who made their forecasts three months ago. Lower translation losses means higher reported earnings.
Finally, higher earnings combined with lower interest rates means that our target price for the S&P moves up 5% from our previous forecasts. Naturally companies with a greater composition of their earnings abroad will benefit more than the average S&P Company. Again, we invest in stocks, not the market. First, we want to know first if the wind is behind our backs when investing and that issue is part of our capital allocation and risk control decision process. Then we do intense research searching for the greatest values with a three-year time frame. The largest percentage of our long portfolio is comprised of companies going through positive change, which we expect will result in higher valuations over time. Our shorts have the opposite characteristics of our longs. We remain 95% net long in our portfolios.
So remember to carefully review all the facts, pause to reflect, consider the proper asset allocation and risk controls, finally do in-depth bottom up research on each investment idea and...
Invest Accordingly!
William A. Ehrman is managing partner at Paix et Prosperite LLC.