If I were to tell you that:
• The price of oil would decline beneath $30 dollar a barrel before Iran had economic sanctions lifted from $90 per barrel a year ago increasing global disposable income by over $3 trillion dollars
• Monetary authorities would all maintain easy monetary policies with the supply of capital far outstripping demand for capital
The Fed funds rate was 0.375% and was on hold for now
• Bank earnings, liquidity and capital ratios continue to improve
• The dollar remained strong and capital flows accelerated from abroad helping to push 10 year bond yields below 2.0%
• That there would be 3 million new jobs created in the U.S in 2015 alone with growth in wages of 2.6% year on year
GNP would continue to expand between 2-2.5% led by the consumer without inflationary pressures and profits, x-energy and materials, would continue to increase
• China expanded by over 6.8% in 2015 despite of major headwinds policy changes and would expand by over 6.0% in 2016
• M & A would reach new heights and remains strong
• Private equity valuations and the number of new issues cooled
• There is a change occurring in national elections everywhere away from establishment (look at Taiwan)
• Japan and the Eurozone would maintain excessive monetary ease
• India would continue to grow around 7%
• Bearish sentiment was at a multi month high and the market was selling at 15 times earnings then; and finally,
• Change was happening everywhere for the better.
Then, would you predict a rising stock market, excluding energy and material stocks, or a falling one?
There is a major disconnect between perception and reality in the marketplace today as emotions are overcoming reason. Whose view of the global economy would you consider most relevant and on the mark: Jimmy Dimon, Chairman of JP Morgan Chase, or a market pundit/news commentator?
I suggest that you read for yourself the transcripts of earnings conference calls, as the media has been taking many comments out of context. We participate in at least three conference calls a day during earnings season to gain a true perspective of what is happening in the real world.
This is a period of excessive volatility. It creates tremendous opportunities to capitalize on inefficiencies in the marketplace. Each long investment in our portfolio has superior management and is going through positive change which will lead to more revenue and volume growth; enhanced global competitive positive; higher returns on revenues and capital; increased free cash flow to be used for reinvestment in growth and enhancing shareholder value; and finally each one has a current yield over 3%. But, change does not happen overnight so you need patience and liquidity to let it unfold.
For example, I owned GE for 18 months, purchased at $19 per share, before the marketplace woke up and began to re-evaluate the stock. It took Nelson Peltz's filing to turn the light bulb on for investors. His cost is $27. We are still in the early stages of GE's transformation.
As I say, this is a market of stocks, not a stock market. Unfortunately, electronic/technical/systematic trading takes no prisoners and can override fundamentals over the short-term. Stop thinking as a trader and start thinking as an investor! Don't buy for next quarter's earnings but focus instead on the next few years' volume and revenue growth, competitive position, the mix of business, operating margins and returns, cash flow, especially free cash flow, and valuations. We want multiple ways to win on each investment while protecting our downside too. We are global investors with a global perspective!
Let's take a look at the key data points by region that occurred last week;
The United States takes center stage as the largest economy in the world. It appears that fourth quarter GNP growth slowed significantly from the third quarter and follows a similar pattern that has existed for several years with one strong quarter followed by a weaker one with overall growth remaining in the 2-2.5% range without inflation and led by the consumer.
Jimmy Dimon, Chairman of JPM mentioned on the 4th quarter earnings call last week that he sees continued strong growth by U.S. consumer; GNP growth between 2 and 3%; continued good business demand for loans; continued strong M & A as his book is full; continued improvement in credit quality; maximum write-down for energy loans at $750 million with oil prices around $30 per barrel and max write down exposure to the materials sector of $200 million out of a total loan portfolio of $837 billion and total assets on $2.4 trillion; continued growth in deposits and decent growth oversees. JPM has little exposure to China, which he mentioned is slowing but still showing above average economic growth. Its quite amazing that JPM recorded record earnings despite a relatively flat yield curve. The heads of Citi, PNC, WFC and USB echoed his comments. I was on each call.
Growth in the United States continues to be led by the consumer (over 68% of GNP) as the production sectors, including energy and materials, remain comparatively weak. Data points to reinforce this view include: University of Michigan consumer confidence index rose to a 7 month high of 83.3; the gauge of expectations six months out increased to 85.7; retail sales fell 0.1% in December and rose only 2.1% over the prior year (lower gasoline sales penalized this number); manufacturers sales and shipments fell 2.8% compared to a year ago while inventories rose 1.6% therefore the inventory/sales number rose to 1.32; producer prices fell 0.2% in December but rose 0.1% excluding food and energy; consumer comfort index rose to a 3-month high of 44.2; import prices fell 1.2% in December and 8.2% over the last year and finally the Beige Book was reported last Wednesday which supported an improving labor market, "slight to moderate growth" in consumer spending, weakness in manufacturing penalized by a strong dollar, additional problems in the energy patch and finally little sign of wage pressures and minimal price pressures.
I believe that the U.S economy will expand in the low end of 2-2.5% this year, inflation will run under 1.5% and the Fed will raise rates two times or less in 2016. Policy will remain accommodative. Watch the national elections as the status quo is out and change is in the air for D.C., too. Throw out the bums!
Chinese Premier Li Keqiang confirmed that China's economy grew close to 7.0% in 2015 which is still quite amazing considering all the changes going on to stem past excesses and shift emphasis to consumption/services (40% of the economy) from production/exports (60% of the economy). China finished with over $3 trillion in foreign reserves and is still generating $50-$55 billion in trade surpluses per year. China's consumer and economy has also benefitted greatly from lower energy prices. Change is hard but I applaud their government who has a five-year plan to build a stronger and sounder foundation for the future. The Asian infrastructure bank was launched this week. I expect China to grow at 6-6.5% in 2016. China is on the path towards joining the established global economic leaders with policies to back it up. Did you happen to notice what Haier was willing to pay for GE's appliance business to become a true global competitor? Ten times trailing EBITDA vs. 7 times, which Electrolux had previously offered.
Export growth in the Eurozone and Japan are suffering from changes in global trade patterns and weakness in demand. Both the ECB and BOJ are maintaining incredibly easy monetary policies but there is a limit to what that can accomplish. There is a pressing need for more regulatory and financial reform to stimulate growth in both areas. Did you notice that Germany ran a record budget surplus of $13.14 billion? The government has earmarked $6.5 billion to cover migration related costs. Regulatory, budgetary and financial change is in the air to support and stimulate growth.
Here comes Iran on the global energy markets. Iran complied with the terms of its international agreement to curb nuclear development. Therefore sanctions were lifted on Saturday and $50 billion in frozen cash was released. Iran can begin trading with the rest of the world including selling oil. I believe that much of the recent decline in oil below $30 per barrel factored in Iran selling an incremental 1-1.5 million barrels per day on the marketplace by mid-year 2016. Global production currently exceeds global demand by 1.5 million barrels per day and storage is already full to the brims. It has not helped to have unusually warm weather in parts of the world curbing demand growth.
Industrial commodity prices have continued to weaken, too, in concert with oil, despite reductions in production, capacity and inventory levels. If the world continues to grow even at 2.5-3%, industrial commodity prices will begin to rise as inventory levels are drawn down. I expect dividend cuts even at the strongest companies but that is a positive at this point, not a negative.
Expect many bankruptcies in the energy/industrial commodity and materials markets. The financially strong companies as well as private equity funds will buy these hard assets at 3 to 5 times EBIDTA offering great value and returns on their investment even at these depressed prices as the debt gets extinguished.
The reality is that the outlook for global growth is not all that bleak although it may not reach historical rates of gain. On one hand, the global consumer is the huge beneficiary of lower energy prices and low inflation but on the other hand, those countries/companies that are resource- or production-based will suffer. While price determines value, I like to invest where the wind is at your back which is the U.S. where consumption is nearly 70% of GNP compared to a much lower level in Europe, China, Japan, and most emerging markets. It is very difficult to see a recession in any of the major industrialized countries but growth will stay sub-par until there are regulatory and financial changes to stimulate growth as the most of the gains from monetary ease are behind us and depreciating one's currency is never the answer. Don't let the pundits fool you. A strong dollar is good for many reasons.
Right now the stock markets are being controlled/manipulated by the electronic/systematic technical traders rather than investors. Fear is everywhere and capitulation may have already occurred. It does not help to hear Larry Fink, head of BlackRock, say that the market can decline near term but will increase even more later in the year. That is talk of a trader rather than an investor and argues for passive management over active management.
The bottom line is that I see value everywhere and no recession. If you believe the economy will slow for an extended period of time and won't pick up much as we move through 2016, then buy the global pharmaceuticals and consumer staple stocks. But if you see growth, albeit slow, for an extended period of time, then look at industrials, too, and eventually, some financially strong commodity companies. Banks as a group are just cheap under any scenario. It is amazing that JPM had record earnings with such a flat yield curve and that is very telling. It goes for the other major banks, too.
Volatility, confusion and fear create opportunity. We love it! There is more to say but that is enough for today. Look at the facts and take out all of the emotion before making any decisions. Invest, don't trade.
So remember to review the facts; step back and reflect; consider proper asset allocation; maintain excess liquidity and control risk; do in-depth independent research on each investment and...
Invest Accordingly!
William A. Ehrman is managing partner at Paix et Prosperite LLC. He served as head of the Investment committee at Century Capital Associates, followed by head of investments for Worldwide Equities and Private Equities at the Quantum Fund. He was George Soros’ first partner.