Fears of an economic slowdown or worse have all but gone away over the last few weeks as the latest key data points indicate that the U.S economy is on stronger footing-stronger than most of the pundits expected.  Growth has begun to rebound from a weak fourth quarter and beginning of the year. 

The U.S economy appears to have repeated its pattern of the last few years of advancing strongly only to be followed by a period of subpar growth only to be followed by another period of stronger growth. A mindset shift appears underway as the glass now seems half full from half empty. This shift has had a profound impact on investors who have gone long economically sensitive stocks, covered industrial commodity and energy stocks and added to their overall stock exposure.

Fortunately, for Paix et Prospérité investors, we made these changes a few weeks ago as anyone who has been reading our blogs can attest. Our performance has far outperformed all indexes while still remaining approximately 94% net long. Last week I presented at the "Best Ideas" conference hosted by Investipedia and Craig Kaufman. There I discussed many of the themes that I have been writing about over the last year including:

1.     You need to have a true global perspective with a systems theory approach to investing; monitoring the key economic, financial and political variables but equally as important, understanding the interdependencies-both internal and external on all the global economies and markets.

2.     You need to have and continually recheck your core investing beliefs to provide and maintain a strong compass for investing

3.     You need to control risk and maintain excess liquidity at all times

4.     You need to do independent in-depth research on each investment for yourself.

5.     You need patience to let situations unfold whilst monitoring them closely to see if they remain on course or not and adjust your investment accordingly in light of this.

For those of you who missed the conference I also discussed how the investor and allocators must change many of their past practices such as:

1.     Their need to engage a global investor for each asset class rather than a regional one.

2.     Their need to pay more attention to the CIO and the structure of the investment team rather than checking the boxes. For instance, Paix et Prospérité has outsourced almost all of the mid-and back-office investing rather than on administration.

3.     They should consider separate managed accounts if the assets are large enough rather than being part of a fund. There are a multitude of reasons why that favor the investor and also fare well for the fund manager, too.

4.     Their need to think as an investor with a time horizon of 1-3 years.

5.     They should consider a small hurdle rather before an incentive fee kicks in with a high water mark.

I was surprised by how many of the investors have an arcane and fixed mindset looking for a quick gain rather than thinking as a true investor. Wealth is created by compounding returns over time and controlling risk each day.  I have compared our strategy to that of a master chess player in that we think 3 or 4 moves ahead while being cognizant of what's right in front of us.

At the conference I was asked for a single best idea. There is no one idea that trumps the mix of proper asset allocation, portfolio structure, and a portfolio of best ideas that leads to outperformance.

So, lets go back and review what happened last week to cause this shift in mindsets and big rallies in global stocks while the bond markets faltered.

The biggest change in perception was toward more growth than generally believed in the United States. I recently had written that conditions were improving as we were moving through the winter and I was not adjusting my forecast for 2-2.5% GNP growth for 2016.

The key event supporting more growth was the February jobs report on Friday: 242,000 new jobs were added; the unemployment rate held at 4.9%; revisions added 30,000 jobs to December and January than previously reported; the average workweek fell by 0.2 hours to 34.4 hours; the labor participation rate rose to 62.9; the 12-month average for wage gains was 223,000 jobs; average hourly earnings DROPPED by 0.1% and are up 2.2% over the last year and over 500,000 people have re-entered the workforce over the last few months. The bottom line is that nearly 3 million new jobs have been created over the last year supporting the economy/consumer spending and wage gains have been minimal meaning few, if any, inflationary pressures.

The Fed Beige Book came out on Wednesday, which indicated that a majority of regions reported an expansion in economic activity led by relatively strong consumer spending supported by labor growth and modest wage gains. Weakness persisted in the energy patch and exports.

Other key data points included: the trade deficit widened to $45.7 billion as exports fell 2.1% from the prior month; the consumer comfort index fell to 43.6 in February while the index to measure buying intentions declined to 39.9; the ISM non-manufactures index fell to 54.3; factory orders rose a surprisingly 1.6% in January while unfilled orders rose 0.1%; new orders rose for manufactured durable goods rose by 4.7% and shipments by 2.0%; productivity decreased by a seasonally adjusted 2.2% in the fourth quarter as output rose by 1% while hours increased by 3.2%; the market U.S service business activity index fell to 49.7 in February while the composite index for output held at 50.0; construction spending rose by 1.5% in January; the small business growth index rose to 100.75, a twelve month high and auto sales surged to an annualized rate over 17.5 million units in February.

Overall we see no reason to change our forecast for the year.

There was a lot of news out of China this past weekend as China's National People's Congress opened its annual session yesterday beginning with a speech by Premier Li Keqiang. Key comments included: targeted growth of between 6.5-7% for 2016; targeted CPI of around 3.0%; M2 target growth of 13%; a budget deficit of 2% of GDP; monetary policy will used to maintain reasonable liquidity; a proactive fiscal policy; a stable yuan; as part of an international basket of currencies; deeper reforms of the financial sector; added reforms of the stock and bond markets; crackdown on lawful activities in the securities and future markets; ensure no systematic or regional financial risks escalate; develop internet finance; develop private banks; growth in social financing of 13%;  create 10 million new jobs; reform state owned firms; increase subsidies for laid off employees; address issue of zombie firms using mergers, reorganizations, bankruptcies and debt restructuring and "innovation is the primary force for development...we should expand major infrastructure projects...and we will promote greater use of Chinese equipment and services in international markets."

Finally, is was estimated that retail sales of consumer goods will increase 11% in 2016; fixed investment will increase by 10.5% in 2016; and direct investment in China will reach $128 billion this year. China will lay off 5-6 million state workers over the next few years in inefficient industries like coal, steel and other commodities sectors that are non-productive.

I applaud China for having an operating plan for the next several years. While transitioning its economy to be more consumer-based and market-oriented, China is at the same time reducing its dependence on exports and closing down inefficient, non-productive assets. I have confidence that China will continue on its path growing by 6-6.5% a year which is still incredible considering the size of its economy. Patience is needed, as there will bumps and stumbles along the way. Don't bet against China!

Economic data points out of the Eurozone continue to be disappointing with growth below previous forecasts and deflationary pressures still apparent.  Private sector growth in Germany, France and England hit multi month lows in February as manufacturing has virtually stood still and services have weakened too. Consumer prices actually DECLINED by 0.2% in February, which is just another catalyst for ECB action later this month while Euro zone factory growth index dropped to 51.2, a one-year low.

Again, monetary policy is not the cure that all are still hoping for and there is a great need for coordinated financial, regulatory and tax changes to stimulate demand.

The outlook for Japan and India is quite different. I remain pessimistic on the prospects for Japan, as monetary policy has done about all it can do and the government is still constrained by large budget deficits and debt. Fourth quarter GNP actually declined by 1.5% and consumer spending and external demand remain weaker than anticipated. I still doubt whether the government will raise retail taxes later this month as many still assume. The strong yen has not helped things for sure. India, on the other hand, continues to do quite well and the government is projecting a budget deficit of only 3.5% of GNP for the year starting April 1, which is an eight-year low. India continues to shine bright as a place to invest for the next several years.

Trading in the energy and industrial commodities markets continue to confound the pundits as supply in most cases is still outstripping demand. I wrote over 6 weeks ago that the bottom in industrial commodity prices was getting close as producers, large and small, were cutting current production and future spending plans to bring supply into balance with demand and one could project actual deficits if demand continued to grow in future years. I suggested waiting for dividend cuts by the strongest and lowest cost players as that would be the last shoe to drop--and it has occurred, so we acted accordingly. The stocks have risen by 30% over the last two weeks. It is just the beginning if our thesis holds out as we move to actual supply/demand deficits later this year and next. On the other hand, the supply/demand characteristics for oil remains bleak as OPEC refused to cut production while Iran is on its way to increase its production by 1 million barrels or so by mid year now that sanctions have been lifted. It is estimated that U.S crude production will fall by 700,000 barrels per day in 2016 which means that the energy market will still l remain in excess supply relative to demand. So why have prices firmed? As I mentioned four weeks ago when I covered my energy shorts, being short energy is a crowded trade and most of the price declines are behind us so why keep the exposure. The risks to some sort of a production deal do not warrant the short position at this time. I made my money!

So where does all of this leave us and are there any changes in our core beliefs to warrant a change in our asset allocation, net exposure and liquidity. The short answer is "No." The biggest change in the last few weeks has been in the mindset of investors who now see the glass half full from half empty. I want to reiterate that the markets are undervalued based on fundamentals but market psychology is tricky especially during a Presidential election year. The Republicans are pulling out all stops to bring down Trump. You may ask why and the simple answer for me is that they cannot control him. Ironically, their actions may be the very thing that gets him the nomination. The electorate is anti-establishment. Even Hillary Clinton, who is clearly part of the establishment, is having surprising difficulty stopping Bernie Sanders. Truthfully none of the candidates excite me and the status quo is no longer acceptable. Change is needed along with positive actions to stimulate growth.

In closing, remember to review all the facts, step back and take a deep pause, consider proper asset allocation and risk controls, do in-depth research on each idea as change offers great opportunities to profit on both the long and short sides of the market and ...

Invest Accordingly!

William A. Ehrman is managing partner at Paix et Prosperite LLC.