The global economy has been held hostage by trade conflicts, but times may be a changin’: China/U.S. signed Phase 1 of a trade deal last week; the Senate ratified the USMCA moving it to the President’s desk for signature; the EU is moving to avoid a major trade conflict with the U.S. over our major technology companies; and finally, the U.S. and India are negotiating a trade deal which hopefully will be signed when Trump visits India within the next several weeks. We believe that the culmination of all of these trade deals plus aggressive global monetary ease along with fiscal stimulation will lead to an acceleration in the global growth as we move through 2020 and into 2021. It won’t happen overnight but build sequentially.
It has become clear that Trump’s agenda during the election year will not rock the boat, play to his constituency, introduce tax legislation that will benefit the middle/lower classes, and continue to reform healthcare. He probably will attempt another large infrastructure bill as well. But unfortunately, nothing will pass the Democratic House. Finally, we also expect movement on Phase 2 of a trade deal with China before elections that will include reducing tariffs even further. Whew, that is a lot of wind to the back of our economy that will potentially boost business/consumer confidence, accelerate our growth and that of the world, and lead to an acceleration in capital spending which will benefit productivity gains down the road. How can the Democrats counter all of this, win the White House and additional Congressional seats? Won’t happen!
The cards continue to turn up supporting our view that the first half of 2020 will be the low point for global economic growth, after a pause in 2019, with much better days ahead well into 2021. Remember that all of these favorable developments just happened! We are factoring into our forecast that the trade deals with China and Mexico/Canada alone can add .5% to our GNP run rate by the fourth quarter 2020. On the other hand, problems at Boeing (NYSE:BA) clearly will penalize our GNP at least through the first half of this year. Net-net, our GNP real growth will exceed 2% but be a much higher run rate by the fourth quarter 2020.
We now believe that the yield curve will steepen more slowly than we envisioned as growth builds sequentially throughout the year such that the 10-year bond yield will NOT reach 2.5% until sometime in 2021. It also means that the dollar will fall more slowly too, and industrial price increases will accelerate later as well. But, to be a successful investor, you need to look over the valley into the second half of 2020 and beyond.
The bottom line is that the stock market remains in a sweet spot – undervalued with monetary ease everywhere; very low interest rates (zero real rates); inflation staying contained below the target range of all monetary bodies; stock, cash and earnings yield at very attractive levels relative to bonds/cash; and investors underweighted stocks relative to bonds. Our objective for the S&P 500 will most likely come closer to the upper end of our long-standing range of 3,400 to 3,600 as the market multiple penetrates 20 times earnings on the upside which will surprise the experts, including Barron’s Round Table.
We have been somewhat surprised that all boats are rising in the stock market today. We believe that the reason is an acceleration in global growth which benefits economically sensitive stocks while pressuring defensive stocks. This will not occur overnight, rather gradually as we move through 2020 into 2021. We made a shift a few months ago out of defensive stocks into more economically sensitive stocks. This has contributed to our outperformance over the last 6 months. The principle reason for this is that the vast majority of our investments have similar characteristics: strong managements, superior business strategies, exceptional free cash flow generation, above-average dividend yields along with large stock buybacks, and were priced for a recession. Again, look at earnings/cash yields relative to bonds. That’s what we look for in an investment before committing.
Let’s quickly review the most recent data points by region – briefly look in the rear-view mirror before we look ahead though the windshield, once again.
United States: Our economy continues to be supported by the consumer, which, along with government spending, are 85% of our reported GNP. On the other hand, industrial production continues to be weak hurt by the Boeing strike and the desire to reduce inventories into year-end. Specifically, retail sales for November-December rose 4.1%, excluding autos; housing starts rose 16.9%, that’s right, in December; consumer confidence jumped to 99.3 in January; job openings were 6.8 million; and government spending was at record levels as the U.S. deficit topped $1 trillion in 2019. Consumer prices rose an adjusted 0.2% in December and are up only 2.3% from a year ago.
On the other hand, production continued to be weak, dropping 0.3% in December, but fortunately, it accounts for only 10% of GNP. Interestingly, the January 2020 manufacturing business outlook bounced back big time signaling a potential bottom.
Finally, the Beige Book came out last week mentioning that the U.S. economy was on solid footing, reporting continued modest growth. We were especially pleased to read that the U.S. government will start issuing a 20-year bonds in 2020 in a big way, taking advantage of low rates while lengthening its average maturity.
The U.S economy is in fine shape as we enter 2020 with better days ahead.
China: The country not only reported stronger fourth-quarter results than expected, there were meaningful pickups in industrial output which rose 6.9% in December as well as fixed investments and total employment. We continue to believe that relations between the U.S. and China will improve this year that will boost business/consumer sentiment such that their economic growth will be above general expectations. China is finally opening up its doors for foreign companies letting them keep full control. All good!
Clearly, we are more positive on investing in China than we have been for some time.
Eurozone/U.K.: Nothing good yet economically coming out of this region which is the weak sister of the world. German economic growth hit a 6-year low last year at 0.6% as the manufacturing sector entered a clear recession. Britain’s November GDP actually fell 0.3%. We will avoid investing in this region until there are policy changes on fiscal stimulation, trade and regulations.
The U.S. and China are both tails that wag the global economic dog. Since we are optimistic on the two most important economies of the world, we should also be optimistic about the rest of the world, too, as they rely on both markets for growth. Again, the global economy won’t roar overnight, but it is reasonable to assume/invest on the thesis that it will build sequentially over 2020 into 2021. We expect both global growth expectations and earnings estimate to rise as we move through the year above current expectations. It is hard to be pessimistic when all of this growth is happening when inflation/interest rates remain muted as we expect.
Our portfolios continue to emphasize technology, especially the semis: global capital goods, industrials and manufacturing; financials, especially the big U.S. global banks; the credit card companies, especially as they enter China; low cost, cash generating industrial commodity companies; some retailers; agricultural plays and many, many special situations where their intrinsic value far exceeds current value. We do not own bonds as we still expect the yield curve to steepen over time and are no longer long the dollar which may have already peaked.
Remember to review all the facts; pause, reflect and consider mindset shifts; turn off the pundits/experts; look at your asset mix with risk controls; listen to as many company earnings calls as possible; do independent research and…
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.