Investment Management

Rude Health …

Economically, the US is in rude health. Manufacturers are very busy as seen in Chart 1. The Eurozone is also “chuggin’ along” – just not at as rapid a pace.

The service economies in America and in the Eurozone are expanding smartly (i.e. a score over 50 means expansion).

Manufacturing activity at current levels is usually associated with GDP (Gross Domestic Product) growth of around 4%.

Corporate profits as a percentage of US GDP have rarely been higher in the last 60 years.

Bloomberg (publisher of Business Week magazine) produces a financial conditions index, incorporating a variety of market-based indicators. This demonstrates, from a financial perspective, that financial conditions are healthy – and in fact have rarely been better.

Lastly, the National Federation of Independent Business small business optimism index rose to its highest level in August since tracking began in 1974, exceeding the September 1983 record, with a print of 108.8. Small business, the largest employer in America, is optimistic. Moreover, small businesses are hiring and investing in capital equipment.

Company earnings have been surprisingly strong – exceeding Wall Street estimates through the first half of 2018. We are expecting another good quarter of corporate results in Q3, which will further underpin market valuations.

UNINTENDED CONSEQUENCES (WE SUPPOSE???)
In the name of national security, the Trump Administration imposed tariffs on imports of steel and aluminum. The origin of the metals – from friend or adversary – does not matter. Steel imports from Canada and the EU will be taxed. Aluminum purchases from Russia and Canada will be taxed. These tariffs were ostensibly designed to reinvigorate industries which have dramatically declined over the years for a host of reasons – mainly economic and technological. Because of the new tariffs, a US “price umbrella” has been created, which has made the remaining US steel and aluminum operations increasingly profitable. This newfound profitability was meant to encourage industry expansion – starting new smelters and hiring new workers. Those goals might be interrupted by the steel workers who are now threatening to strike unless they get a share of the tariff gains. In short, the workers want a permanent wage share of what might/should be a temporary tariff/tax gain. If labor is successful, costs will rise, wage inflation will be stoked, and company profit margins will decline, especially if the tariff goes away. Profit margins decline and perhaps the companies are back to where they started because the laws of market economics ultimately rule. We are not sure that this is what the administration had in mind when they initiated this tariff. So, we put this under “Unintended Consequences”.

THERE IS AGREEMENT ON ONE THING……
Across the spectrum of liberal to conservative economic thinking, authorities generally believe that tariffs are counterproductive. They are artificial barriers to market forces which impede the free flow of commerce. Politicians impose them to make political points, under the guise of trying to protect some industry or to help some group. But these political/economic artifices disrupt markets, creating unintended instances as outlined above. Today, we have major US corporations lobbying in concert with the Chinese, the Canadian, the Mexican and the Eurozone governments against American-imposed tariffs. This is, in itself, an oddity to have American companies join forces with foreign governments to lobby against American tariffs. But it is also a “sign of the times” recognizing that corporate supply chains are no longer national – but international. Markets have figured this out. Market efficiencies have demanded this. As the markets change so also will the supply chains – not because a politician demands it, but because the market requires it. Inserting politics into markets rarely ends well. We are still in the “early innings” of the tariff spat. So far, not much damage has been done. This kerfuffle should not be allowed to expand too greatly or be around for too long. We still believe that “cooler heads will prevail” and deals will get done.

OUR CRYPTO REVIEW…….
Several months ago, we penned our thoughts regarding a supposedly budding new investment vehicle, cryptocurrency, which had “caught on” with a number of traders and some members of the “smart money” set. We said then that we did not understand Bitcoin or Ether, what they were for or what they could do for markets. What we did understand was that these “currencies” were expensive to “mine” and used an enormous amount of energy. Most importantly, these currencies were not controlled by governments. This last point is obviously attractive to crypto advocates – but is most unattractive to government bureaucrats because they like control and are not willing to cede an important lever of community control via a country’s currency. So far in 2018, from January’s high, the MVIS Crypto Compare Digital Assets 10 Index has collapsed 80% – surpassing the Nasdaq Composite Index’s 78% peak to trough decline after the dot-com bubble burst in 2000 – OUCH! Digital “gold” has not yet been discovered.

CLOSING ARGUMENT……
Economic fundamentals remain strong in the US and overseas, providing valuation support for many equity markets. The economic strength is prompting central banks in America and elsewhere to “snug” monetary policy carefully – nothing dramatic, but certainly directional. In time bond markets could offer competition to stock markets – but not yet. Political “noise” is causing investor disquiet in a number of emerging markets. So far, the dissonance is not “out of control”, but it is taking its toll on certain exchanges. So far, the US marketplace is mostly ignoring the turbulence. It is not going down – but it is also not going up as fast as earnings are going up, thereby making US stocks relatively cheaper than they perhaps should be. Bull markets do not die of old age. So, as long as the fundamentals hold strong, we think investors should remain as owners of equities.

 

PREDICTIONS FOR 2018

1) Inflation will rise above 2%, using the Fed’s favorite measure – Yes – at 2%
2) U.S. GDP >+3% & international GDP growth will accelerate –  Yes – US GDP >+4%
3) U.S. unemployment will decline to 3.6% & ex-U.S. unemployment will decline – Yes – Unemployment at 3.9% on its way down
4) U.S. corporate profits +12% with higher profit growth ex-U.S. –  Yes -Stronger than the experts were expecting
5) The dollar will drift lower –  No – The dollar has been strong so far; trade worries, flight to safety
6) The U.S. bond curve will get “flatter” but not “invert” – Yes
7) Investment spending will rise again –  Yes – Confidence is strong & people are investing
8) Republicans will take a “political beating” in the midterms –  Still believe
9) Consumer confidence in the U.S. & abroad will stay strong – Yes – still strong
10) Equity markets will do well, while bond markets will stagnate –  Yes – Markets are starting to separate

 

A FINAL THOUGHT

The opinions expressed in this Commentary are those of Baldwin Investment Management, LLC. These views are subject to change at any time based on market and other conditions, and no forecasts can be guaranteed.

The reported numbers enclosed are derived from sources believed to be reliable. However, we cannot guarantee their accuracy. Past performance does not guarantee future results.

We recommend that you compare our statement with the statement that you receive from your custodian.

A list of our Proxy voting procedures is available upon request.

A current copy of our ADV Part II & Privacy Policy is available upon request or at www.baldwinmgt.com/disclosure