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The Goldilocks Economy And Financial Markets

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The pundits/naysayers are at a loss for words as the global stock markets continue to confound them as they march upwards. The global economy is surprising the experts too, as growth estimates continue to lift for this year and next. Inflation expectations are now at the center of the debate within the financial community, as inflationary pressures have not risen as growth has accelerated and unemployment has declined meaningfully.

Janet Yellen changed her tune this week. She now appears much more concerned that low inflation may not be transitory. That has been our view, all along.

We remain in the sweet spot with accelerating growth, increasing earnings estimates and lower than expected inflation and interest rates at this point in the cycle. This does not mean that the yield curve will not continue to steepen. It will until the monetary authorities declare victory and reduce meaningfully their overly accommodative monetary stance. But that won’t happen anytime soon as we expect all of them, including our Fed, to remain one step behind until they gain a clearer perspective on where inflation is going down the line. It is much harder for them to fight deflation with interest rates so low and their balance sheets bloated than to fight inflationary pressures. Now you can understand their reticence in shifting their policy too soon.

On another note, I want to applaud Jimmy Dimon’s (Chairman of JP Morgan) comments Friday on how embarrassing it is to be an American because our politicians in DC can’t come together and enact policies that would benefit our country and its citizens. How often have we said that it is amazing how strong our economy and stock markets are despite all of the headwinds out of DC. While I don’t know if growth can accelerate to 3% as Trump and his team suggest if his policies were passed, it clearly would accelerate from the 2+% path that we have had over the last few years. And our stature/influence would rise in the world, too.

Did you see JPM’s and Citi’s earnings reports? Record earnings despite a relatively flat yield curve. The best is yet to come for the financials for a multitude of reasons that we have been discussing for months. Financials remain one of the largest percentages in our portfolio. BAC is up next this week.

The IMF lifted its economic growth targets once again to 3.5% in 2017 and 3.8% in 2018, up from 3.1% in 2016. Europe has been the most surprising positive region followed closely by Japan. We expect China, India and the Emerging markets to surprise on the upside too. Unless Trump’s pro-growth, pro-business agenda is enacted into law, we expect U.S growth to stay stuck in the 2+% range even with all of the executive orders signed by Trump, reduction in regulations, growth in employment and benefits to be realized by his trade policies. If you were senior management of a U.S corporation, would you alter spending plans now or wait to see what/if any of Trump’s agenda is enacted into law? Personally I’d remain cautiously optimistic and refrain from major changes for right now.

I characterize this as a Goldilocks economy– not too strong as to cause monetary authorities to tighten significantly; not too weak fortunately as there is not much more that can be done to boost growth, but one that grows just right at the aforementioned rates without much, if any, inflationary pressures.

Earnings under this scenario would continue to expand and probably surprise to the upside as corporations have done an excellent job of pruning costs and shifting their business mix to higher margin areas. M&A activity has helped too as corporations are merging or selling off less profitable businesses to be stronger, more globally competitive and more profitable in the future. Low interest rates plus rising earnings is the recipe for higher stock prices. Not a shabby outlook at all.

Let’s drill down and see which industries are best positioned as investments for the foreseeable future. We have already highlighted the financials. Multinational industrials are as large a percentage of our portfolios as financials. These companies are benefiting from acceleration in global growth as volume and prices are improving along with margins, as costs have been taken out of the businesses and the product mix has shifted to more profitable lines. We continue to like some tech stocks, financially strong, low cost industrial commodity producers, including domestic aluminum and steel, as well as a handful of special situations undergoing organic change or merger of equals. We have highlighted Dow and Huntsman before and would like to add Praxair to that list as it is merging with Linde to form an industrial gas powerhouse.

We fully expect that many companies will report over the next few weeks better than expected numbers for the second quarter and raise estimates for the year. Many managements will reiterate what Jimmy Dimon said which was that the U.S economy could be on the verge of great things only if our Congressmen came together and did their jobs supporting America and its citizens. I keep shaking my head, as it doesn’t take a genius to figure out what needs to be done: tax reform, an infrastructure program to rebuild America; repeal/or amend Obamacare; free but fair trade; energy independence; and a better educational system including job training for the needs of the 21st century.

Paix et Prospérité continues to outperform all indices as we stick to our disciplines, do independent research and fully understand our former partner George Soros’ theory of reflexivity.

So remember to review all the facts; step back, pause, reflect and consider mindset shifts; look at your capital allocation with proper risk controls; do independent research on each idea and …Invest Accordingly!



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