The Trend Is Your Friend

We expect further gains ahead as investors are significantly under-weighted in equities while being over-weighted in bonds and cash.

While we do expect the overall stock market to continue to rise as it remains undervalued still today, the key to outperformance will be stock selection.

We began shifting the composition of our portfolios away from defensive stocks selling at record high valuations to more economically sensitive companies selling at recession valuations.

Last week stock prices rose to all-time new highs as bond prices fell. There were material progress and enhancements made on the three key data points that we have been monitoring and discussing over the last several weeks: monetary policy, trade, and Brexit.

We are bemused listening to the pundits/experts each day as their views shift with the wind as they continue to miss the overriding positive trends influencing the financial markets. We expect further gains ahead as investors are significantly under-weighted in equities while being over-weighted in bonds and cash.

While we do expect the overall stock market to continue to rise as it remains undervalued still today, the key to outperformance will be stock selection. As we have gotten more confident that global growth has passed an inflection point from further downgrades to stabilization/acceleration next year, we began shifting the composition of our portfolios away from defensive stocks selling at record high valuations to more economically sensitive companies selling at recession valuations.

Technology remains a core holding, too. The common trait among all of our investments is that each company has superior management, winning short- and long-term business strategies, super strong financials and are generating tremendous cash flow to support growth initiatives, higher dividends and stock buybacks.

Let's first review the three key data points that we are monitoring before reviewing what is occurring by region:

Monetary Policy.

Accommodative policies exist everywhere in the industrialized world. More money is being created than used by the real economy which is good for financial assets. We were not surprised that the Fed cut rates again last Wednesday reducing the Funds rate to a range of 1.5-1.75% as global growth remains sluggish and uncertainties from trade to fiscal relief/Brexit are still not resolved. What did surprise us, though, was Powell's comments in the follow up news conference when he admitted that the Fed would NOT even think about raising rates

until

inflation was sustained at or above 2%.

Remember that inflation has run under 2% for nearly 10 years now. We have discussed over the years that low inflation was NOT transitory as the Fed clearly still believes due to the combination of globalization (competition), technological advancements and disruptors. Our conclusion Wednesday was that the Fed will remain accommodative a lot longer than generally perceived and will permit the economy to advance much longer, even running hot, until/if inflation rears its ugly head which we don't expect.

While we do expect the yield curve to steepen over the foreseeable future as global growth picks up, we believe that medium- and long-term rates will stay contained making equities, especially those with good dividends, more attractive as long term investments compared to even 5% long term bond yields. Never forget that low rates force investors to move out on the risk curve which also favors equities as an asset class.

Trade.

We continue to hear favorable comments out of DC and Beijing that trade talks are going well and that Phase One of a trade deal could be signed in the foreseeable future. China even admitted on Friday that a consensus in principle with the U.S had been reached on the core trade concerns. The White House confirmed that talks between Vice Premier Liu and Robert Lighthizer/Steven Mnuchin had gone well. We were pleasantly surprised to hear President Trump chime in and say that Phase One would represent 60% of a long-term agreement. We do not expect an all-inclusive trade deal to be concluded before elections next year, but we do expect talks to continue and the U.S to postpone any additional tariff hereby reducing tensions between the two countries at least through election 2020.

Brexit.

Prime Minister Boris Johnson finally won support for an election on December 12 to hopefully settle Brexit one way or another. We continue to believe that there will not be a hard Brexit no matter what happens as the economic ramifications are just too negative for both Britain and the Continent.

One of our core beliefs is that we believe that Trump knows all too well that his reelection hinges on a strong economy and stock market. He will clearly do all in his power to make sure that this happens which means that he cannot escalate trade tensions, even with Europe. And that his agenda must expand next year to include a new round of tax cuts for the lower and middle class and other plans to boost the economy which hopefully includes an infrastructure and new health program. He may even talk about closing some tax loopholes that benefit the wealthy. Clearly fiscal policy will be wind to the back of the U.S economy to go along with a very accommodative Fed.

Let's take a quick look at what is happening globally that support/detract from our continued belief that there is no place like home:

The United States

The vast majority of recent data points strongly suggest that the U.S economy will continue to roll along with 2+/-% growth well into 2020 supported by consumer and fiscal spending. Beside the Fed meeting, the key economic stat of the week was the monthly employment numbers which were nothing short of sensational: U.S payrolls increased by 128,000 jobs despite a 42,000 job loss due to the GM strike; hourly wages which may also have been hit by the strike rose 0.2% from the prior month and are up over 3% from a year ago; the participation rate increased to 63.3, the highest level since 2013; and August and September employment numbers were revised up 50,000 and 46,000 respectively. The Labor department said its employment-cost index rose only 0.7% in the third quarter and 2.8% from a year ago. The U.S economy will add over 2 million jobs this year on top of the 4 million jobs created over the prior two years and wages are increasing faster than inflation. All of this bodes well for a great Christmas 2019 and beyond.

Here are some other stats reported last week: personal income increased 0.3% in September; disposable personal income rose 0.3%; PCE increased 0.2%; and the personal savings rate held at a whopping 8.3. It was reported that the U.S economy expanded by a surprising 1.9% in the third quarter as consumer spending rose at an annualized rate of 2.9%; non-residential fixed investment fell at a rate of 3.0% annualized; inventories were reduced penalizing growth and the trade sector continued to hurt growth too.

On the other hand, housing and government spending were a tailwind to economic growth in the quarter. The Consumer Confidence Index for October was reported at a very healthy 125.9; the Present Situation index at 172.3 ad the future expectations index stood at 94.9. It was no surprise that the manufacturing sector continued to contract in October with the PMI sitting at 48.3, which was a slight improvement from the prior month; new orders index increased slightly too to 46.2 while the backlog index fell to 44.1.

Thank heaven the consumer plus government spending comprise nearly 90% of reported GNP as they remain strong while manufacturing and trade remain weak. U.S economic growth will remain around 2% for the foreseeable future. Let's see if some of the manufacturing numbers pick up now that the GM strike has ended too.

China

The Caixin/Markit manufacturing PMI which is mostly small/medium size companies rose to 51.7 in October as both production and new orders accelerated meaningfully from the prior month. On the other hand, the official government PMI dropped to 49.3 in October which is more represented of government owned businesses and larger companies.

The bottom line is that the Chinese manufacturing sector remains under tremendous pressure due to the trade conflict with the U.S. Even if an interim deal is reached with the U.S., we see corporations continuing to diversify their supply chains away from China despite the governments continued attempts to persuade them to stay. Growth in consumer spending and services will NOT be enough to sustain China's growth above 6% in 2020 and beyond. China 2025 is in doubt!

The Eurozone

The baton has finally been passed from Mario Draghi to Christine Lagarde as head of the ECB which we view favorably as Europe needs guidance from fresh blood with a more global perspective that she brings with her. Chancellor Merkel of Germany and her party are in trouble as evidenced by her party losing an election last week in a resounding way as calls for major fiscal relief were at the forefront of their loss.

We are confident that change is finally in the air as the debate throughout Europe is now regarding major fiscal stimulus along with major regulatory reforms. It is hard to imagine the outlook in Europe getting any worse without major upheaval/rebellion from the status quo led by a super conservative Germany. Did you notice that European Consumer Confidence fell to a -7.6 in October? That is a negative sign.

Japan

The Bank of Japan met Thursday and reasserted their intent to throw everything into the Japanese economy to revive it and hopefully move inflation up to 2%. Wishful thinking as the country really needs global trade to improve to boost its own economy as the government is out of fiscal tools and the BOJ can't do much more than they already have.

So why do we believe that the global economy is in the process of bottoming out and will improve next year?

We are confident that global trade conflicts have already peaked as it serves Trump's political desires to have a strong U.S. economy along with higher stock prices going into election. President Xi has to stem the tide of corporations leaving China which weakens the country's long-range planning and jeopardizes his aspirations for China 2025. Clearly both the U.S and Chinese economies will benefit from a cessation in escalating trade conflicts as will the rest of the world too. In addition, we see increased fiscal/regulatory relief in China, India and Europe next year too on top of the huge amount of fiscal stimulus here in the states.

The bottom line is that growth is bottoming out and will begin to accelerate next year. Clearly the financial markets have already begun to sniff this all out as evidenced by the rise in bond yields globally to go along with a weakening dollar. Change is in the air and the new trend will be your friend.

As we said earlier, we began adjusting our portfolios weeks ago reducing our defensive holdings selling at their highest valuations in decades and buying some more economically sensitive companies with great managements with strong financials selling at recession valuations well below intrinsic value. We own technology companies; financials; global capital goods/industrials/machinery companies; cable with content; industrial commodities; retail with a housing bent; agricultural related and many special situations. We are flat the dollar although we expect it to decline and own no bonds as we expect the yield curve to steepen.

Remember to review all the facts; pause, reflect and consider mindset shifts; look at your asset composition with risk controls; do independent research including listening to earnings call and... Invest Accordingly!

Editor's Note:

The summary bullets for this article were chosen by Seeking Alpha editors.