THE WINTER LETTER
Any sufficiently advanced technology is indistinguishable from magic.”
– Arthur C. Clarke
Economic Perspective
President Trump promises corporate tax reform (read tax cuts), a reduced regulatory burden (gutting Dodd-Frank and dropping the DOL’s fiduciary requirement for brokers) and expanded infrastructure spending. All business confidence builders and likely to increase corporate profits. But most of his initiatives require Congressional approval. Yet the political landscape is fraught with incalculable risk. Call it political volatility or risk of a Twitter tantrum or the erratic outbursts of a narcissist, but the peace of the world is at its greatest risk since the end of the Cold War. A misstep could also have dire economic consequences.
Struggling with the headwinds of a rising dollar which reduces foreigners’ appetite for more costly American goods, the US industrial economy endured multiple quarters of a profits recession. Once corporate tax reform is implemented, profit levels should rise.
Fourth quarter 2016 GDP only grew at 2% annually well off the third quarter pace. Hidden within that statistic was tepid consumer spending. Despite the growth outlook abroad improving, the US economy will be lucky to sustain its current 2% growth path. Faster growth also suggests a faster pace of interest rate hikes by the Federal Reserve in the coming year. And bear in mind most of the new president’s initiatives are inflationary.
Our primary trading partners, Europe, Japan, China, offer little support for global economic expansion. Europe remains mired in a growth recession and China, transitioning to more emphasis on consumer spending rather than capital investment, is struggling with declining economic growth rates.
In a global environment of weak economic growth and negligible inflation, only the Federal Reserve has successfully raised rates. Fiscal stimulus has been anemic. Corporations, while willing to acquire scale through mergers, have been unwilling to invest in additional capacity.
Market Thoughts
In the long run, financial markets exist to facilitate the efficient allocation of capital. Short term they give market participants premature ulcers. The year opened with a rise in global stock prices. As January goes so goes the year; but history suggests that we may have witnessed the year’s entire net advance in US stock prices in this first month. However, we will not be spared further intermittent volatility.
Geopolitical risks cloud the outlook. Populist demagoguing and anti-globalist sentiment from Brexit to Marine Le Pen’s pursuit of the French presidency stalks Europe. Isis is building a toehold in Libya. Turkey’s President Erdogan reaches for executive powers under the pretext of Kurdish separatism. In an effort to navigate the treacherous market waters we emphasize sectors like: more resilient large cap names (Illinois Toolworks, General Electric); the out-of-favor pharmaceuticals and biotech (Eli Lilly, Merck, Pfizer, Gilead, Celgene); entertainment (Liberty Media, Disney, Comcast); technology (Microsoft, nVidia, and Google), dividend plays like ProLogis and ONEOK Inc.; and specialty manufacturing (Hexcel, Reliance Steel, and Wabtec).
Stephen K. Bache, CFA
Sources: Business Week, The Economist, New York Times, The Wall Street Journal; Johannes Fried, Charlemagne
