THE AUTUMN LETTER
The useful historians are not those who give general descriptions of facts and explain them by reference to general conditions, but those who go into the greatest detail and reveal the particular cause of each event.”
– Giambattista Vico, Italian philosopher of history
(1668-1744)
Economic Perspective
Tariffs and risk of a trade war with China dominate the economic prospects. Other significant concerns include a potential partial reversal of the Trump corporate tax cut, rising interest rates, growing wage and product inflation (partly a consequence of higher tariffs), and a dramatic rise in global corporate indebtedness since 2009. The political fallout of a divided nation contributes to economic risks. Housing sales appear softening. Employment levels remain high. Business capital investment, a necessary prerequisite for labor productivity growth, slipped in the latest quarterly GDP results. Despite all these concerns, no catalyst as yet appears on the horizon to trigger anything beyond a correction in the stock market.
Bonds. The long secular bull market in bonds ended in 2014 when long-term interest rates hit their trough. Rising wage inflation, regular increases in short term interest rates by the Federal Reserve and global turbulence portend higher long-term interest rates ahead.
Gold. Gold is a haven in times of heightened political turmoil, but as the bullion generates no income only storage fees, it may prove less attractive in a higher interest rate environment, when a crisis atmosphere only prevails intermittently.
The latest results for GDP growth suggest a noticeable acceleration in the tepid pace of growth the US economy has experienced during the recovery since 2009. Though, absent sustained capital investment by business, GDP growth will revert to the sluggish two percent that has prevailed during the recovery.
Market Thoughts
Corporate earnings results cooled from a spectacular first half of 2018. The decline is from spectacularly high rates of profitability for Corporate America. Investors severely punished the stock prices of those companies with misses in either revenue or earnings growth. Going forward financial services firms, technology and industrials should do better in a slightly stronger economy. Financials bolstered by higher interest rates and thus wider interest rate margins (Alleghany, White Mountains). Technology (Google, Microsoft, nVidia) and industrials (Illinois Toolworks, Reliance Steel, Wabtec) boosted by revenue growth. Very long term, we remain positive on the pharmaceutical (Eli Lilly, Merck, Pfizer) and biotechnology (Amgen, Biogen, Celgene, Gilead) sectors despite temporary political challenges.
Gradual economic recovery makes one cautiously positive about stock markets. On a valuation basis, despite the first good year in the past three for the stock market, U S stocks are richly priced. We will continue our deliberate, prudent and cautious investment strategy.
Personal Note
I invite you to view my first (and likely only) television appearance. Watch the Reach the Beach/Family Adventure episode of Cycology Today at https://youtu.be/TSZNcZOSpZM. Enjoy.
Stephen K. Bache, CFA
Sources: Bloomberg Business Week, The Economist, The New York Times, Jim Holt, When Einstein Walked with Godel
