THE AUTUMN LETTER
Glaub, was wahr ist; Lieb, was rar ist; Trink was klar ist,
(Believe, what is true; love what is rare; drink what is clear.)”– German proverb
Economic Perspective
(Just back from a family expedition to my natal city of Munich. And a testing of the Reinheitsgebot.)
Despite the disruption wrecked by Hurricanes Harvey and Irma, the US economy generated vigorous annualized growth of 3% in the latest calendar quarter ended September 30, driven in part by a global economic resurgence. Similarly, consumer confidence surged in October to its highest level in 17 years. Yet the ISM indicator of manufacturing activity slipped in October after hitting a 13 year high in September.
The latest results for GDP growth suggest an acceleration in the tepid pace of growth the US economy has experienced recently. Commodity prices will likely follow suit. Consumer prices will rise in sympathy. And the Federal Reserve should continue its policy of raising short term interest rates gradually as inflation targets are met and reducing its mammoth bond holdings. Janet Yellen’s successor as Fed chair, while a Trump appointee, will continue her gradualist policies.
Market Thoughts
Momentum stocks dominate the market; it suffers from bad breadth, with the majority of index movement coming from just five stocks: Apple, Alphabet, Amazon, Facebook and Microsoft. As the old saying goes, trees don’t grow to the sky. We are in the middle or late stages of a bull market but probably only the early phase of a bubble.
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 (Ansys, Google, Microsoft) and industrials (Illinois Tool Works, Parker-Hannifin, Versum Materials) boosted by better currency comparisons versus the soaring dollar last year. Very long term, we remain positive on the pharmaceutical (Bristol-Myers, Eli Lilly, Novartis) 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.
Stephen K. Bache, CFA
Sources: Bloomberg Business Week, The Economist, The New York Times, Joel Tillinghast, Big Money Thinks Small; Patrick Leigh Fermor, A Time of Gifts
