We have entered the initial innings of global reflation, and the pundits are already throwing off negative vibes implying that the markets have moved too far, too fast and too early in the shift to global expansion.
Let me restate the obvious. Global bond markets, risk-off, are still over-owned while global equity exposure, risk-on, is still at/near multi-year lows as few believed that mindset changes here and abroad would really happen, although it was staring us right in the face.
Paix et Prospérité’s question was not whether it would happen, but rather but how fast the baton would be picked up by governments to stimulate economic growth to stem the rise of populism which endangered their very existence.
It’s fascinating to watch how the success of Trump has accelerated the reflation process. It has boosted confidence in politicians everywhere who are supporting change and has given a huge boost in confidence to business as well that positive change will finally occur.
Needless to say, the financial markets are finally looking through the front windshield anticipating changes in government policies supporting economic growth, higher inflation, and much higher corporate profitability as evidenced by the continued shift occurring from risk-off assets, bonds, into risk-on assets, ad equities. This move is still in the early innings as the pendulum shifts from the overly restrictive policies of the last eight years to positive changes in fiscal, tax and regulatory policies that are pro-growth. We anticipated this shift, and our portfolios continue to outperform by a wide margin.
Before I discuss the events of the week that support our view, I’d like to commend Trump and his transition team. When I went out a limb early supporting Trump, I made it a point to say that I expected that he would moderate his more extreme views and not to worry as he is the ultimate negotiator starting from an extreme point while knowing it is not realistic and then being willing to accept less while still getting much of what he wanted to close the deal.
The early signs support this view. Look at the cabinet nominations and other appointees to date which include women and former adversaries. Look also at his conversation with with the NY Times editorial staff, how he dealt with Ford and Carrier on moving more plants to other countries by offering incentives to stay, his Thanksgiving address, his tweets and more. While he will keep the essence of who he is and gain much of what he wants, he is becoming more moderate.
Now, on to the events of the week that support our reflationary theme:
1.) The following events occurred in the U.S.: consumer confidence soared by 8.4 points to a one-year high of 85.2 in November; Fed notes supported that a rate hike is near, most likely December, and the financial markets took the news in stride as good news is finally good news; the manufacturers PMI rose while output and new order growth hit a one-year high; and the Trump-led government is crafting many bills supporting its agenda such that it will hit the road running after being sworn into office in January.
I expect that the new government will offer a tax plan such that much of the $2.5 trillion dollars held overseas by U.S. multinationals will be repatriated. The added tax revenues will support domestic infrastructure spending while the net increase in domestic corporate cash will support increased capital spending, acquisitions, strengthening balance sheets, higher dividends and increased share repurchases. It should be good for the dollar too. All positive outcomes.
2.) The U.K. government seems to be following the growth policies of Trump: a reduction in the corporate tax rate, an increase in infrastructure spending and much higher spending on science and technology. In fact, Mrs. May, the Prime Minister, committed Britain to having the lowest tax rate of the world’s 20 biggest economies.
3.) The Eurozone PMI for manufacturers and services reached its highest level of the year in November as political change is in the air and consumer/business confidence is on the rise.
4.) China is tightening controls over overseas investment, as it wants to keep the money at home to finance economic growth and improve corporate balance sheets. The country’s foreign reserves fell to $3.13 trillion in October as outflows rose to over $207 billion in the third quarter. The yuan has continued to weaken and hit new lows last week for the year. On the other hand, China is trying to cement its trade relationship with its Pacific partners as TPP flounders. Don’t cry for China, as its economy will expand by over 6.5% in both 2016 and 2017 led by the consumer and services.
5.) OPEC still is having problems unifying a production deal to reduce its output by 3% as long as non-OPEC producers, including Russia, reduce their output by 500,000 b/d. Global economic growth in 2017 will boost prices as supply/demand improves and global inventories, now at record levels, decline. We maintain our view that oil prices are range bound between $40 p/b on the downside and $55 p/b on the upside at which point increasing shale production becomes economic again. If prices even stabilize at $55 p/b, that is still a positive for global growth. Remember that prices were over $100 p/b just 4 years ago.
The overwhelming evidence supports our reflation thesis adopted a few months ago. In fact, momentum is building quickly such that positive change in fiscal, tax and regulatory policies will occur earlier in 2017 than we envisioned a few weeks ago. Governments are jumping on the bandwagon accepting that Trump will do most of what he said he would do. For example, both the governments of Canada and Mexico want to sit down with the Trump administration to discuss ways to strengthen NAFTA, which means making it more fair for the U.S.. It was equally important for me to see Trump offering carrots to both Ford and Carrier to stay here rather than building plants offshore. It is indicative of how he will handle this issue in a way that is good for industry and America. To interview and possibly engage Romney as Secretary of State was telling too. Bottom line is that Trump is making the right moves. Sorry NY Times!
The bottom line is to stay the course and continue to look through the windshield toward the horizon. Invest in the new winners that will benefit from global reflation; sell/short the old winners which were defensive stocks; sell all bonds expecting the yield curve to continue to steepen as monetary authorities stay one step behind the curve; stay long the dollar and invest in industrial commodities.
Finally, be patient as we are in the early innings of the reflation thesis. Stocks are still under-owned as an asset class while bonds are still over-owned.
Remember: review the facts; pause, reflect and consider mindset shifts; review and implement the correct capital allocation along with risk controls; do in-depth, independent research on each idea and…
