Paix et Prospérité’s success has been our ability to anticipate and react to change while keeping an eye towards the future. We structure our portfolios after in-depth top down and bottom up research and being patient enough to profit as it all unfolds. We tend to buy early, anticipating a change in perception of the investment environment, and sell early when our perception becomes reality. Our actions since October clearly show that we have stuck to our disciplines and do what we say.

We went totally defensive last October fearing the Fed selling off most all of our economically sensitive stocks and buying defensive stocks (mostly drugs and consumer nondurables) while raising 35% cash along the way. Following the Fed’s about face in December, we quickly reversed our positions buying back the economically sensitive stocks and reducing our defensive names while going virtually all in.

And as we became even more confident in March/April that U.S economic activity along with corporate profits would be much stronger than we envisioned, we sold the remaining defensive stocks including all the drugs while adding to our economically sensitive and technology holdings as well as to some additional special situations. We only bought best in class with excellent managements, wining strategies, strong financials and above average dividends/cash flow. We remain fully invested today as we still believe that our economy has years to run especially if there are trade deals as we expect.

Our first quarter GNP forecast has risen from 1.5% four weeks ago to 2.4+% today. Real growth for the year will most likely surpass 2.7%. Stronger growth will translate into higher than expected profits as corporations entered 2019 lean and mean. We continue to favor investing in the U.S, and also in China, as growth will be better than expected while interest rates will remain subdued as inflationary pressures will stay muted along with capital inflow from abroad arbitraging lower rates overseas.

Again, while investing in the Emerging Markets, Europe and Japan looks so temping as valuations appear so cheap, we feel that the risks are too high if trade deals are not reached. The bottom line is that our market remains 10% undervalued today with many stocks having far more upside than the market. Active management should outperform passive management in this environment. We have for sure!

There’s no place like home.

Let’s look at the economic data points reported last week that support our view that economic activity has indeed accelerated in the U.S and China while not yet in Europe and Japan.

The United States economy continued to improve through over the last two months as evidenced by: the U.S trade deficit narrowed in February to an eight-month low of $49.4 billion reflecting a 1.1 percent rise in exports and only a 0.2% increase in imports; U.S retail sales rose 1.6% in March, the largest gain since September 2017; chain store sales rose 5.0% last week; the Beige Book came out seeing slight-to-moderate growth across the U.S with an improving housing market; and first quarter earnings reported so far are exceeding forecasts.

On the other hand, February manufactures’ and trade inventories rose 0.3% from January while sales rose 0.1% so the Inventory/sales ratio rose slightly to 1.39. Industrial production fell 0.1% in March but has since rebounded in April.

Trade talks opened officially with Europe and Japan last week. It is interesting to note that France and Belgium were against new trade talks with the U.S at this time. We continue to believe that reaching a trade deal with Europe will be difficult which will hurt Europe’s economy far more than ours. On a more positive note, it appears that trade talks with China are progressing well with a possible signing ceremony as soon as Memorial Day.

We expect that the U.S economy will accelerate over the next few quarters and will get an added boost in 2020 once trade deals are implemented. Also, don’t count out the power of the Presidency to stimulate growth into the elections.

China’s economy accelerated throughout the first quarter: GNP rose 6.4%, factory output jumped 8.5% in March, retail sales expanded 8.7% and investment was up 6.3%. The government is taking no chances so it is considering added stimulus to boost consumer demand to mitigate any threats posed by trade tensions with the U.S. The government has already unveiled tax and fee cuts amounting to $300 billion while the Central Bank has cut banks’ reserve requirement rations five times over the last year to spur lending.

We expect China’s economy to expand by 6.5% for the year and better next year once trade deals are implanted removing business/consumer uncertainty that exists today.

We remain concerned about prospects for the Eurozone until there are financial, economic, regulatory and trade reforms needed to better compete globally. The ECB can’t do it alone. While the Eurozone PMI rose slightly to 47.8 in April, it is still hovering at its second lowest level since April 2013 as output fell for the third month in a row. In addition, new orders were down for a seventh consecutive month; input buying has fallen and business hiring has stagnated. Certainly not a pretty picture.

By the way, Germany, the engine of Europe, cut its economic forecast in half for 2019 to just 0.5%. The German government simply refuses to use its budget surplus to stimulate growth which would assist the whole region. While we would expect trade deals to be a near term boost to Eurozone growth, it won’t be the long-term answer until the region faces its real imbedded problems.

We expect the BOJ to cut its economic projections for Japan next week. Recent data for exports and production remain weak while consumer demand has been sluggish impacted by weak wage gains. Japan badly needs the U.S ad China to reach a trade deal to be followed by a trade deal between the U.S and Japan in order for growth to pick up. We would avoid investing in Japan until trade deals are reached as their economy is simply too reliant on exports.

Looking ahead, we have gained added confidence that our global economic and financial outlook is close to the mark. We continue to favor investing in the United States and China as growth has already accelerated while avoiding the Eurozone and Japan until trade deals are reached. We are monitoring all trade talks closely as deals will lead to an acceleration in global growth in 2020 and beyond. And, we do not expect much of a pick-up in inflationary pressures due to the competitiveness of globalization, rapid changes in technology and the rise of disruptors industry by industry pressuring prices.

How have we changed our portfolios over the last few weeks?

As we gained added confidence in our economic outlook and after listening to many first quarter earnings calls, it is clear that corporate profits will be higher than initially forecasted in 2019. Maybe it was a blessing that everyone turned pessimistic in the fourth quarter as it is obvious that corporations entered this year with a very conservative outlook therefore any positive economic surprises will rapidly translate into higher than expected earnings. Virtually all of the companies that we own in our portfolios that have reported so far have raised their forecasts for this year.

We want to make a brief comment on the drug stocks. Healthcare stocks went from 40% of our portfolios in October to 20% in January to virtually nil today. The primary reasons are that their valuations reached historical highs as safe havens in the fourth quarter, relative earnings growth was narrowing to more economically sensitive parts of the economy and the government was challenging health care pricing/costs/profits. One of our rules is to avoid areas where the government is in your face and own areas where the government is behind your backs. Clearly health care pricing will be a political football over the next two years so why swim upstream owning them until they get really cheap. Not yet!

We currently own global industrial and capital goods companies like HON; technology at a fair price to growth including the semis like INTC; cable with content like DIS; housing related to benefit from low interest rates like HD; low cost industrial commodity companies generating huge positive cash flow like RIO; global financials domestically domiciled like C; domestic steel and many special situations. We remain flat the dollar although we expect it to weaken once trade deals are reached and we believe that the yield curve will grudgingly steepen as growth accelerates.

Review all the facts; pause, reflect and consider mindset shifts; look at your asset mix with risk controls; do independent research and… Invest Accordingly!

Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.

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