Guild Investment Management, Executive Summary, Mar. 30, 2017

Executive Summary

 

1.  Some expect Trump to stumble – and if he does, we see opportunities across the Atlantic.  European stocks have not recovered nearly as robustly as U.S. stocks in the period since the Great Recession.  The Eurozone’s markets still suffer from an overhang of negative sentiment — especially in the wake of Brexit, and in the face of upcoming French elections that could see the victory of anti-European nationalists.  

Still, underneath this negative view, we see Europe participating in the global growth inflection. Business and consumer sentiment and outlook indicators, and hard data “green shoots,” suggest that accelerating GDP growth and inflation are on the way.  After the defeat of the Republican effort to repeal and replace the Affordable Care Act, the U.S. market is looking forward much more eagerly to tax and regulatory reform and a robust infrastructure program.  If the U.S. market environment gets more challenging — especially if those high-profile reforms are delayed — we’re looking closely at Europe.

2.  Rex Tillerson brings a CEO’s negotiating style to the State Department.  The austere, no-nonsense style of Rex Tillerson, the new secretary of state, reflects both Mr Tillerson’s business experience and the new administration’s desire for streamlined operations.  As a man who has run a big multinational, his experience as a negotiator is leading him to prefer quiet, closed-door diplomacy to the more public media displays of his predecessors.  This approach, and Tillerson’s careful competence as a negotiator, is assuaging the fears of those who thought the new administration’s foreign-policy rhetoric was too aggressive.  Whether it’s worth the ruffled feathers and media misunderstandings will depend on the results that the new State Department boss is able to achieve.

3.  Market summary.  The U.S. market is gradually grinding ahead.  Many fear a correction, but problems and reversals of a political nature so far have done little to hurt the markets’ slow and steady progress.  A small correction has taken place, with the market falling 3.5% peak-to-trough, and we have added to some stocks that have become good values in our view.  We favor technology, specialty materials, selected healthcare companies, and financials after their recent correction.  We also favor European stocks as they correct.  Longer-term, Europe has great potential.  We remain optimistic that the rally in the U.S. will continue.  None of the negatives that would create a recession, nor a major war or world banking crisis, are on the horizon.  Gold continues to move gradually higher with some volatility.  Oil, which has been out of favor, may be able to mount a rally to the mid $50s or $60s per barrel, but probably does not move dramatically higher.  The U.S. dollar correction has ended, and we expect the dollar to move up by 5 to 10%.  U.S. investors who own foreign stock markets should be sure to hedge the currency.

 

We See Opportunities Across the Atlantic

Our basic view on the U.S. market remains positive.  As we’ve written in recent letters, we believe that the post-election rally doesn’t just reflect the optimism of businesspeople and consumers about positive developments in U.S. tax and fiscal policy.  Midway through last year, markets were already beginning to reflect the passing of the dollar and oil shocks of 2014 and 2015 — the impacts of a large and sudden rise in the value of the U.S. dollar, and of a large and sudden fall in the price of oil.  The arrival of a new administration after a bitter and divisive election campaign served to underscore the turn, and sentiment helped propel the stock market rally, even if it was not the rally’s fundamental support.

Now markets are pausing and digesting the rally.  As we have said, with the positive fundamentals still intact, and with sentiment indicators still continuing strong, we remain buyers of any normal correction.  We do not see imminent risk of recession or the arrival of a recession-driven bear market.

U.S. Markets Respond to the Legislative Process

Market sentiment does not seem to have been very adversely affected by the new administration’s first legislative defeat — the failure of its bid to repeal and replace the Affordable Care Act.  We did not believe that the effort to repeal Obamacare represented a real priority of the President.  Rather, we thought he embarked on it first as a deal with more ideologically driven Congressional Republicans, in the hopes that it would smooth the way for the items he cares more about — particularly corporate tax reform and infrastructure development.  Those items are not just more personally important to the President — they’re more important to the markets.  With the health care push done for now, all eyes are on the next legislative items — and the stakes are certainly higher.

We are cautiously optimistic that if the administration’s heart is really in the push for corporate tax reform, there is significantly more scope to draw in cooperative legislators from both sides of the aisle.  We remain prepared to adjust our investment strategy appropriately as we continue to monitor the political and economic environment in the U.S.

However, in recent conversations with our clients and colleagues, we have often been asked where else we can look for opportunities should the market environment in the U.S. become more challenging.  One key region we are examining is Europe.

Europe:  Like the U.S., Turning the Corner

Sentiment on Europe among global investors remains suppressed.  We understand why: we have often commented on Europe’s woes in these pages.

Here’s a recap.  After the global financial crisis, Europe was hit by sovereign debt crises in Greece, Portugal, and other peripheral countries — with the threat that even Italy and France might not be immune to similar problems.  Throughout Europe, populist movements have gained traction in response to these crises, and in response to unmanageable migrant inflows, stagnant growth, and high unemployment.  These populist movements have imperilled the integrity of the Eurozone, threatening to pull several countries out of the common currency if they gain power and raising the specter of true financial chaos in that eventuality.  The European banking system remains relatively weak and undercapitalized, in contrast to the U.S. banking system, which has placed itself on much firmer footing in the wake of its 2008 “near death experience.”  In response to these conditions, the European Central Bank has pushed interest rates into negative territor y, a financial experiment with as-yet-undetermined consequences.  And meanwhile, on Europe’s eastern flank, an emboldened Russian bear continues to test NATO’s resolve with swagger and provocation, threatening the return of a cold war.

That sounds like a lot of negatives.  And yet, Europe is experiencing an acceleration of economic fundamentals and of sentiment much like what’s happening in the U.S.  With one significant difference: European stocks have priced in a lot less optimism than their U.S. counterparts.

Here is a graph showing the 12-month forward price-to-earnings multiples for the U.S. stock market (the S&P 500 index), the German stock market (the DAX index), the French stock market (the CAC 40 index), and the broad European stock market (the EuroStoxx 50 index).

 

Source:  Bloomberg

As you can see, the valuation multiple of the U.S. market has continued to expand (with hiccups) since 2011.  On the other hand, Europe’s valuation has moved sideways since 2014.

Currently, on the basis of next-12-months earnings estimates, France trades at a 17.7% discount to the U.S.; the EuroStoxx at an 18.3% discount to the U.S.; and Germany at a 22.9% discount to the U.S.

These European markets have appreciated since last year, but are still not pricing in the full extent of improving fundamentals.  Inflation, GDP growth, and sentiment are all trending higher and accelerating.

For example, recently released composite European PMI numbers continue to show acceleration.

 

Source:  Bloomberg

The PMI, or purchasing managers’ index, is a sentiment indicator calculated by interviewing business managers about their outlook on a slate of growth and business performance metrics.  So it is a “soft” indicator, but one with historical value in capturing economic dynamics that have not yet shown up in lagging official statistics.  Analysts are seeing nascent upticks in GDP growth, and beginning to increase their outlook — especially in the context of the emerging “global reflation.”

More positive data have shown up in other sentiment indicators.  European businesses are getting bullish, like their U.S. counterparts.

 

Source: Bloomberg

 

And so are European Consumers.

 

Source:  Bloomberg

How Big Is the Political Risk?

Markets may not be pricing in Europe’s participation in the world’s growth inflection because of the perceived overhang of political risk.

After last year’s crescendo of political surprises — including the Brexit vote and the U.S. political election — analysts have been cautious about writing off upcoming political developments in Europe that could be disruptive.  The Netherlands roundly rejected the populist insurgency of anti-immigrant firebrand Geert Wilders in their recent election.  Now all eyes are on France, as nationalist Marine Le Pen — who has pledged to pull France out of the Euro — faces down her main rival, Francois Fillon, an establishment candidate weakened by scandal.  It looks unlikely that she will achieve a victory even if she makes it to the run-off round in May.  But after the Brexit and Trump surprises, who will go out on a limb to make that claim with conviction?

Without venturing a prediction about the French election, we will make a few observations.  Even if she wins, Ms Le Pen’s political clout will be weakened by her party’s pariah status: no other parties will cooperate with her agenda, and the Front National does not have the votes to push it through alone.  Perhaps Wilders’ defeat in the Netherlands marked “peak populism” in Europe — but even if it did not, we think it is unlikely that the Euro will be collapsing from political pressure any time soon.  As we have often observed, the devotion of Europe’s elites to the European project is deep.  They will not give up easily.  And they are not weak.

With all that said, we are cautiously optimistic that the improving fundamentals will overcome fear of political turmoil in Europe.  Those improving fundamentals — inflecting GDP growth and inflation — could also permit the ECB to normalize policy in a gradual manner that will be helpful for European banks.  

With European stocks at such a discount, we remain alert that if the environment in the U.S. becomes less positive, we can still look across the Atlantic for investment opportunities.  As in the U.S., we are aware that a correction could happen in Europe at any time.

Investment implications:  European stocks have not recovered nearly as robustly as U.S. stocks in the period since the Great Recession.  The Eurozone’s markets still suffer from an overhang of negative sentiment — especially in the wake of Brexit, and in the face of upcoming French elections that could see the victory of anti-European nationalists.  Still, underneath this negative view, we see Europe participating in the global growth inflection.  Business and consumer sentiment and outlook indicators, and hard data “green shoots,” suggest that accelerating GDP growth and inflation are on the way.  After the defeat of the Republican effort to repeal and replace the Affordable Care Act, the U.S. market is looking forward much more eagerly to tax and regulatory reform and a robust infrastructure program.  If the U.S. market environment gets more challenging — especially if those high-profile reforms are delayed — we’re lo oking closely at Europe.

 

Market Summary

The U.S. market is gradually grinding ahead.  Many fear a correction, but problems and reversals of a political nature so far have not hurt the markets’ slow and steady progress.

A small correction has taken place, with the market falling 3.5% peak-to-trough, and we have added to some stocks that have become good values in our view.  We favor technology, specialty materials, selected healthcare companies, and financials after their recent correction.  We also favor European stocks as they correct.  Longer-term, Europe has great potential.

We remain optimistic that the rally in the U.S. will continue.  None of the negatives that would create a recession, nor a major war or world banking crisis, are on the horizon.

Gold continues to move gradually higher with some volatility.

Oil, which has been out of favor, may be able to mount a rally to the mid $50s or $60s per barrel, but probably does not move dramatically higher.

The U.S. dollar correction has ended, and we expect the dollar to move up by 5 to 10%.  U.S. investors who own foreign stock markets should be sure to hedge the currency.

Thanks for listening; we welcome your calls and questions.

Tim Shirata
Executive Vice President
Guild Investment Management, Inc.

12400 Wilshire Blvd. Suite 1080
Los Angeles, CA 90025
Tel: (310) 826-8600 Fax: (310)826-8611
email: tshirata@guildinvestment.com
http://www.guildinvestment.com

 

 

The publisher of this newsletter is Guild Investment Management, Inc. (GIM or Guild), an investment advisor registered with the Securities and Exchange Commission. GIM manages the accounts of high net worth individuals,investment partnerships, trusts and estates, pension and profit sharing plans, and corporations, among other clients.

Your receipt of this newsletter does not create a personal investment advisory relationship with GIM although some recipients may also be advisory clients of GIM. GIM has written investment advisory agreements with all its personal advisory clients, which sets forth the nature of that relationship.


The newsletter makes general observations about markets and business and financial trends and may provide advice about specific companies and specific investments. It does not give personal investment advice tailored to the needs, objectives, and circumstances of individual readers. Whether investment ideas and recommendations are suitable for individual readers depends substantially on the personal and financial situation of that reader, which GIM, as the publisher of the newsletter, makes no effort to investigate.

GIM attempts to provide accurate content in its newsletters to the extent such content is factual rather than analysis and opinion, but GIM relies primarily on information compiled or reported by third parties and does not generally attempt to independently verify or investigate such information. Moreover, some content and some of the assumptions, formulas, algorithms and other data that affect the content may be inaccurate, outdated, or otherwise flawed. GIM does not guarantee or take responsibility for the accuracy of such information.  Please note that investing in stocks, other securities, and commodities is inherently risky, and you should rely on your personal financial advisors and conduct your own due diligence in connection with any investment decision.

A Special Comment for Guild’s Clients

If you are an investment advisory client of GIM who is receiving this newsletter, please note that the fact that a general recommendation is made of a particular security, commodity, or investment area to its newsletter subscribers does not mean that investment is suitable for you or should be purchased by you. For example, GIM may already have purchased such securities on your behalf or purchased securities in the same industry (and an increase in the position for you may represent too much concentration in one security or industry), or GIM may believe the investment is not suitable for you based on your risk tolerance or other factors. If you have questions about the recommendations in this newsletter in relation to your account at GIM, please contact Monty Guild or Tony Danaher.

Conflicts of Interest

As of the date of this newsletter, GIM’s investment advisory clients or GIM’s principals owned positions in areas that are the subject of current recommendations, commentary, analysis, opinions, or advice, contained in this newsletter. GIM’s advisory clients or principals are currently long U.S. and foreign equities. GIM and its principals have certain conflicts of interest in its relations with its investment advisory clients and its newsletter subscribers resulting from GIM or its principals holding positions for its clients or themselves which are also recommended to its clients. GIM may change the positions of its clients or GIM’s principals may change their positions (increasing, decreasing, and eliminating them) based on GIM’s best judgment at any given time, including the time of publication of the newsletter. Factors that lead GIM to change or eliminate its positions may include general market developments, factors specific to the issuer, or the needs of GIM or its advisory clients. From time to time GIM’s investing goals on behalf of its investment advisory clients or the personal investing goals of GIM’s principals and their risk tolerance may be different from those discussed in the newsletter, and the investment decisions made by GIM for its advisory clients or the investment decisions of
its principals may vary from (and may even be contrary to) the advice and recommendations in the newsletter.


In addition, GIM or its principals may reduce or eliminate their positions in an investment that is recommended in the newsletter prior to notifying the newsletter subscribers of such a reduction or elimination. The publication by GIM of a “target price” or “stop loss” for a particular security or other asset does not necessarily represent the price at which GIM intends to sell or will sell any such assets for its advisory clients or the price at which GIM’s principals intend to sell any such assets.

As a consequence of the conflict of interest, GIM’s clients or principals may benefit if newsletter subscribers purchase assets recommended by GIM since it could increase the value of the assets already held by GIM’s investment advisory clients or GIM’s principals. On the other hand, GIM’s principals and clients may suffer a detriment if they seek to acquire additional shares in securities that have been recommended and the price of the securities has increased as a result of purchases by newsletter subscribers.

 

To help mitigate these conflicts, GIM seeks to avoid recommending the securities of individual companies where GIM or its principals have an ownership position and where the issuer is small or its securities are thinly traded−that way sales by GIM in advance of possible sales by newsletter subscribers would not be likely to cause any significant decrease in the sale price to newsletter subscribers. GIM has a fiduciary relationship with its investment advisory clients and cannot agree on behalf of such clients to refrain from purchases or sales of a security mentioned in the newsletter for a period of time before or after recommendations for purchases or sales are made to its newsletter subscribers.

GIM encourages you to do independent research on the securities or other assets discussed or recommended in the newsletter prior to making any investment decisions and to be especially cautious of investments in small, thinly-traded companies, which are usually the most risky investments that you can make.


Disclaimer of Liability

GIM disclaims any liability for investment decisions based upon recommendations, information, or opinions in its newsletters. GIM is not soliciting you to execute any trade. Nothing contained in GIM’s newsletters is intended to be, nor shall it be construed as an offer to buy or sell securities or to give individual investment advice.

 

The information in the newsletter is not intended for distribution to, or use by, any person or entity in any
jurisdiction or country where such distribution or use would be contrary to law or regulation, or which would subject GIM to any registration requirement within such jurisdiction or country.

Leave a Comment

Your email address will not be published. Required fields are marked *