October 4, 2017

While Jim is away on vacation, other members of the TBA Investment Committee will write the market comment. Today’s comment is from Maris Ogg.

“…full of sound and fury, signifying nothing” Macbeth Act 5 Scene 5

Lately when I read the news, I am reminded of this line from Macbeth. There is a lot of talk coming out of Washington but action is lacking. The topic du jour, of course is tax reform, which is getting significant airtime, but is unlikely to result in much. Tax reform takes work, real bi-partisan work with prodding and cajoling and promises from the White House. We see little evidence that the current crew in Washington is capable of such work, let alone on a subject as difficult as tax reform.

For investors, who perennially hope for improvements to the business climate from Washington initiatives, this can result in disappointment, although the last 10 months experience with the new administration should temper expectations. In fact, all of the blather from politicians over the summer as they wrestled with Health Care, the debt ceiling, North Korea and now tax reform has tended to obscure the important events that have impacted markets over the past year.

After Mr. Trump was elected, the conventional wisdom was that he was the reason behind the muscular market rally that began last November. Looking back, one could make the case that the market has risen despite the Republican takeover. In fact, the better argument is that in 2017 we have seen clear confirmation that the economic recovery in Europe has truly taken hold and is probably sustainable. After an initial economic bounce-back after the 2008/2009 recession, European growth stalled and for the past 7 years has been stuck in a range from -1% to +1% growth. Many observers made the case that Europe was becoming Japan and would experience a stagnant economy for decades. Recently, however we have seen European consumer confidence improve, industrial production pick up and the leading indicators in Europe are signaling that strength will continue. Business confidence is at its highest level in over a decade, and Q3 gross domestic product in Europe grew by a better-than-expected 2.3%. To be sure, the European central bank has been aggressively stimulating the economy with their own version of easy policy and QE, but like our Federal Reserve, they are discussing backing off on the accelerator.

The Chinese economy is also regaining its footing after a slowdown probably caused by the crackdown on corruption in 2014. Growth there is somewhere in the mid-single digits, although with China, one has to triangulate the estimate by examining the few economic statistics that cannot be manipulated. At any rate, it appears that the Chinese people are also now consuming more of their production internally, which is healthy, in addition to their sizeable exports. In fact, global leading indicators are improving, demonstrating growing economic strength outside of the US. Importantly, this now includes Europe, Japan and even Brazil. In fact, the US, Europe and China account for about 61% of nominal global GDP. Add 6% for Japan and 5% for India and Brazil and over 70% of the world’s GDP is from countries with expanding economies and increasing leading indicators. This is a powerful positive for corporate earnings and the US has never experienced a recession when corporate profits were rising. I’ll show you the picture and spare you the 1000 words. The Orange line is earnings and the blue line is the S&P index.

Chart Courtesy Macrotrends.com

Of course investors must also consider valuation. At about 18X earnings, the stock market is selling at fair valuation. This suggests to us that the positive outlook is probably incorporated in today’s prices. But remember, bull markets usually do not die of old age or due to high valuation. They usually end with recession. Today, because Europe appears to be entering a durable recovery, and most developed and developing economies are expanding, a recession in the next 12-14 months looks unlikely. But high valuation does imply that investors should be careful to adjust their asset mix and stay within their long term guidelines. As the stock market has appreciated, equity exposure for the average portfolio has risen, and this is probably the time to begin to rebalance back to more normal equity percentages. Give us a call if we can be of help in this process.

I’ve no idea whose birthday it is.

Maris A. Ogg, CFA 610-260-2216

Additional information is available upon request.
# – This security is owned by the author of this report or accounts under his management at Tower Bridge Advisors.

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