Once again, there was little economic news. Most of the economic data last week highlighted the slow pace of inflation.
For the next couple of weeks we are likely to get much in the way of new economic and corporate data. The two pending market moving events are this week’s FOMC meeting and the G-20 summit at the end of the month where Presidents Trump and Xi could meet to discuss trade. At the moment, the consensus view is that the Fed will keep interest rates where they are for now but will hint of a possible cut between now and the September meeting if inflationary pressures stay muted and the short end of the yield curve stays inverted. Likewise, the consensus is that Trump and Xi will meet and come to no conclusion regarding trade and tariffs but they will both express optimism that a deal in the not to far distant future is achievable. Both of these can be seen as binary events. Either they stay true to consensus or any deviation brings about a meaningful market reaction. Those reactions can go in either direction. A Fed Funds rate cut this week, done to ensure a continuation of the record-long recovery would be well received. Conversely, no change in rates and no post-meeting statement hinting at a possible cut over the next 90 days would almost certainly lead to a market correction of some size.
As for trade, no deal is near. That may not stop Mr. Trump from voicing optimism. He certainly views the stock market as the scorecard for his economic policies. He knows the markets want closure to the tariff issues. While he will almost certainly not be able to deliver a comprehensive plan this month, talks of progress may be enough to placate investors.
Also, later this month, Democrats will begin a series of internal debates among the 24 announced Democratic candidates. Actually, only 20 will debate on stage but no one really cares now about the 4 with the lowest polling positions. Given that each will have no more than 5 minutes to speak, none are going to use the debate stage to get too deep into policy initiatives. Nonetheless, an obvious general theme is already taking shape. Most want to roll back at least part of the corporate tax cut initiated last week. Most espouse some form of expanded infrastructure spending. Virtually all want government to take an expanded role spending more money to help middle and low income America. At this point in time, markets are not too focused on the various platforms of individual candidates. Clearly, markets would have a tough time accepting The New Green Deal or Democratic Socialism. We live in a capitalist society where the private sector owns or controls most of the productive assets. That has been the case throughout our history. Some Democrats suggest a variety of socialism might need our needs better. But I doubt our nation, soon approaching its 250th anniversary, wants to solve whatever problems face us but tearing apart the capitalist backbone and replace it with significant state ownership of productive assets in banking and healthcare. So, while the media and Republicans will pounce on some of the more extreme positions laid out by progressive Democrats, this isn’t where we are headed and markets understand that.
Clearly, it is possible that the activist wing of the Democratic Party can capture a majority of primary voters and pick a candidate farther left than I suggest. But if that happened, history would suggest that such a move would be political suicide. Extreme candidates on either side of the aisle have a long history of getting trounced in the general election. Of course, there is always a first time but, for now, markets are not even remotely pricing in such an event. Even should a very progressive President get elected getting majorities in both chambers of Congress to pass appropriate legislation would be extremely difficult. Just look at recent past. President Obama got one signature piece of legislation passed, the Affordable Care Act. And a decade later, our health care system is still standing and companies within the health care sector are still thriving. The only other major legislative piece, Dodd-Frank, would have been passed in some form as an aftermath of the financial crisis under any administration although it may have looked much different under Republican leadership. As for Trump, his signature legislation, of course, was his bill that reduced the corporate tax rate to 21%. It may still be too soon to judge the long term impact of the law. What we do know is that corporate cash flows have increased markedly but corporate investment spending, after a brief spike, has settled back down to normal levels and GDP growth is only marginally higher than it was before the tax cut became law.
In sum, monetary policy, demographics, technology advances, and modest improvements in productivity have more to do, long term, with economic growth than the actions of any President.
If fiscal policy’s role in our economy is perpetually overstated, with growth settling into a 2-3% range (probably toward the lower end of that range), and with inflation dormant, what should investors do? First, we should note that while fiscal policy’s impact on the overall economy may be overstated, its impact on individual sectors can be significant. Clearly, for instance, the ability of commercial and investment banks to take risk and use maximum leverage has be altered dramatically since the financial crisis. Tariffs and the threat of tariffs have slowed trade between China and the U.S. The government is pounding on drug pricing. The generic drug industry has been in a tailspin for almost a decade with no sign of abatement. One of Wall Street’s old saws says, “Don’t fight the Fed”. I would argue “Don’t fight the White House” deserves equal consideration.
Thus, we all need to monitor our portfolios continuously to make sure our companies aren’t in the cross hairs of government. But with that obvious exception, buying great companies that can grow revenues in line with nominal GDP (i.e. +4-5%) or better, that generate free cash flow to buy back 2-4% of shares outstanding, and pay a dividend that provides a meaningful yield should be a wonderful long term strategy. Companies that have less control of their own destiny may entail more risk. Energy companies, for instance, can’t control the price of oil. Multinationals can’t control the value of the dollar. Right now, doing business with the Chinese offers elevated risk. While tensions could ease at any time, they are unlikely to disappear as long as China provides the biggest economic threat to U.S. leadership.
Finding great companies isn’t all that difficult. In sports, we pick athletes to all-star teams and most of the picks are obvious. We do have to be careful that we don’t pick great companies with a backward looking lens. Barron’s this week highlights its all-star team of best managements. How many do you own? You don’t want to own them at any price but it is a good place to start if you want to build a shopping list for the next correction.
Today, Venus Williams is 39. Barry Manilow turns 76.
James M. Meyer, CFA 610-260-2220
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