Letter - April 2017

 

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Fork in the Road

After a strong run, post-election, the stock market peaked at the end of February. Since then it has stalled with little direction. Volatility has been low. Interest rates that had risen sharply in anticipation of fiscal stimulus post-election have settled down at levels which suggest that the economy at best is going to continue to grow at an anemic rate.

Democrats, steaming over the loss of the White House and Congress, have been angrily antagonistic in their opposition to the President’s pro-business, pro-growth agenda. The Republicans are split, fighting amongst themselves, squandering their majority status. The conservative wing of the party was instrumental in defeating the first major piece of legislation put forth by the President, repeal and replace ObamaCare. The executive branch itself seems to be in disarray as different factions in the White House jostle for the favor of the President’s ear threatening the Republicans' agenda of tax cuts, infrastructure spending and healthcare reform.

After initially being accused of pandering, the new administration has seen its relations with Russia turn sour in light of the poison gas attack against civilians by Syria, a Russian client state. By bombing the air field from which the attack was launched, the US administration has signaled a more muscular and confrontational foreign policy towards not only Russia but China and North Korea as well. Surprisingly, markets have reacted calmly in the face of deteriorating conditions overseas. While initially after the attacks there was a flight to safe assets such as the dollar and gold, the move was immaterial. Stock prices barely moved. That markets have been unaffected so far by political and international uncertainty and turmoil is notable and perplexing.

It feels like we have come to a fork in the road.

One fork leads us along a bearish path. For the past nine years the market has climbed a wall of worry fed by super low interest rates despite anemic, subpar economic growth. Led by high priced growth stocks (Amazon, Tesla), by some measures, the market is now trading at historically high valuations reminiscent of the 2000 tech boom despite all the problems highlighted above. The jobs market is approaching full employment, wages are growing and employers are having to pay more to find workers. This sets the stage for accelerating inflation which would force the Fed to raise interest rates, always a danger signal for the stock market. Yet as the market continues to hover near its highs without a meaningful correction, investors seem complacent.

The other path argues that the stock market has plenty of room to move higher. Recent economic reports have shown underlying strength. Growth is accelerating world-wide. Forward looking corporate revenues and profits are rising, justifying current valuations. With rising employment and increasing wages, consumer spending which accounts for 70% of GDP, is likely to remain strong.

Inflation is under control and looks to remain benign for the foreseeable future. Successful implementation of deregulation, infrastructure spending and tax and healthcare reform has not yet been fully discounted, leaving room for the market to run.

The choice of investment strategy depends upon which path investors choose. When it comes to macroeconomics, we are congenitally cautious. The best we can do is practice precision guesswork. We can see merits in the argument for following either path. But the truth is that we find it hard to find new, investable ideas. The returns don’t seem to justify the risk we foresee. We continue to carry above average cash balances and daily look for new ideas. Should there be a meaningful correction in stock valuations, we have the firepower to add new positions. We will shamelessly follow the advice of Yogi Berra who famously said, “When you come to a fork in the road, take it.”

Tom Herzig

 

As a Registered Investment Advisor regulated by the Securities and Exchange Commission, P.R. Herzig & Co is required to offer clients copies of our form ADV Part 2. This form describes in plain English our business and how we operate. The form can be found on our website, prherzig.com. Hard copies are available upon request.

 


 

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