My key takeaway from the events over the last several months is that there is no place like home.
It is apparent that U.S economy is doing better than most and that U.S-based companies are more rapidly adapting to the global competitive landscape and are making the hard and needed strategic changes in their businesses to thrive no matter what the economic landscape. Yes, that may be an overly simplistic generalization, but it is by and large true.
Take GE, for example, as it exits nearly half its businesses—namely finance-related units—and focuses entirely on its rapidly growing and higher-return industrial businesses. Over $350 billion in assets are being sold off. On the other side of the spectrum, take a look at Google, which who announced on Thursday a new strategic focus. Its stock added a record $65 billion to its value in one day.
I will discuss the banks later, as there is no sector going through greater strategic changes to adapt to Dodd Frank and a new global financial environment. Banks and financials remain the largest part of our portfolio and achieved multi-year highs last week.
My investment process combines a top-down, global and macro-economic outlook with bottom-up microanalysis of each region, industry and company. Quite frankly, in years past, I spent a lot more of my time deciding on asset allocation and sector emphasis based on my view of the global economy, but now the dynamics of each region and each company within a sector are more complicated. I have to drill down further into each region, industry and company.
I tend to run a more concentrated portfolio than most, as I must have first-hand, in-depth knowledge of each investment. I am an analyst at heart. Also, my turnover tends to be low, as I invest rather than trade. Once I understand a company's strategy and buy into it, I monitor the company closely to see if the strategy is adhered to. If so, I gain added confidence in the investment. If not, I pare back the position, as there are many fish in the sea. My long-term objective is to double the value of each portfolio every five years, including dividends, and maintain liquidity at all times. I have successfully exceeded this objective for 35 years, after fees.
Recognizing and taking advantage of change is my greatest strength. I tend to look for long-term trends. Simplistically, I invest long in companies increasing volumes/revenues. I want companies with rising margins and rates of return on capital, as well as a competitive advantage. I short those on the other side of the spectrum. This investment strategy is time tested and it works.
Now let's take a look at what happened last week by region and consider the investment implications going forward.
Approval of the third bailout by Greece and members of the eurozone was the main news out of the region last week. It is clear to many members of the eurozone, the IMF and to me that Greece's economic and financial problems are far worse than initially believed and that the probability of success even with this bailout is very low. The IMF believes that the euro does not work in its current form and that the eurozone needs major financial and regulatory reforms to succeed. Sound familiar? It was obvious that the ECB granting Greece another 85 billion euros over three years would weaken the euro and it did, with the currency falling below 109 to the dollar. Germany, ironically, is the clear winner of a weaker euro, benefitting from cheaper exports, although the government won't admit it. The European stock markets rose and interest rates fell in Spain and Italy, but rose in Germany. Basically, the can was kicked down the road and Greece exiting the euro was postponed for another day. Major change is needed in the eurozone if it is to become a meaningful global economic unit.
Doubts remain about China despite the continued rally in the stock market and a reported 7 percent gain in its economy in the second quarter. Chinese banks lent a staggering $209 billion to margin lenders to stabilize the markets. My concern is that the government is resorting to short-term fixes that run counter to long-term goals. I was bothered that outstanding loans for companies and households rose to 207 percent of GNP at the end of June, up from 125 percent only seven years ago. China has not de-leveraged, as have the United States and Europe. I still hope that the government enacts programs to reduce leverage and excessive risk to build a sounder foundation. Fortunately, the government has the resources to smooth the transition to a consumer led economy. It will take time and patience, but I am confident that China can sustain long-term growth over 6 percent per annum.
The economic outlook for the United States seems pretty good. The Fed's Beige Book was released last week, confirming a continued improvement in the domestic economy, with a pick-up in employment. Important data points reported last week included a 0.3 percent increase in industrial production. Capacity utilization rose to 78.4 percent, housing starts rose 9.8 percent, consumer prices rose 0.3 percent in June (but only 0.1 percent over the last year), producer prices rose 0.4 percent, import prices fell 0.1 percent, the budget deficit remained near a seven-year low and retail sales, the big measure, fell a disappointing 0.3 percent in June.
Fed Chairwoman Janet Yellen reiterated her view that the first rate increase will come this year and that future increases will be scattered and moderate, depending on the economic data points. I believe that the Fed is hamstrung by problems overseas, strength in the dollar and weakness in commodity prices. The dollar hit a 10-year high last week.
Finally, if it matters, the White House cut its projections for growth in 2015 and 2016 to 2.0 percent and 2.6 percent, respectively, and lowered its inflation forecast.
I should add that the nuclear deal with Iran appears to be moving forward and its impact on oil prices declining was seen right away. In addition, Japan lowered its growth targets for 2015 and 2016 and maintained its commitment to expanding the monetary base by $648 billion over the next year.
My core beliefs remain intact so I see no reason to change my positive fundamental outlook for stock markets, while remaining negative on bond markets as the yield curve steepens. But what became crystal clear last week was that all stocks are not alike and there are tremendous opportunities to make money if you recognize and invest in change.
I mentioned earlier GE, Google and the banks. But the list could go on and on as their managements are acting as their own activists and are dramatically altering their business plans to succeed in a slow-growth, competitive world. I have never seen such broad-based movement in companies large and small. And it is starting to happen overseas, too.
The bottom line is that U.S.-domiciled companies are leading the way in change. In addition, our economy is acting better than most others and has also built a strong foundation for the future. The dollar is showing the way. A successful investor needs to be patient and let change play out, as the benefits over time will be enormous. My biggest concern are the lack of economic growth and politics. But the positives far outweigh the negatives.
