My head swirls listening to the pundits every day. When the markets rise, we hear why it will continue up and when it falls, like last week, the same "wise" men tell you why that trend will continue.
These experts very rarely step back, review all the facts, reflect and invest accordingly.
Everyone appears to be a trader and attempts to pick the tops and bottoms of every market move. Maybe that is why the pros are underperforming so badly. They are smart to a fault. Yes, we live in a volatile world and events influence daily actions, but it is critical to differentiate between short-term trading swings and long-term investment trends. That is what we do best and the reason we have outperformed all averages by a wide mark for 35 years.
This was a newsworthy week and there were a lot of events to chew on. Before I get to them, I'd like to suggest that you read two small pieces that I wrote during the week in response to specific events that I found particularly relevant to investing in today's environment: "What if Greece Leaves the Euro" and "Buffett's Message."
Keeping things simple, here’s what I see happening if Greece left the euro:
1. Greece would return to the drachma, which would be significantly devalued against the Euro.
2. The euro would rise in value since weak countries such as Greece have held it down.
3. European stock markets would decline, hurt by a rising euro and potential bank write-downs of Greek debt.
4. The European economies would be hurt and Greece would enter a deeper recession.
5. All financial markets would go down initially, like when Switzerland revalued but then recovered over time.
Greece proposed its list of reforms on Saturday to hopefully satisfy the ECB and its own people. Even if they are accepted, lots needs to happen, including realization of their objectives.
I doubt whether Greece can live up to its previous agreements with the ECB to get funding, but I also believe that the ECB needs to be more understanding of the situation and more flexibility regarding past terms. It remains to be seen what happens.
"Buffett's Message" dealt with the reverse merger by Heinz, a 50 percent Berkshire Hathaway company, with Kraft. Buffett continues to focus on strong management, with sound strategic objectives, tight cost controls, strong financials and positive cash generation.
I might add that this was a brilliant financial move as it was tax efficient to Berkshire and took a private company, Heinz, to a 50.5 percent owner of a public company, Heinz Kraft. Buffett has made over 300 percent in two years owning half of Heinz with Oz.
The second point of this piece was that this really is a market of stocks rather than just a stock market. I draw your attention to Dow Chemical's move at the end of the week, utilizing a Morris Trust transaction by merging its chlorine business with Olin and gaining over 50 percent of the new public company. Dow reaped over $5 billion in value on the deal for its shareholders without paying taxes and continued to shift its mix to value-added, higher margin products. As Andrew Liveris, chairman of Dow, said on Friday after his deal with Olin, we are our own best activists. Congrats to both. Great deals.
The key event of the week was clearly the impact of the civil war in Yemen on energy prices and the way its neighbors responded—particularly Saudi Arabia. The real battle throughout the Middle East is a sectarian conflict between the Sunnis and the Shiites. Saudi Arabia has assembled a coalition of Sunni states to fight in Yemen against the Iranian backed Shiite Houthi rebels. Take a look at a map of the region to understand the importance of Yemen for its shipping lane, where 3.8 million barrels move per day. The price of oil rose dramatically during the week, but they fell on Friday as tensions eased.
Two conclusions can be drawn from these events:
1. Energy independence should be a top priority for the U.S. to ease its dependence on the price of oil.
2. The U.S. is totally ineffective at influencing policy in the Middle East and elsewhere.
If there is an agreement reached with Iran on its nuclear development and sanctions are eased, significant new supplies of oil will enter the market, pressuring prices further. Watch carefully as events unfold in the Middle East.
Let's take a look at events in other key areas of the world:
While fourth-quarter GDP was reduced further to 2.2 percent and first-quarter projected results were reduced to less than 1.0 percent, we remain optimistic about the rest of the year and 2016. The key to growth remains the consumer; consumer spending actually accelerated in the fourth quarter to a 4.4 percent rate of gain. Offsetting factors were relatively weak exports, a downward revision of inventories and government spending and weak reported profits, which are understated. I’m closely watching economic data for April to see if the economy accelerates as anticipated after a very harsh winter. I expect it will.
Federal Reserve Chairman Janet Yellen spoke on Friday and acknowledged how Fed policy is being influenced by a strong dollar and weak growth overseas. In addition, she stressed that the path in interest rate policy after the first increase will be very gradual, unless the data suggests a different course of action. While the financial markets may pause after the first funds increase, I expect the economy to keep rolling along. I find it hard to fathom that the 10-year bond is below 2.0 percent at this point in our economy. An improving economy and higher inflation will be good for profits and more than offset any small increase in rates.
Harry Reid's announcement that he will step down as minority leader in the Senate could also have an economic impact. I have not been a fan of his policies and actions and believe that if Sen. Chuck Schumer assumes the role, his leadership of Senate Democrats will be better for business, financial companies specifically, and our economy.
Meanwhile, it is becoming increasingly clear that economic activity is improving in the Eurozone for the reasons we have mentioned many times before:
1. QE is having a positive effects on interest rates.
2. A decline in the euro has improved global competitiveness and exports.
3. The decline in energy prices has boosted consumer disposable income and spending.
The closely watched purchasing manager's index rose to a four-year high reading of 54.1 in March, indicating a sharp pickup in economic activity. Mario Draghi, head of the ECB, reaffirmed that the bond purchase program will continue at least until September 2016. But as I noted earlier, much will depend on how events unfold with Greece.
Finally, events in Japan and China continue to develop as anticipated. While inflation is being held down near the zero line in Japan due to declining energy prices, the call by government for corporations to raise wages is finding wide acceptance. Consumer spending is rising in Japan, while the unemployment rate has declined to 3.5 percent. Watch for policies to reduce leverage at the BOJ and the accumulated deficit of the government.
China's creation of an Asian Infrastructure bank has found traction, with many countries in and around the region joining as founding members. China has introduced initiatives to leverage hundreds of billions of dollars to finance major rail, port and other projects to assist in regional economic integration and global trade. China's government focuses a lot of its attention on its long-term goals as well as on the shorter-term needs of its economy. China's role as a major player on the world stage is being cemented by its actions, which is all good for the future.
Let's wrap this up and reveal why I advise investors to stay the course:
The harsh winter has had a huge negative impact on the level of economic activity in the United States over the last several months, but the key ingredients for resumption in 2.5 percent to 3.0 percent growth are in place. The consumer, which is over 60 percent of GNP, will lead the way, boosted by an increase in disposable income due to declining energy prices.
While many headwinds remain, like the impact of a stronger dollar on exports and reported profits from overseas operations, the U.S. continues to improve its competitive position in the world and improve its operating efficiencies globally.
Interest rates will stay historically low, influenced by strong foreign capital flows; the Fed will not raise rates until the fall at the earliest and the rate of increases will be gradual; the dollar advance will be gradual until growth overseas is more sustainable; the inflection point in European growth has occurred, but watch events in Greece next week; the foundation for sustainable growth has improved in China, Japan and India, which will add to global growth; energy and commodity prices will remain weak until supply, demand and inventory levels are in better balance and, finally, the financial markets will remain healthy. But all regions, industries and stocks are not equal.
It is time to stay patient, maintain liquidity and let events unfold. The global economies are in much better shape now than at any time over the last five years, but risks will always exist. Invest in companies recognizing the global competitive environment and the fact that companies are implementing strategic changes in goals to enhance growth rates and raise rates of return on sales.
Step back, review all the facts, reflect, decide on asset allocation, then regional industry and company selection and … invest accordingly.
