The U.S. Economy and Stock Market
Fundamentally, the U.S. economy continues to be strong, and recent data indicate that the trend will continue.
Fundamental stock market indicators are bullish. Corporate profit growth is strong, exceeding 23% for the first six months. Strong corporate profits are positive and correlated with stock market appreciation. Strong corporate profit growth, exceeding 20%, is expected for the remainder of 2018. U.S. price-to-earnings ratios have fallen to 16.7, which is slightly below the long term average for U.S. price-to-earnings ratios. U.S. interest rates are slowly rising, and many are wondering why the Federal Reserve is raising them as fast as they are. The big U.S. budget deficit will increase the need to float more U.S. government bonds, and the flotation of bonds alone will force interest rates up gradually. For this reason, we believe that the Fed, while continuing to raise interest rates, will do so at a slower pace than expected.
At present, technical indicators are more negative.
As we have said, August is usually a difficult month for stocks. Much of Europe and part of the U.S. are on vacation and not paying attention. In recent years, European banking, bond, and currency markets have often been unsettled in August, and this year is no exception..
This August, Turkey has led the parade with a weak currency and a threat to buy a defense monitoring system from Russia. Turkey is a NATO member, and should not be buying any military product from Russia. Turkey also wants to buy F35 airplanes from the U.S., and the Russian software and hardware would make it very easy to monitor and judge the performance of the F35 — allowing Russia to determine weaknesses in the plane and possibly make their planes superior.
The U.S. is also concerned with Germany’s buying much of their natural gas from Russia, which makes them dependent on Russia for that important industrial and heating raw material.
Two questions are being asked. Will the Turkey problem spread and become a bigger emerging-market crisis — as, for example, the Thai crisis of the late 1990s spread to the emerging world? We think that this is possible but unlikely, and put the probability at about 20%. We are carefully monitoring this issue.
How about China? Their stock market is falling, with many fast-growing market leaders falling by over 20%. China was going through a normal reaction to a removal of liquidity from the banking system, and the Chinese government has for months been trying to crack down on the lenders in the informal lending system that are lending at high rates and making promises of outlandish returns. The government believes that they have been somewhat successful, and they have been adding liquidity to the formal banking system for a few weeks. We do not see a crisis occurring in China at the present time.
U.S. Stocks
In our view the current market setback is a normal correction of the type that we have had over 20 times in this bull market. Stock prices have been coming down to attractive levels, and we expect that stocks bought during this decline will be higher within a few months. Our favorite sectors for bargain hunting are: big disruptive technology companies, healthcare including hospital operators and some pharma and biotech, cybersecurity, financial technology providers, a few specialty retailers, and some travel technology and entertainment providers. With trade disputes and a strong dollar we are staying away from big banks and big U.S.-based exporters.
Non-U.S. markets continue to be unattractive for U.S. investors because of the very strong U.S. dollar. Foreign currencies are falling versus the dollar, and as a result, any foreign profits gained are greatly lessened in U.S.-dollar terms.
Gold
Gold and metals in general are under substantial pressure due the very strong dollar.
In spite of an increase in international tensions, a rising inflation rate in the U.S. and many other countries, and banking system problems in Italy, currency problems in Turkey and other concerns, gold has broken down from its trading range and pierced the $1200 range. We continue to believe that gold, all metals and many other industrial commodities will be under pressure as long as the U.S. dollar continues its rapid ascent toward 100 on the DXY index.
Cryptos
The current crypto bear market lumbers on. Ether [ETH], the cryptocurrency associated with the Ethereum Network, dropped below $300, underlining the currency’s fall from grace as a one-time challenger to Bitcoin for crypto dominance. The bear market may be related more generally to problems with Ethereum, the platform used as a basis for many initial coin offerings in the past two years. Frequently ICO participants paid for their tokens with ETH, and the recipients may now be cashing out en masse, driving a downward spiral. The Ethereum network, which is meant to function as a platform for distributed applications, is still struggling with issues of network latency and throughput. This bear may not go away any time soon.
Thanks for listening; we welcome your calls and questions.
