Global Market Commentary

Second-Quarter U.S. Earnings Come In Strong


93% of S&P 500 companies have reported second-quarter earnings; the remainder will continue into early Sep-tember. As of this writing, bottom-up earnings for the S&P stand at $32.63, representing a 5.9% quarter-over-quar-


ter increase and a 10.6% year-over-year increase. In short, earnings are strong — and with four quarters of earnings growth under our belts, we can say that the 2015–2016 “earn-ings recession” is firmly behind us.


Earnings growth has been led by energy, technol-ogy, financials, and healthcare; the sectors with the most companies beating estimates have been tech, healthcare, industrials, and financials. On average, operating margins have again reached record highs.


U.S. multinationals were another point of strength. 55% of U.S. companies in the top 10% of foreign exposure have beaten on both EPS and sales, com-pared to 30% of companies with pure domestic exposure. Those beats have been driven by com-panies with exposure to emerging markets; 60% of those with high EM exposure beat on their top and bottom lines, while only 37% of those with high European exposure did so.


We listen to many company earnings conference calls, and the sentiment being expressed by man-agements has in general remained strongly posi-tive, often commenting on improved demand. The beneficiaries of secular technological trends have been particularly optimistic, but so have cyclical companies experiencing strong demand growth. Sentiment is positive on Europe, but even more positive on demand in Asia, and particularly in China. Many companies have commented on the success with which productivity improvements are enabling them to offset cost pressures.


In short, the developing 2017 earnings picture is reinforcing many of our views about the current state of the U.S. and global economy and stock markets.


The continued weakness of the U.S. dollar will benefit large U.S. multinationals by supporting foreign demand for their goods and services. The strength or weakness of the dollar contin-ues to be a key variable, and investors should

watch it closely.


  • Global demand continues to be supported by a coordinated global uptick in GDP growth. (Over the weekend, for example, Japanese data came in showing an annualized GDP growth rate of 4% in the second quarter. This is the strongest growth streak in Japan for more than a decade.)
  • Within the U.S., while benefits are continuing to accrue to some cyclical companies which pre-viously benefitted from the “Trump trade,” more benefits are accruing to secular growers in tech-nology, where growth can continue independent of political vicissitudes. In the absence of deci-sive government action on taxes and infrastruc-ture, the market is continuing to favor growth stories in technology.


Investment implications: We remind readers again that the period between mid-August and the first half of October is often a difficult one for the U.S. stock market. If this year follows the usual sea-sonal pattern, we believe that it will pres-ent buying opportunities. Global eco-nomic fundamentals remain favorable


particularly economic growth and mod-erate U.S. dollar strength. Global cen-tral bank policy, although coming closer to an inflection, remains supportive as well. We believe that investors should use weakness to add to positions, particu-larly in the stocks of large U.S. technology companies, many of which remain cheap from the perspective of future earnings growth. We continue to prefer manufac-turing-based emerging markets both to EM commodity exporters and to Europe.


India: Challenge and Potential



It’s been a strong year for emerging markets. The coordinated uptick in global growth which began midway through 2016 has helped propel them forward. Fears have faded of a global trade war prompted by the Trump administration, and some of the initial victims of Trump angst, such as Mex-ico, have been outstanding performers in 2017.


Last week, we wrote about China, describing why we don’t buy a lot of the narrative of mainstream financial media about the Middle Kingdom, why we think the next five years will be much like the past five years, and what principles we use in our own China investment strategy.


In this article, we’ll briefly address one of our favor-ite emerging-market stories: India. We’ve written often on India; here we’ll summarize why we think India has potential, what current developments are most promising, and where the pitfalls are that investors should watch for.

(Investing in individual Indian securities is impracti-cal for most U.S. retail investors, but there is a wide variety of ETFs available, including several funds with broad Indian exposure as well as more spe-cialized offerings for those who want exposure to Indian consumer stocks, small-cap companies, and infrastructure firms.)


As we noted in a recent letter, India is now the fastest-growing major economy in the world. Although it is relatively small — comprising 3% of world GDP compared to China’s 14.8% and the U.S.’ 22.3% — its growth has lagged China’s during the Chinese boom of the past three decades.


The reason for India’s relative underperformance


  • why there hasn’t been an “Indian miracle” to parallel the Chinese miracle — is political. China’s tight central control permitted it to exploit its demographic advantage, a large and cheap labor supply, and leverage it to develop rapidly.


India, on the other hand, throughout the same period, presented the problem of dysfunctional democracy. Its tax, regulatory, and social wel-fare policies were based ultimately in the Fabian socialist mentality that shaped many of the earliest 20th-century advocates for Indian independence, and the country paid a high price in lost opportu-nities for growth by employing this highly flawed model. While China turned into a manufacturing and export powerhouse, India languished, with a distressing proportion of its population remaining illiterate subsistence farmers held down by a cor-ruption that utilized the vast socialist bureaucracy to insert itself into almost all transactions and into all dealing with the government, national, state or local.


This is one reason why global investors were galva-nized by the 2014 election of Narendra Modi and the ascendancy of the Bharatiya Janata Party (BJP). Modi is determined to shepherd India through the changes necessary to make it attractive to for-eign investors and competitive as a manufacturing economy on the global stage. Where his prede-cessors didn’t want to take their medicine, Modi understands that the path to development is well-worn, tried and true, and ultimately unavoidable


  • from low value-added manufacturing to higher value-added manufacturing and services.


It will not be quick or easy. The Indian Prime Min-ister is not the General Secretary of the Chinese Communist Party. Modi has to lead rather than simply command; he has to deal with political adversaries opposed to his program and still dedi-cated to India’s failed development model (and the profits for the corrupt that the old model created).


Here is what he has achieved so far:


  • Convinced many voters that he can clean up tax evasion and rein in government bloat and corruption — firing those who demand bribes and take pay while not showing up for work;
  • Won many seats and elections in the states that had previously been the bastions of the old economy’s corrupt practices;


  • Lifted many limitations on foreign direct investment;
  • Reformed bankruptcy laws to help clean up balance sheets and speed the resolution of bank-rupt companies;


  • Withdrew much of India’s cash from circulation in an effort to combat corruption and tax eva-sion. The cash was later reissued, and tax cheats were identified and punished by loss of capital or by having to pay undeclared taxes;
  • Implemented a countrywide sales tax to smooth interstate commerce and logistics; and
  • Continued the rollout of a nationwide biomet-ric identification system to allow transfer pay-ments to individuals and reduce corruption.


Foreign observers have criticized many of Modi’s efforts, believing that they would be so disruptive that they would end up harming economic growth rather than helping it. These criticisms have so far proved completely incorrect, and his reforms have in fact helped strengthen his party. The BJP controls the Indian parliament’s lower house; the upper house on the other hand is primarily appointed by the governments of India’s states. Slowly, public enthusiasm for Modi’s reforms is bringing the BJP closer to control of the upper house — this is expected to happen by mid-2018, and will allow Modi to make more rapid progress.


What remains to be done?


  • India’s financial sector is burdened by a lot of bad debt accumulated after the financial crisis, and the banking system needs to be recapitalized. The new bankruptcy law was one step in this direction, but further action is needed.
  • Labor laws are restrictive and need to be reformed to ease hiring and firing and encourage manufacturing enterprises to grow.


  • Land acquisition  is  torturously  slow  andexpensive, particularly for manufacturing and infrastructure projects.


    • Much transportation, energy, and communica-tion infrastructure is poor and creates logistical hurdles for business. Easing legal barriers will permit an acceleration of infrastructure invest-ment that can also support Modi’s efforts to pro-mote India as a manufacturing destination.


    Finally, we note one critical factor facing Modi and his development push. He is fol-lowing a well-established development playbook: encourage the use of India’s abundant cheap labor to make it a manufacturing power, and leverage that success into further development. Indeed, Indian demographics are favorable for this strategy; China is already facing unfavorable demographics, while India’s population will be growing well into the 21st century.


    While we think that India has some time, they have to hurry. If India doesn’t shift its regu-latory climate fast enough, when it tries to redeem its “demographic dividend,” it may discover that the robots have diminished it. Modi is, in a sense, in a race against time, and eventually he may be hurt by technological progress. His track record since






    Market Summary


    Markets have recently enjoyed good news from U.S. and international earnings reports. This good news has overwhelmed fears about Korea.


    We remain bullish on the U.S. due to currently strong growth prospects and the expectations of many corporate management teams that their businesses will continue to strengthen. In our view, the technology sector of U.S. and Asian econ-omies will grow rapidly, U.S. industrial companies will grow steadily, and niche technology areas likehis election suggests that he has a good chance of success. That track record suggests to us that India remains an excellent long-term investment.


    We will watch particularly after the BJP gains control of both houses of parliament to see that it is able to make progress in the reform of labor and land acquisition laws — this will be the most important step forward in Modi’s vision for India’s development.



    Investment implications: We look favor-ably on India as a long-term investment theme; we think Narendra Modi’s track record as Prime Minister shows that he has the political skill to achieve difficult and critical reform goals and spark Indian eco-nomic growth. He is in a race to reap the benefits of India’s favorable demographics. 2018 will be an important year to watch, as his party potentially gains control of both houses of India’s parliament and begins to move through extremely important labor and land acquisition reforms. While retail investors cannot typically buy individual Indian securities, there are many ETFs available.










    video games, e-sports, social networks, cloud com-puting, cybersecurity, e-commerce, and financial technology are the areas where investors should have a good part of their focus. Other strong ar-eas may be biotechnology and non-U.S. currencies, especially the euro. We anticipate that demand for stocks has further to run over the next year or two. We suggest that investors take any oppor-tunity to buy stocks during U.S. and global market declines occurring in the next few weeks.


Non-U.S. Bonds, Currencies, and Stocks                     Gold


Income investments in Brazilian bonds still make sense. We expect Brazilian interest rates to fall further. The dollar has given many weak technical signals. We believe that over the next few months, the U.S. dollar will fall in value against some for-eign currencies. We are especially bullish on the euro and view it as a good way for international investors to hold their cash. Equity investments in Japan, India, China, and Thailand can be considered on market corrections.

Gold looks like it can move above $1300/ounce in August. Sometime in mid-September, gold could get a price correction. It is not a positive that gold has risen only modestly over the last few weeks while the Korean situation has dominated the news.


Thanks for listening; we welcome your calls and questions.