The Investing Decision
While dramatic market rotations make for interesting discussion, trying to trade these rotations is treacherous. Equally dangerous is trying to ride momentum, as yesterday’s technology buyers learned today. Cooler headed investors must elevate their market observations to determine whether to be “in” the game at all. Here are the variables current investors must consider:
- Global GDP growth running 3-3.5% with broad international participation
- US GDP growth running 2%+
- S&P 500 corporate earnings growth solid – 2017e 10% higher, 2018e 12% higher
- Inflation expectations subdued - 5 year forward inflation expectations currently 1.87%
- Interest rates anchored - 1% Fed Funds rate, 2.2% 10 year Treasury yield
- Central Bank Policy accommodative – ECB at 0%, Fed hikes next week to 1.25% then stops
- Valuations fair given prevailing interest rate environment – 3% Treasury = 33x S&P 500 PE
This array of positives encourages equity ownership. Whether you want to overweight the reflation trade or the secular stagnation trade is a secondary decision. That’s the difference between investing and trading. The investing decision determines participation, the trading decision determines preference.
Assessing the Tail Risk
Wall Street loves to emphasize and debate lower probability events. Discussing the slow grind higher in the economy/markets doesn’t boost viewership like discussing impeachment. To that end, there are always a list of knowable positive and negative surprises swirling about. Currently, the negative tail list includes Trump impeachment, trade wars, Chinese economic collapse (always on the list), large scale terrorist attacks, North Korean nuclear games and tensions in the Middle East (also always on the list). On the positive tail list we have the potential for tax reform, regulatory reform, health care reform (also a tax cut), infrastructure spending and capital repatriation. This list requires legislative approval, which may seem improbable, but less so than impeachment? The risk of a tail event, based upon the knowable, clearly tilts to the upside. Remember, surprises can be negative or positive.
Bottom Line: Based upon the backdrop of growth, earnings, inflation, interest rates and valuation, you should own this market. Whether you want to own the pro-Trump reflation constituents or the anti-Trump secular stagnation constituents is up to you. Either way, you likely win as the rising economic tide lifts all boats. Lastly, “tail event” discussions engender fear and greed, currently juxtaposing impeachment vs. tax reform. If the probabilities of negative tail events heavily outweigh the probabilities of positive tail events, investment hedging is warranted. Based upon the current array of tail risks, our assessment finds risks tilted to the upside. With the fundamentals favorable and the risks to the upside, the debate between which trade wins in the short run is fun…but superfluous.
Have a great weekend!
David S. Waddell
CEO, Chief Investment Strategist