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Earnings one day at a time

The Days Ahead: More earnings; first sight of Q1 GDP.

One Minute Summary The market definitely had other things on its mind last week. It was a short one to begin with and by Thursday, most eyes were on The Report or the long weekend. We're reminded that financial markets tend to ignore political events unless they’re really going to disrupt things. But the bar is high these days and a divided Congress and polarized opinions is really nothing new.

Healthcare stocks were down around 5% especially the big insurers who stand to lose most from any move to universal access. Somehow, we think they'll still be standing post any reforms. Economic data was better than expected including the consumer sensitive retail sales. Growth in China seemed to stabilize. Companies continue to report decent earnings but there were mostly modest beats and no big moves. The market liked the Apple/Qualcomm patent deal resolution. Qualcomm was up 42%. Not bad for a $96bn company but only back to where it was in 2014.

1.     Recession Watch. As we've mentioned several times, we don't think a recession is around the corner. But Wall Street economists, academics and the Fed all have pretty dismal records when it comes to recession predictions so we’ll not claim special insight. Our thinking is that we've seen modest, slow growth since the Great Recession with no big consumer-led credit bubbles. That kind of pattern is more in line with a slowdown than outright recession. Of course there are a ton of variables that can change things quickly. Trade, budgets, China growth, tariffs. Name it and there’s some chance that it could happen.

But we do know that the Fed looks at the big ones like GDP, change in nonfarm payrolls, PCE inflation and the unemployment rate. These are all lagging or coincident indicators. So they also look at forward-looking indicators including retail sales, industrial production, durable goods and the ISM surveys. We'll look at these in coming weeks but the short version is that none are critical right now.

We view initial claims as important, simply because if you're laid off, you have every incentive to file an unemployment claim. They also come out weekly and tend not to have revisions unless there are things like natural disasters. The recent claims numbers are around 192,000, which are the lowest for 50 years even when not adjusting for population growth. And if we adjust for workforce growth, we see claims are 0.14% of all workers, which is the lowest it’s ever been. Recession peaks for claims and claims as a percent of workforce were 680,000 and 0.4%. So, yes, we've come a long way.

But two things make us cautious. One, the number of people eligible for unemployment benefits plummeted. Put another way, the insured unemployment rate, here in the green line, is only 1.2%. That means two thirds of all unemployed receive no benefits at all.

Very low rate of insured unemployed

That may be because of i) the gig economy or ii) people have not built up enough time in the workforce or iii) workers have reached their limits.

And two, (h/t Capital Economics), is that states have changed eligibility rules drastically in recent years. Some states simply exclude certain professions from unemployment benefits. So hard luck if you’re a real estate or insurance agent, student nurse, intern or part time in some states. You're not covered. Also, some reduced the duration and eligibility of benefits. In the case of NC, for example, claims fell 80% following benefit reductions compared to a national average of 50%.

So what? Well, claims may not be the reliable indicators it was. We feel that the labor market is weaker than it looks, hence our position that wage and price inflation will remain low.

2.     Germany. Any news? Germany is very important in the global economy, where it’s number four in the world, but less in stock market terms, where it's not even in the top 10. In fact, the top three companies in the U.S. have a higher market cap than the entire German stock market, with some change to spare.

But the market is important not least because it serves as a bellwether for the EU block. Last year was rough for German stocks. U.S. trade tariffs, Brexit, low interest and new EU auto emissions all hit the auto companies and banks, together over 40% of the index, hard.

This year, it’s been a much better story. The market is up around 16% for U.S. investor, outperforming the U.S., and is one of the strongest in Europe. It’s not because all has turned around. More that things stopped getting worse. Major indicators like industrial production, capital investment and exports bottomed out in the last few months and that’s after the economy narrowly missed a technical recession in 2018.

The market has always traded at a discount to the U.S. That’s more to do with the sector make-up of the index. The U.S. market has around a 30% weighting to tech. With Germany it’s less than 2%.

German stock market cheap

Current valuations of German stocks are 74% of the U.S., less than the long-term average of 80%. At these levels, we think they’re worth holding.

Bottom Line: It’s a micro, not macro market right now. And we wouldn't have it any other way. It's clear the economy is slowing but not halted, the Fed is hands-off and Treasuries low and stable. We'd like to see solid earnings with stable margins and no surprises.

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Dog swims 130 miles out to sea 

 --Christian Thwaites, Brouwer & Janachowski, LLC 

Please note that this discussion of our investments and investment strategy (including our research and investment process) represents our investments and investment strategy at the date of this commentary, and is subject to change without notice.  We cannot assure that the type of investments discussed in this commentary will outperform any other investment strategy in the future, nor can we guarantee that such investments will present the best or an attractive risk-adjusted investment in the future. This is for general informational purposes only; references to an individual security should not be construed as a recommendation to buy or sell that security.  The securities mentioned in this commentary are only several of the successful as well as unsuccessful investments by us, and do not represent all of the securities we have purchased, sold or recommended.  Although we deem reliable the sources of the statistical and other information referred to in this commentary, we cannot guarantee the accuracy or completeness of any statements or numerical data.  Past performance is no indication of future results.

All charts from Factset unless otherwise noted.

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