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Flying High

The Days Ahead:
Big earnings week in Europe and U.S. jobs.

It was an earnings week. At both ends of the economy we saw Facebook and Boeing report very strong numbers. This is worth a moment. They're up 50% and 53% so far this year. Facebook is now the fourth largest company in the S&P 500, valued at $500bn or $29m per employee. It's worth more than Amazon. Boeing is the 33rd most valuable company, employs 150,000 or 10 times more than Facebook, is worth about one quarter of Facebook and valued at about $900,000 per employee. Boeing ranks 24th in sales in the S&P 500. Facebook is barely in the top 100.

Why all these fun facts? Well, it seems as if both the growth and industrial side of the stock market story is intact. On the growth side, the big leaders (I’m not going to say it…oh, all right FAAMNG) have delivered 20% to 80% earnings growth, er….except Amazon, which has a pact with the market not to make money until it eliminates all competitors, and, all right, ignores Google’s $2.8bn fine from the EU. Anyway, plenty of growth.

Boeing stunned every analyst on the street, generating twice the amount of free cash flow than what the street was expecting. But that's not all. They plan to increase their stock buyback program, return all its free cash flow to shareholders and pre-pay pension commitments that are due over the next four years. In a world of massively underfunded pension plans, that’s a stunner. Oh, and they're cutting 6,000 jobs.

So, at the risk of oversimplifying, we’d say this is what the stock market is about in 2017. It has nothing to do with politics, tax cuts, border adjustment taxes, infrastructure, the promise of 3% growth or any other midnight tweet. It's about steady growth and efficiency from blue-chip companies and spectacular growth from “winner-take-all” tech companies. And that's more than enough.

1. Happy Birthday Mr President:
No, not that one.  Five years ago, President Draghi of the ECB delivered the most memorable Central Banker speech (wait don't change the channel). You don't have to read it (here if you do) but it said that it would do “whatever it takes to preserve the Euro”. This was at the time when you could have made a small fortune if you had a dollar for pundits lining up to curse the Euro to oblivion, that you could not have “monetary union without fiscal union”, that Europe was bound to implode. All made the mistake that Europe is very well aware of its history and that an imperfect union was worth the effort. The ECB, indeed, saved the Euro.

It was a time when Portuguese and Spanish debt was selling at 8% to 15%. Now look. All but Greece borrow at cheaper rates than the U.S. Europe is not out of the woods. Its banks are mostly undercapitalized and recent bailouts in Italy repeated the mistake of preserving debt holders at the expense of taxpayers. Corporate earnings are better but can be improved. But, confidence is turning. Last week we had a barnstormer report from the German Business Survey.

This is what stocks have returned for the year to date and compared to the U.S.

For a U.S. investor, it'sthe top line that counts. Stocks are up 17% compared to the S&P 500 of 10%.

2. Back to U.S.:
We had the Fed meeting and the first estimate of Q2 GDP. On the first, the report only differed marginally from the June report, and the June 2016 report too. Weak inflation, near term risks (read Washington), modest household and business spending. The news was that they intend to start reducing the balance sheet in September. The Fed has done a masterful job at making this as boring as possible. The unwind is coming but we don't think it will be the slightest bit disruptive.

On the GDP, we all knew that Q2 would be better than Q1, coming in at 2.6% compared to 1.2%. Personal consumption (69% of GDP) was up 1.9% but that's down on a year ago and a good chunk of it was more spending on utilities, financial services and healthcare. Not exactly discretionary purchases. Employment costs rose but so did benefit costs so really not sure how much of that is going to feed into final demand.

Anyway, we’re bang in line with the long-term average, which is a ways off the 3% growth bandied around by those who should know better.

Bottom Line:
We're halfway through earnings season and it’s a barnstormer. The blended growth is 9% and even without the energy sectors (which is up more than 300%) the numbers are impressive. The market trades at 17x earnings. Which is exactly where it was last November. So the 13% performance since then is almost entirely earnings driven.


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Bloke owns a Ferrari 430 Scuderia for an hour.

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--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.