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The Days Ahead:
More earnings. China GDP for Q4 2017.
Oh boy. We i) had a rumor that China was planning to sell U.S. Treasuries, (not likely) ii) that the White House will use the State of the Union to withdraw from NAFTA (could happen) iii) that rates would rise faster than expected (no, again) that iv) the Cyclically Adjusted Price Earnings (CAPE) ratio was heading off the charts and that v) a correction was imminent (probably not). Oh and JP Morgan kicked off an earning season with the news they lost $143m to a single client (true but that's around 6% of quarterly net income, so, meh).
But S&P 500 ended up near a record high again. It’s up 4% this year and 22% over the last 12 months. European and Japanese markets are up by even more, helped by dollar weakness. It’s all a combination of the U.S. tax changes, global growth and highly predictable and easy monetary policy (especially overseas). This is an ongoing trend. Remember the S&P 500 earnings grew 14% in Q1 of 2017, 1% in Q2, 6% in Q3 (hurricanes) and are reporting now for Q4 where the estimate is 11%. Elsewhere:
1. Bond Bears About:
Two people (Gundlach and Gross) who don't agree on much announced that the bull market in bonds was mostly over and that if the 10-Year Treasury closed above 2.63% (yes, accurate to two decimal points), then look out.
Why so urgent? Well, it’s mostly because of this:
Without belaboring the point, this basically says that some moving averages and technical breaks (not all shown here) mean that 2.6% is a key level. Throw in some tightening from the Fed, overseas central banks and a rumor, later denied, that China is about to reduce its $1.1 trillion of Treasuries (about 8% of the total) and we saw plenty of scare stories on bonds. But wait:
- We don't believe there’s a “normal” rate for the 10-Year Treasury. It ranged from 5% to 15% for 20 years after 1970 . Before that, the range was 2% to 6%. Since then, 1.5% to 6%. The rate reflects growth, inflation and monetary policy and there’s no evidence of what a normal rate should be.
- It makes little sense to use a long-term moving average (whether it’s a 100 months, as above, or 100 days) and then say it’s undone by two trading days. Big and long-term money simply doesn't move that fast.
- We'd point to the many times we've discussed the low growth of the labor force, low productivity, low wage growth and an increasing dependency ratio (the ratio of employed to retired workers), as evidence of a slow growth slow inflation economy.
- Sure, some short-term pressures will affect the CPI and exhibit 1 right now is energy, with oil up 25% over the last year. It's about 10% of the CPI and meant the latest inflation print was 2.1%.
- The demand for long-term Treasuries seems pretty high and above the supply level (the Treasury is funding more at the short end).
- As long as China runs a trade surplus with the U.S., and it’s currently around $350bn, the only place they can put the money is into Treasuries. Yes, they can invest in the U.S. or buy stuff but those deals don't seem ever to be approved.
We could go on. But bottom line is that while the 2-Year Treasury rose above 2% last week for the first time in 2008, the curve just kept getting flatter and we don't see that changing.
What does all that mean? Long-term bonds are still a good bet, especially Treasuries where we don't have to worry about credit.
2. Should We Worry about Warren?
No. We saw an interesting break on Berkshire Hathaway (BRK.A) last week. The “A” shares ran over $300,000 and on Friday traded at $314,000. To put that in perspective remember the stock has never split and is, by far, the most expensively priced stock in the market. The next largest is Priceline at $1,900 and Amazon close behind at $1,300. One reason BRK has never split is to highlight how far the stock has come. The earliest price we found is from 1976 when it was $67. So, that’s a return with so many digits that it's easier to think of as if you had invested $25,000 in one share, you would now be worth a cool $117m.
It’s outperformed the S&P 500 by so much the charts aren't even fair. So let’s look at it against Apple, our favorite phone company.
Yes, it’s time point dependent. But our point is that well-managed businesses, given time to grow can make for spectacular returns. We've always liked the growth in book value of the company, which is pretty much unbroken for 30 years. Mr. Buffet has always said he will buy the stock if it trades below 120% of the book value, something, he says, is hard to do. Today it’s around 160% against a long-term average of 150%. To us, that offers some protection.
Anyway, last week, BRK broke with a long tradition of not announcing any successor by naming two vice-chairmen, one from the reinsurance business and the other from the energy side. The market trusts both and we’re pretty certain that either will keep the company intact and that its core businesses (BNSF, GEICO, General Re and Precision Castparts) will do very well in cyclical growth. It also currently pays a 27% corporate tax rate so the new 20% rate will grow EPS by 11%.
Bottom Line: Earnings start up in earnest and we’re looking for CEO commentaries on taxes and growth. Expect more bond scare talk but much of the price action is seasonal. We expect a 2.5% to 2.7% range for a few months more.
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Startups (but not incumbent companies) sensitive to corporate tax rates
Fox business news
JP Morgan lost $143m on a single client (p3)
--Christian Thwaites, Brouwer & Janachowski, LLC
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