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Before reading Berkshire Hathaway's third quarter report (NYSE: BRK.A) (NYSE: BRK.B), we were going to titrate this week's text entitled "What's wrong with an economy?" strong (especially if inflationary pressures were under control)? Buffett has bought for nearly $ 13 billion worth of shares, bringing the total recorded so far this year to a record $ 24 billion over four years. If Buffett has found sufficient value in the third quarter, imagine what he bought in October using its huge excess liquidity, markets falling more than 5% from September 30.
Buffett has already indicated that equities are his preferred asset class, with earnings performance far exceeding bond yields, valuations of private equities and real estate. The recent Berkshire report made clear how lower tax rates and changes in depreciation boosted earnings, cash flows and after-tax returns on equity.
Corporate America not only continued to post huge gains in profits, up more than 20%, also in the third quarter, but also a significant improvement in cash flow, free cash flow and return on equity. Companies not only increase their dividends and buybacks, but reinvest in their business, which will increase future earnings. It is clear that earnings comparisons will harden next year, as lower tax rates are a one-time event, but capital investments, strict cost control, technological advances and share buybacks should result in another gain above average corporate earnings / shares in 2019.
The stock market multiple at less than 16x earnings is too low, the 10-year Treasury yield being less than 3.2% and banks' capital / liquidity ratios at new heights. Stop looking at historical multiples as long as 10-year cash remains well below historic ranges.
This brings us to what we wanted to talk about this week and what is wrong with a strong economy as long as inflationary pressures remain under control. We smiled when the experts said that last week's job report may have been good for Main Street, but bad for Wall Street. It's ridiculous! As Kudlow says, "economic growth is the path to prosperity".
The non-farm payroll increased by 250,000 and the unemployment rate remained at its lowest level in 48 years, as more people entered the labor market. Gosh, it's terrible. Do not! The concern was that hourly wages had risen 3.1% over the previous year, fueling inflationary anxiety with further increases in the federal funds rate. Keep in mind that productivity gains accelerated to 2.2% improvement in the third quarter, meaning real wages increased by less than 1%. In addition, inflation in the third quarter actually declined 1.6% from the previous quarter, below the Fed's 2% threshold.
We still expect the Fed to increase rates in December and twice or less in 2019, based on data points. We expect Powell to give up on his statement that the funds rate is well below normal and indicates that the Fed will adjust its rates based on its current view of economic growth and inflation. We continue to believe that the Fed's main concern is to raise rates too quickly, push the dollar higher, have an impact on global cash flows and slow our economy too much for one economy to perform well in the world. . Imagine the consequences if we refuse too!
Deflation is still a much bigger risk than inflation. Have you monitored housing starts, auto sales and prices of industrial products? None of them reflect an overheated economy and uncontrollable inflationary pressures. By the way, the widening trade deficit reflects a strong US economy and weakness abroad. Have you noticed persistent weakness in China, Europe and Japan? It only makes sense to assume that imports are growing faster than exports, despite the strength of the dollar.
The bottom line is that US growth is not only good, but necessary, with the slowdown in global economic growth. Powell is expected to pause after the December rate hike, monitor the data in the coming months and maintain an accommodative stance by keeping real rates low as long as inflationary pressures remain under control.
Trade issues remain a major obstacle to global growth. Business and consumer confidence plummeted as uncertainty delayed major spending plans. We remain confident that the United States will reach agreements with the ECB and Japan before China. We hope that Trump and Xi will agree that trade talks are reopened between our countries, but do not expect a quick agreement. If Trump postpones tariff increases and higher rates, markets will recover significantly. Do not miss their November meeting!
What do we do?
Listening to corporate conference calls has boosted the confidence that an investor needs to monitor the valley in a VUCA environment (volatility, uncertainty, complexity, ambiguity). Systematic e-commerce is the scourge of fundamentalists, because you do not need prisoners, but if you keep excessive cash, such as Buffett, you can get excellent investments at great prices by keeping a deadline. one to two years. We have rebuilt positions in many of our long-term core assets after teleconferences, with a bright future.
We invest in companies whose volumes, operating margins, cash flow, free cash flow and return on equity are on the rise. It is a diverse list of financial, industrial, capital goods, healthcare, cable, airline, steel and aluminum companies, technologies at a fair price for growth and many special situations in which internal changes add significant value. We expect the yield curve to increase, but not too much from there. The dollar remains the currency of choice.
In the end, growth is a necessity. The Fed must therefore be very frank, because the alternative is much worse. And we do not expect inflation to feel bad. Like Buffett, we see great value in the current market. Stay on course, keep the excess liquidity at all times and invest for the long term as trading is a losing proposition.
Finally, we expect this week's elections to be a non-event, with Democrats taking control of the House and Republicans retaining control of the Senate. We only want all politicians to put the country ahead of the party. Wishful thinking.
Do not forget to go through all the facts. pause, think and consider changes in state of mind; examine the composition of your assets with risk controls; do independent research and … invest accordingly!
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