A Message from Baron The U.S. Economic & Stock Market Outlook

Greeting Everyone!
My last U.S. Economic and U.S. Stock Market Outlook report was January 10, 2017. So how has my forecast panned out? Answer: So far so good!

In that report I foresaw a positive economy and stock market and expected that if Trumps economic policies were implemented that 2018 would be set up to be one of this country’s best performing stock markets of all time. I also said we would know a lot more by June or July and we do and so I am updating my forecast accordingly.

So what do I see in my crystal ball now? Once again I will bullet point the positives and negatives with my Outlook/Forecast at the bottom.

Positives

  • U.S. economic growth is accelerating.
  • Consumer and Business Confidence is soaring.
  • U.S. inflation is decelerating. It has slowed to around 1.4%.
  • Wages are up 2.5% for the year.
  • Average hours worked are up 2.0% for the year.
  • Real GDP up 3.1% for the year. That’s very good and the trend is accelerating!
  • Job growth is accelerating.
  • Corporate profits are surging. Both Durable Goods and Capital Goods hit a 33 month high recently.
  • The Global Economy is showing signs of life with the IMF revising their world growth forecast to 3.5% (Note, the IMF routinely over estimates world growth but even if they once again overshoot it’s a trend in the right direction.)
  • Trump has frozen or rolled back regulations. Some 1,731 Preliminary Proposals or Final Rules have been contained. New rules and regulations are down 40% since the peak under Obama in 2011. New rules and regulations are at a 17 year low under Trump. This is hugely bullish for the economy and stock market. No wonder Business Confidence is soaring!
  • Small investor negative stock market sentiment. Fearing the stock market is overpriced small investors have been selling and thus liquidity is growing.
  • Stock markets worldwide are undervalued 5-10% across all major sectors!
  • Worldwide inflation is decelerating! That’s like a tailwind for the world’s economies.
  • It is unlikely the Federal Reserve will raise interest rates anymore this year due to decelerating inflation.
  • On the horizon tax reform, specifically tax cuts for small businesses. This is where most of our job creation occurs.
  • Also, we currently suffer from the highest corporate taxes of any major country in the world. A lower corporate tax would be great overall but is also expected to dislodge and allow the repatriation of trillions of dollars held overseas. Did you know that over 80% of a cut in corporate taxes winds up going to workers in the form of pay increases? Makes you wonder why anyone would be against it???
  • Illegal immigration is down substantially with more reforms coming.
  • Trumps very positive energy policies have helped reduce energy costs which are a major expense to businesses and families.
  • Japan’s economy, the world’s third largest, is soaring! This helps the world and thus the U.S.
  • Many of my listed negatives from my last report in January, 2017 have gone away! I’m finding it harder to find major negatives this time around!
Negatives   
  • Eurozone growth seems to have peaked. Spain, Italy and France are laden with debt, over taxation, poor demographics, and bad immigration policies. The EU is the world’s second largest economy.
  • China continues to struggle taking on more and more debt. In the first five months of 2017, China has added more debt than the United States, United Kingdom, European Union, and Japan combined.
  • The Republican led Senate failed to repeal Obamacare and not one Democrat stood up to help the situation. This is bad economically and bad from a confidence standpoint as well as a healthcare standpoint. There is talk of a $40 billion dollar Obamacare insurance company bail out. This betrays the voters who will surely take it out on those Senators standing in the way of repeal and reform. Worst of all it doesn’t look like repeal and reform will even happen in 2017. This creates a bad atmosphere that hurts Consumer and Business confidence which in turn hurts the economy and the stock market.
  • Tax reform. Will we get it this year? It’s expected we will get some sort of watered down version but we expected Obamacare to be repealed and new market driven reforms to be developed. If we don’t get tax reform this year then Overall Consumer and Business confidence will suffer and thus the economy and stock market will suffer.
  • Corporate debt stands 30% higher today than at its prior peak in September 2008. Some of this debt was created buying back cheap shares of a corporations own stock. Fortunately corporate profits are strong and rising rapidly.
  • The U.S. Dollar has dropped 10% since the beginning of the year.
Outlook/Forecast

Stay the course! In May, 2017 I weeded the garden of my Baron Capital Management’s Globally Diversified Portfolio (currently mostly U.S. centric) of underperforming equities (These were primarily commodity based positions purchased to take advantage of expected inflation that never materialized and instead has decelerated!). We plowed our freed up capital across the remaining markets and sectors. This has proven to be a very successful move. However, at this time I see no changes that need to be made. For example, a few weeks ago technology stocks corrected and have since rallied back even higher. I expect more of the same from other sectors as their prices exceed their values and U.S. economic growth and corporate profits continue to accelerate.

There is a lot of talk, speculation and even fear that the U.S. stock market is overbought. This depends upon how you measure the market. I’ve seen various ratios supporting the argument that the market is overvalued but I prefer to use the Benjamin Graham approach to valuation which has withstood the test of time and is the same method Warren Buffet has successfully used his entire investing career. Using that measure the market is not overvalued. We have had a few overpriced sectors correcting while other underpriced sectors pick up their pace. These “rolling corrections” have allowed our markets to move higher and higher. From a “value” prospective our U.S. market is actually undervalued by at least 5% overall.

As for 2018. I still see a positive 2018 economy and stock market. Much will depend upon healthcare reform and tax reform. Many observers don’t see either happening until the Spring of 2018. There is an old saying, “Buy on rumor, sell on fact.”. So the rumor is “reform”. Until that promised day I foresee 2018 as a good year but not so good as once expected.

We also have the 2018 elections. I believe we are going to see more of the same trend we have seen since 2010. The public is not in a good mood despite the improving economy. Some “Establishment” Republican’s will lose to primary challengers while many Democrats will go down. The switch of political parties by the billionaire Democrat Governor from West Virginia to Republican tells the story. I know at least six billionaires and while they are all eccentric, they are all very practical. They will go around a mountain rather than over or through it. That’s what the Governor of West Virginia just did. He looked over the political landscape and made the call that to be a Democrat in West Virginia wasn’t healthy for his re-election prospects. In addition, 2/3rds of the seats up for grabs are held by Democrats. Right there the numbers are against them. About the best I can see the Democrats doing is holding on to what they have but in this environment and with their attitude, views and policies I see them being big losers. No one with common sense believes Trump is a Russian operative. That narrative has grown old and is killing the Democrats and the longer they persist with it the more harm they will create for themselves. Likewise, fighting to save Obamacare is futile and will just create more harm for those that do. Obamacare violates basic economics and is unsustainable and goes against human nature. Worst of all the people don’t like it!!! Propping it up with endless government subsidies is folly even during the best of times.

In summary, 2018 should be a good year for the stock market especially with the continuing promises of healthcare and tax reform somewhere on the horizon!  

Thanks everyone!

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