This commentary was issued recently by money managers, research firms, and market newsletter writers, and has been edited by Barron’s.
Railroads on a Roll
Momentum Strategies Report
Clif Droke Market Analysis
April 29: Particularly looking stellar during the latest earnings season are transportation stocks, as exemplified by the textbook linear trend pattern in the chart of the Dow Jones Transportation Average (DJTA). This may come as a surprise to some, especially given the persistent strength in crude oil prices (incidentally, Goldman Sachs has forecast $80/barrel oil by summer, which, if realized, would be a 25% gain from today’s prices).
One of the primary areas of strength in the transportation group is (again, surprisingly) railroads. Already there have been some merger and acquisition announcements and positive earnings results from the major rail shippers, and this has helped propel the remarkable comeback of this once-neglected arm of the transport sector.
Norfolk Southern (NSC) is an excellent example of leadership among the Class 1 railroads, with CSX (CSX) not far behind in relative-strength terms. Persistent strength in the railroad stocks, while not offering any forecasting value for the broad equity market, has historically been an indication that the economy is likely to improve in the coming 3-9 months.
Stellar U.S. GDP Outlook
Economic and Financial Analysis
April 29: U.S. first-quarter GDP growth came in at 6.4% annualized, a little weaker than we had been looking for (7.4%) and just a touch softer than the 6.7% consensus. Consumer spending rose 10.7%, which was actually above what we had been factoring in, while non-residential fixed investment rose 9.9% and residential investment posted a 10.8% increase with government spending up 6.3%. However, a run-down in inventories subtracted a hefty 2.6 percentage points from GDP growth, and net exports subtracted 0.9 of a percentage point as strong consumer demand sucked in imports while exports fell due to economic weakness overseas.
Looking toward second-quarter GDP, it is clear that consumer spending in March was very strong, supported by the latest $1,400 stimulus checks, and this provides a strong base for growth in the current quarter. Encouragingly, restaurant-booking data, security-check numbers at airports, and daily debit- and credit-card transaction numbers suggest that momentum has carried through into April. With 142 million Americans also now having at least one dose of the Covid vaccine and the economy opening up more and more each day, we are penciling in a double-digit GDP growth figure of around 12.5% annualized….
In fact, we strongly suspect that the level of real GDP in the U.S. will be higher in 4Q 2021 than it would have been if there had been no pandemic and the U.S. economy had instead continued growing at its 2014-19 trend.
Pessimistic on China H Shares
April 29: China’s H-share market lagged its A-share counterpart in most of 2019 and 2020. While A shares benefited more directly from China’s domestic liquidity and monetary easing in the past two years, H shares were hammered by political turmoil in Hong Kong and the Sino-U.S. trade frictions. The sharply widened price divergence between these two markets in the second half of 2020 lured mainland investors to H shares earlier this year, reversing the valuation gap and quickly closing the “arbitrage” opportunity.
We remain underweight China within a global portfolio. Since both A-share and H- share markets are subject to the same macro fundamentals, we are also pessimistic about H shares. We believe the risk/return profile of H shares is asymmetric in the next six to 12 months: The upside potential is limited as China’s stimulus has passed its peak strength, while the downside risk is material due to rising odds of further domestic policy tightening, as well as ongoing geopolitical tensions with the U.S. Additionally, stock prices in the onshore market have fallen more sharply than H shares since February, potentially providing a better buying opportunity for the former beyond the next six months.
All in all, any meaningful valuation gap between the two markets cannot be maintained over a prolonged period of time. As such, even if the A/H market premium becomes elevated again, we caution against arbitraging the valuation gap on a cyclical basis.
—Mathieu Savary, and Team
What Inflation Numbers Miss
The Lancz Letter
April 27: Many investors have yet to recognize the seeds of inflation that are already upon us. Official government inflation numbers do not include food or energy. In addition, government economists consider homes an asset—not a good or service to be consumed—so home prices are not factored into inflation data. Therefore, three of the key areas that are already soaring in price, that directly affect all Americans, are not even considered in the official inflation numbers.
The truth is that grocery prices are at seven-year highs, with the CRB Foodstuff index up 15% this year alone, while the prices of existing homes surged 17% last month, compared to a year ago, the fastest pace ever recorded. Investors not factoring rising inflation into their investment equations are making what will be a very costly mistake.
Tax Hikes Don’t Clobber Stocks
Truist Advisory Services
April 26: At the individual level, tax policy can have significant and varied consequences. Also, the after-tax rate of return of holding stocks, all else being equal, would be less with higher taxes. However, from a historical market perspective, the data suggest other factors have often overwhelmed tax policy.
Tax policy should not be viewed in a vacuum. This can be seen when looking back at tax-rate regimes by decade. The business cycle matters, as do valuations, geopolitics, monetary policy, and other factors, such as the path of the recovery from the pandemic.
• Despite extremely high taxes, the 1950s had the best stock market returns of the past 70 years, as well as a robust economic environment, aided by the post-WWII boom and stock valuations that were very low coming into the decade.
• Conversely, despite very low taxes, the 2000s were beset by the aftermath of the bursting of the technology bubble, record high valuation levels, and the 2008 global financial crisis.
• More recently, despite a tax increase in 2013, stocks rose more than 30%. The market was supported by below-average valuations and a significant rise in monetary stimulus as the Federal Reserve’s balance sheet was ramping up.
• Conversely, in 2018, despite tax cuts, stocks were down about 4%. Starting valuations coming into the year were well above average and at a cycle high. At the same time, monetary policy was becoming more restrictive as the Fed started to unwind its balance sheet and raise short-term rates on fears that the economy was overheating.
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