Climbing the Wall of Worry – by Bernhard Koepp – YouTube Video & Transcript

In this video, Bernhard Koepp, CEO of C.J. Lawrence discusses discusses 6 points:

1) Market nearing a new high; positive fundamentals remain with the crowded trade.

2) Economy- The parade of eye-popping Q2-GDP data is out but GDP outlook looks positive; Inflation – “Fed will tolerate higher inflation before raising short-term rates”

3) Market Technicals & Money Flows

4) US Dollar weakness supportive for Growth Stocks

5) Will Budget Deficits doom the stock market?

6) Revisiting our Tilted-V

Video Transcript

Bernhard Koepp:
Yeah. Hi there. This is Bernhard Koepp from C.J. Lawrence, and it’s August 18th. Well, ’tis the season to climb the wall of worry. I mean, typically in August it’s a quiet time, but here we are quietly making a new high in the market. So everybody knows about this crowded trade, so we’ve been talking about this off the low. It’s really the technology stocks and some of these Bulletproof stocks that have weathered through the covert shutdown on the technology side, on the communication side, social media, healthcare, biotech, and specialty retail that have really carried the market. People are worried again, why? Because the market is making an all time high again. So I wanted to revisit some of the concepts and macro concepts and look at the market in more detail. So what have we learned on the economy?

Bernhard Koepp:
So we got the eye-popping data for Q2 GDP. So let me go through the parade. Basically, United Kingdom down 60% in Q2. That takes the UK, the United Kingdom economy, back to 2004 levels. I mean, these are extraordinary numbers which shows you how tough it was for them through the shutdown. The Eurozone, if we take all of the Eurozone countries altogether, it was minus 40%. China, it was minus 36%. And the US was at minus 32.9. So let’s put this into a context, because in our previous videos we’ve talked about, this is not your typical cyclical downturn. This is a very different… You have to model this recession and recovery in a very different way than previous cyclical downturns. So let’s look at the context of GDP growth in the US. So fourth quarter of 2019, we were tracking at 2.4%.

Bernhard Koepp:
We were coming out of an economy that was really tracking between 2 and 3%, inflation was tame. We were worried about double dipping a recession back in 2019. Actually, that’s why the fed became more accommodated. So Q1 2020, so that’s January, February, March, the COVID crisis started hitting around February really. So Q1 GDP in the US was -5%. These are quarter on quarter annualized numbers. Then we fast forward to the second quarter, that was the -32.9% down, which is an eye-popping number for sure. Then we look at the third quarter. Actually, if we look at some of the data that some of our favorite economists are tracking, it’s actually tracking at +24 to 26%, roughly. So we’re going to get a big up number in the third quarter. We’re seeing that also within our companies and what they’re reporting in terms of retail sales and things like that.

Bernhard Koepp:
But then the question is, what’s the normal rate that we will go to in the fourth quarter? So there’s a big question mark there. Is it somewhere between 1 and 2%? That’s really up in the air, but it’s clear that the V-shaped recovery is really there. We’re seeing that in a lot of the data, and I’ll go into more detail a bit later. So inflation is the other big question mark. I’ve said in my previous videos that one of the things that could really derail this big move in stocks is if we get a blow back in inflation before the recession ends. So the last thing you want is a lot of inflation when you’re in the middle of a recession, because that puts the fed and the policy makers at a point where they cannot move.

Bernhard Koepp:
So let’s look at inflation. So fourth quarter again of 2019, we were at about 2%. First quarter, we saw no impact of the COVID shutdown on inflation yet, and we were still at about 2% CPI. Again, this is the annual number. Second quarter, that’s when we saw the impact on inflation, so we got a big dose of deflation. So CPI was down 1.6%. Third quarter, the estimates now are a bounce back to 1.9. And if we look at what economists are thinking about in terms of the fourth quarter of this year, we’re actually… Most are forecasting a reduction in CPI again. Think of what’s happened. So we’ve had a big resurgence in commodity prices, oil is back above 40. But if you think about the things that really matter, food, rent, there was some food inflation clearly, and we saw that in the Q3 number.

Bernhard Koepp:
We’re seeing that in the middle of the Q3 number, but things like rents, which are also a big component of CPI will likely be down. So think of all the people that have apartments in urban areas that have moved to suburbs, creating a housing boom, and things like that. So that’s all going to have a downward pressure on CPI. So that keeps us constructive about equities, because as long as interest rates are at zero, and we have an improving economy and inflation is in check, there’s no other game in town but equities. So let’s look at market technicals and money flows. Since June, market breadth has really broadened out. So beyond the crowded trade, which is really the four areas that I talked about, that’s tech, communications, healthcare, and consumer, it’s good to see industrials actually outperforming in the last month.

Bernhard Koepp:
I mean, that actually started back in June already. Materials, as I said, have bounced back a lot. Oil is above 40. We’ve talked in the past that $40 oil is critical for some of these shale producers in the Bakken and in the US. These are the North American oil producers to actually break even and create cash flow. That takes some of the pressure off the credit markets, so that’s good news. Let’s look at money flows. It’s been all into bonds and out of equities, so there’s a big question of where is the bubble forming? A lot of people are saying it’s in equities because the equity market’s at an all time high. We would argue it’s actually in the bond market, because all the money has been flowing into the bond market and out of the equity market.

Bernhard Koepp:
So if we get a dip here, which we expect, this is the normal pattern going into the September, October period, typically we think new money will actually go into the equity markets rather than into the bond market. Another point is dollar weakness, which is very important to watch. Actually, as we said in the past, the dollar has weakened versus global currencies. That’s actually good news, because it means that global growth is picking up. So we don’t want the US dollar only to be the sort of currency of last resort. If other currencies are starting to perform better, it really means that a global growth is picking up. But dollar weakness means growth stocks actually do better when there’s dollar weakness. Why is that? Because growth stocks tend to have high degrees of foreign revenues and earnings.

Bernhard Koepp:
So look at some of the companies like Microsoft and Apple. Almost half of their earnings and revenues are actually abroad, so a positive currency translation back into the US dollar is actually positive for many of the S&P 500 heavyweights. So we think that’s quite good news actually for earnings near-term. Commodities also do quite well when the dollar weakens. Think about commodities, whether it’s oil and gas or any of the materials, the production costs typically are US dollars. So if the dollar declines, it puts pressure off margins for the producers, which is good news for those stocks. I wanted to talk about the election. I mean, yesterday the Democratic Convention kicked off online, so I think the best way to talk about the election is really to talk about budget deficits. So there is a lot of talk amongst market practitioners and economists.

Bernhard Koepp:
What role does do budget deficits and huge budget deficits have on the stock market? Obviously the numbers that are being talked about in Congress and in the Senate about additional stimulus, these are mind blowing numbers. We’re talking about trillions of dollars to basically build this bridge to when the economy’s fully open. That’s going to create massive deficits. It’s interesting, if you look at deficits, large deficits in the past, they really haven’t had much of an effect on the stock market in those periods. So what’s had more of an effect on the stock market if we go into periods of austerity. So running big deficits is not a problem actually for stocks, it’s actually more of a problem for bonds and currencies. So you got to be much more careful about credit risk in those times, because what happens, we saw this in the ’80s, you have this crowding out effect where governments get their money, and corporations and others may not.

Bernhard Koepp:
That is a problem during periods of high budget deficits. The other problem is currencies. Running huge double deficits in trade and budgets create big dislocations in currencies, so that’s something we’re watching closely. And it’s also one of the reasons actually that gold is doing very well. I mean, it’s kind of strange that gold is actually not acting as a hedge, but it’s going up sort of with the stock market. But that is really, I think, a hedge against declining currencies. So in the past, we spoke about the tilted V, our view that the economy has this tilted V recovery. So the recent data, as I mentioned, is very strong. Vehicle production is through the roof in the US on the recent data. We just got housing, also is surging. Think of all the people that are fleeing urban areas and going to the suburbs. There is a shortage, certainly in our area, a shortage of housing everywhere.

Bernhard Koepp:
Everybody’s looking for that house because they don’t know if their kids are going to be going to school from home or not. The next thing is retail sales. I mean, we got July numbers for retail sales. The retail sales numbers are at the previous peak. This is extraordinary. If somebody had told me two months ago that we are going to exceed the previous peak in retail sales, I would have said they’re crazy, but it shows you that the economy is opening up. The healthcare pandemic is not resolved, clearly, but it’s clear that despite all that, the economy’s opening up fairly quickly. So the bad news, of course, is that the economy won’t be made whole until 2021. I mean, the stock market is already priced in the fact that the economy will be made whole, but if we’re looking at projections right now, it’s really 2021 before the US economy kind of breaks even in terms of GDP. In terms of earnings power of our companies and so forth, that will come much earlier.

Bernhard Koepp:
So it’s interesting to watch that. And the leading economy right now that a lot of economists are watching for this trend is really China. And it’s interesting to see the Chinese economy and GDP is now exactly at the previous peak. So they’ve already gone through the worst. They’ve done their thing. GDP is now trending, going into September, is trending exactly where it was before, and probably by the year end will be trending higher than the previous peak. So that’s very good news, and we’re seeing that this trend also in some of the European economies where things are getting back to normal. So we will certainly have flare-ups in terms of the healthcare, the COVID virus. That will continue, but it is still our best guests that the tilted V recovery that we’ve been talking was well on track and that the safest place to invest money is actually equities, not bonds. So we continue to stay the course. Thank you for listening, and if you have any questions, give me a call, (212) 888-6342. Take care.