Cheech & Chong - Douglas Fairbanks Corsican Brothers Movie Posters

In Oxford Financial’s Market Update (“Aaachoo” – April 6, 2018) I wrote, “Damn the tariffs, Earnings ahead… The risk to me is earnings disappointment. I think the fear of an all-out trade war is overblown; much like the concern about a possible Euro government default was in 2011. ”  Earnings for the quarter that ended March certainly did not disappoint.  Analysts such as Zacks expected average earnings to beat year prior by 17.8% when in reality the average earnings surpassed year prior numbers by 24% on 8.7% higher revenue.  This was the strongest earnings season in nearly seven years.  Yet, just like using your rear view mirror to drive down the freeway can lead to bad results, you can’t base stock valuations on yesterday’s earnings. The widely read Zack’s Earnings Reports are expecting earnings in 2018 to increase 19.6% over last year with Q2 earnings estimates at +17.9%.  But estimates for 2019 are only expected to grow 9.6%. I can hear the media personalities saying “yes but it’s still growth.”  Okay, but valuations and prices are based on growth trajectory so if a stock is currently trading at 25 times earnings based on growth of 20%+ and then only increases earnings by 10%, it’s still an increase yes, but is unlikely to continue to support values at 25 times earnings.  This is why as an investor you have to evaluate the stock and not just the company because the stock price does not always reflect the actual business. 

Reasons such as emotions, short-term trend investors, apathy, and expectations affect prices. 

Identifying the cause behind big moves in stock price can be vital to determining what action to take. 

The whole idea of a China-US trade war makes me think of The Corsican Brothers.  If you don’t know the Alexander Dumas book or 1941 movie with the great Douglas Fairbanks, Jr. or 1984 Cheech & Chong version of this story, it’s about Siamese twin brothers raised in completely different circumstances that feel each other’s pain and pleasure.  China and the US act as the two brothers in my opinion.

Is the US bluffing?  I don’t think so for two reasons.  First, if we have to take a few body blows in this fight, the US economy is as healthy as it’s been in a long time to handle it.  Second, if trade rules can be improved with China then the US economy can jump into a higher gear.  Basically, it’s being willing to take a step back to take two forward.  But a full-out trade war could have ramifications to the US that I hate to imagine.

China cannot afford a full-out trade war either.  Remember that China has a monstrous debt load that needs to be fed every day.  An analogy would be comparing it to the US mortgage market before the 2008-09 financial crisis.  If China were to suffer a real slow down of exports the fallout could have exponential consequences to the Chinese domestic economy which would impact the global economy. 

In both movies, after experiencing pain from the other the two brothers eventually learn to work together.  The 1941 classic ends in the death of both brothers avenging their parents while Cheech & Chong’s ends with them returning to their lives in a modern day rock band whose music is now loved by the crowd.

Will China and the US learn to work together rather than inflicting pain on each other by damaging themselves?  Will this real-life parallel end in each other’s demise or them enjoying the crowd’s cheers?  I hope and believe the latter but as this “movie” plays out between them, I expect the markets will overreact to good and bad news in the short term.  Meanwhile, the earnings trajectory of growth remains THE fundamental data point to the short & intermediate term.

So, for the next two quarters do NOT get caught in daily ups and downs as I expect the markets could especially be volatile with the added joy of living through another media flamed firestorm: US mid-term elections.  Having some cash ahead of volatility can help smooth out the ride and offers a potential for long-term joy by seizing upon short-term sales in the markets.  No one can accurately predict the markets with certainty. Hold investments that give you long-term comfort for their business during bouts of market frenzy. 

 

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