“This Is What It Sounds Like … When Doves Cry” – July 12, 2019

“This Is What It Sounds Like … When Doves Cry” – July 12, 2019
Morgan Lewis Posted on July 12, 2019

Here’s the news of the week – and how we see it here at McAlvany Wealth Management:

“This Is What It Sounds Like … When Doves Cry”

It’s hard to think about the market environment this week without this tune from the late Prince running through our heads. A dovish Fed has the wind at our back for our hard assets strategy. Further, it seems clear that, despite positive non-farm payroll data, the Fed is concerned about a slowing global economy because “manufacturing, trade, and investment are weak all around the world.” Powell’s Congressional testimony was decisively accommodative despite a sharp rebound in payroll data and the US/China détente. We find it extraordinary that, despite the fact that some positive domestic economic data has allowed the Fed some wiggle room, both the Fed and the financial markets have voted otherwise. In general, we have continued to see a melt-up in risk assets.

The melt-up in defensive stocks began to show some early signs of exhaustion, and upside momentum has begun to slow. Valuations as a whole are very clearly extended, although we are still able to identify pockets of reasonable value and attractive potential total returns. We are optimistic that a rotation will allow us the opportunity to build the MAPS portfolios in the infrastructure and specialty real estate areas over time, and we maintain a patient and steady hand.

We continue to find energy intriguing, as it has begun to show signs of life. Despite escalating tensions in the Straits of Hormuz, another week of inventory draws (8.3MMbbl draw versus a same-week historical average of 2.5MMbbl draw), and capital discipline on the part of producers and the continued deleveraging of their balance sheets, the stocks have lagged year to date. Producers continue to drop rigs, and the rig count is down five percent sequentially. It has been very easy for large institutions to be underweight the sector, and given a more sanguine fundamental picture, as well as a Fed clearly committing to a weaker dollar, we are dipping our toe into some ideas where we see value as well as opportunities for growth.

We think scale and consolidation will continue to be important for U.S. producers, and we think the M&A theme will continue to unfold in the months ahead. There are still too many “zombie companies” that have zero access to capital and marginal assets. However, by and large, the industry is healthy and has learned to live within its means. Additionally, Tropical Storm Barry, headed for the Gulf of Mexico, may temporarily shut in up to 1/3 of production in the area. We believe this confluence of positive fundamentals paints a favorable backdrop, and we look for best-in-breed assets run by superior management teams at reasonable valuations.

Despite some moderating pessimism on the possibility of a trade war with China, base metals have continued to underperform. This is due to weak manufacturing data despite the fact that we see ongoing inventory draws. Many of the diversified mining companies have had good year-to-date performance given the 70-plus percent rise in iron ore prices this year. We believe that those stocks will also present some future opportunities, particularly those that have committed to stable and growing dividend policies. Steel prices have begun to show a pulse due to low levels of scrap (a key input for electric arc furnace steel making), low inventory levels and some moderation of input costs.

Quarter-end updates and pre-announcements are beginning to trickle out. This week we read a statistic that indicates that negative preannouncements exceed positive preannouncements by a ratio of 3:1. As we continue to broaden our positions, we are cautious and very mindful of the opportunities that earnings season may bring about. Gold producers tend to release production numbers a few days after quarter end, before announcing their full financials. Thus far it has been a mixed bag, and we are being selective. In general, we believe that input cost inflation, with the exception of labor, has remained largely in check. We should accordingly see margin improvement on higher commodity prices at this stage of the cycle. That said, the market priced in a new monetary policy paradigm quickly, and we are therefore very selective and disciplined in our stock-picking process and portfolio allocations.

We thank you for your continued interest and support.

Best Regards,

David McAlvany
Chief Executive Officer

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