MARKETS ARE RATTLED. WHY CONFIDENCE HAS BEEN SHAKEN.
On July 30th, I provided my views that we as investors would be right to expect more volatility in the markets following the Federal Reserve’s interest rate decision the next day, July 31st. To say we have had volatility since then would be an understatement. Investors are rattled. In fact, I don’t think we’ve had a day since the rate decision where markets didn’t move by at least 1% in either direction. Interestingly, it hasn’t been driven as much by the Fed decision, at least on the surface, but more by an escalation of the trade dispute with China. Yet, if we were to stop there, we might miss the greater issue that should be part of the conversation: the markets have been fragile for some time, and the new amplification of the trade dispute has all but neutralized the potential benefits that the Fed rate cut on July 31st provided, especially economic confidence. If confidence goes, so goes the economy. If the bond market is telling us anything, it’s that confidence has been shaken.
What Has Changed Since the Fed Rate Cut Announcement?
Just a day after the July 31st Fed decision to cut rates by 0.25% (which was what I saw mostly as “scratching an itch” to make the president and stock market happier), President Trump announced via his Twitter account that the US would on September 1st put a “small additional Tariff of 10% on the remaining $300 Billion Dollars of goods and products coming from China into our Country.” We can question the timing of this announcement all we want, but suffice to say that markets globally were quite spooked over this tweet and perhaps for good reason. This is because the new “small” tariff would affect primarily consumer goods coming from China, which, my friends, is a ton of everyday stuff, and it would either pass right through to the consumer (see: price inflation) or have to be absorbed by companies via compressed margins and thus earnings. Second, the mere announcement of these new tariffs, in my opinion, wiped out any of the positive buzz (which wasn’t much) that investors felt immediately following the rate cut, thus utterly wasting a cut that may be really important should the economy sputter.
China then retaliated over the weekend of August 3rd by allowing its currency to drop relative to the dollar (or, in the eyes of some, reducing its focus on supporting its currency) and announced that it will not purchase US agricultural products and was serious—no really—this time. The Trump administration called China out for currency manipulation, and we were off to the races with volatility. Since these announcements, additional countries have taken measures to cut rates and thus reduce their currency value relative to the US. As a result, it could be argued that any benefits from the Fed rate cut just a few days prior have been wiped out due to the new headlines.
Update: Since the initial “new tariffs” on Chinese exports announcement August 1st, the Trump administration has reversed course on the recent tariffs, or at least deferred its decision on additional tariffs until mid-December to help preserve the holiday shopping season (their words, not mine). This may have been the first admission from the current administration that tariffs are starting to cause some real pain, and if consumer confidence goes south, there would be no worse quarter for that than Q4 2019.
Not All Disputes Become Wars—This One Is Getting Close, Though
I’ve been hesitant to call the trade dispute with China (and Europe, and …) a war, contrary to what we all have perhaps read in the media. That is because in my mind, disputes tend to have multiple sides that are ticked off at each other before a resolution is eventually found, whereas wars tend come from pent-up aggression and result in stalemates, drag on far too long, and have profound casualties on both sides. Wars are often a battle of attrition, where one side simply outlasts the other. Though there have been casualties here in the US (farmers especially), I’m not sure there has been enough profound pain to truly call this a war, but it could be coming, and faster than we would like. We are now nearly 17 months into this dispute, and it shows few signs of letting up. Of course, the core barometers I get paid by my clients to watch are the bond market and stock markets, and both seem of late to be signaling that things are getting achy.
If we are indeed in a trade war, the question then becomes which side cries uncle first. Is the Trump administration willing to accept higher casualties within the US economy and thus stock market performance? Since the current administration seems to have made (my opinion) stock market performance a major proxy on whether it deserves another four years in office, are they willing to see a potential recession and negative market as proper medicine to be taken to meet longer-term trade agendas that frankly may be in the better interests of the US?
There is an old saying about the stock market that certainly holds true today: investors hate uncertainty more than bad but certain news. Perhaps one of the bigger issues with the trade disputes is not that they are happening but how they are happening. Businesses and investors are in many respects on Twitter watch. Will the trade dispute end tomorrow via a tweet? Could it be escalated further? Nobody knows. While I can honestly admire the goals of the administration with respect to trade disputes and in particular intellectual property, I suspect markets are tiring of the tactics and communication style. Confidence is deflating. Even if the dispute were to end tomorrow via tweet, could we believe the source? That is the struggle.
What Can Investors Do?
In my message on the 30st, I suggested that I would let the bond market be my guide over the nearer term. I continue to feel this way today, that the bond market is trying to tell us something isn’t quite right in the economy Since that communication, rates have continued to plummet, perhaps to the point of defying today’s economic reality, but maybe not tomorrows. If you see a bond investor with an umbrella, best you have one too.
At Aberle Investment Management, we first believe investors should first make sure their portfolios are properly diversified. If you have 3 technology funds or 100 individual stocks, that does not make you diversified. You just own the same things. It’s important to have instruments that are designed to zig when the others zag, because doing so helps to smooth out an otherwise bumpy ride. If you don’t know if your portfolio is properly diversified, reach out to us. We can run a complimentary stress test report to help you understand your exposure. If you are a client with a 401k plan that is not part of our watch, consider having us advise you on your investment.
Within our client portfolios, we have taken our equity exposure to the lower end of the normal range for given client risks, while at the same time upping our relative exposure to lower volatility instruments both domestically and globally. We have raised our dry powder via money market funds and short-term bonds and may do more still. We’re okay missing out on a breakout higher until we see evidence that it has staying power. Note, we are not out of the stock market. We’ve just throttled down quite a bit; an important distinction.
What we don’t suggest is that investors try to make massive shifts in portfolios trying to time these swings. It’s a losing proposition, in our view. We’ve seen instances where investors sit on massive amounts of cash, convinced that stocks will go lower, only to have the same view several years later. Stay engaged but stay disciplined.
Should we get a truce in the trade disputes (more likely as we get closer to the 2020 election cycle), then perhaps we’ll see an improved outlook for the economy and thus markets, but again, as long as interest rates fall, we see no need to try and catch what might be a falling sword for our clients. And I all but promise we won’t change our minds based on a tweet.
I’ll wrap it up where I started. The core issue at hand is confidence. I believe businesses and investors are losing confidence in the direction of the economy and the effects of a bipolar trade policy that, more often than not, feels disorganized and spontaneous. Should the Christmas shopping season falter due to tariffs, we best hope the Fed comes forward with the limited cuts it has remaining. It’s already wasted one bullet.
Until next time, thanks for reading.
Brian Aberle, CFP®
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