Market Update May 14th, 2019

We believe a China trade deal should eventually be reached, and despite heightened market volatility, we continue to expect an upward bias for stocks throughout this year.

The recent setback in the trade negotiations with China and the additional retaliatory tariffs rattled markets again yesterday. After hitting new all-time highs two weeks ago, the S&P 500 retreated around 4 ½% from those peak levels as of yesterday, and recovered some of that today.

We agree with the majority of economists who believe the best trade policy is free trade with no tariffs, barriers to entry or subsidies. Free markets and global trade have proven to be the best way to promote global prosperity.

As Trump said at the G7 summit meeting last year, “That’s the way it should be, no tariffs, no barriers and no subsidies…that would be the ultimate thing.” But Trump’s apparent love for tariffs today stem from the fact that they are a negotiating tool, and a tool that he has complete control over. That makes tariffs irresistible to deal-maker Trump.

While there are potential dangers associated with trade battles and tariffs, and they ultimately punish consumers in both countries, we are in favor of free and fair trade, and we think working to eliminate lopsided tariffs and the theft of intellectual property is overdue. However, new tariffs, harsh rhetoric and other hard ball tactics raise additional risks, and they wreak havoc on investor anxiety levels.

The collective tariffs by both sides may now impact our economic growth by a couple of tenths of a percent per year, and it should hit China’s economic growth quite a bit harder. (We currently export around $180 billion in goods and services to China per year, which is about .9% of our GDP, while China exports around $560 billion to the U.S., which is about 4.6% of their economy.)

Who knows whether markets will drop further before they turn back up as investors continue to react to day-to-day developments until a deal is finalized. Since we think US and global fundamentals and valuations continue to favor stocks over other asset classes, we are not willing to gamble with the fast money traders, on where the stock markets might go in the coming days or weeks. We think the risks of being burned or left behind are as great, or greater, than the risk of further temporary market declines right now.

If the trade battle is prolonged, it will likely cause more companies to shift supply chains out of China, toward other countries like Vietnam, Mexico, Singapore, or back to the U.S.. China will likely try to re-route business also. We think any near-term economic weakness this creates in the U.S. and China should flow toward other countries and be favorable for other international markets, helping that portion of our portfolios outperform.
We expect downside risk to be limited to minor single-digit percentage pullbacks given the improved technical health of the market in the wake of the 2018 correction, which placed shares into stronger hands as the weak holders fled the market.

However, we also never want to underestimate the market’s ability to overreact at any time. Despite all of their long-term efficiency and vaunted liquidity, the capital markets remain hostage to modern programmed algorithms, which at any moment are capable of unleashing limitless numbers of trades within milliseconds.

From our original introduction to the dangers of programmed trading on Black Monday in 1987, to the Flash Crash of 2010 (that showed us how mind-numbingly stupid these machine generated algorithms can be), to the exaggerated market correction late last year…all are reminders of how much chaos the algorithms and computer generated trading can spawn in moments of stress. The markets recovered quickly after each of these outsized declines, but many who sold into the teeth of the corrections out of fear, permanently harmed themselves…by instinctually trying to protect themselves.

And remember, there are still many stock perma-bears out there since 2008 that the networks are all too eager to parade back on their shows every time markets fall, to tell us how much worse it’s going to get.

I’m perma-bearish on the financial media. If you want to sound smart, get attention and attract viewers, you scare people. And there is nothing like shock n’ awe sensationalism to make great media click bait and get people to tune in or read articles.
I find the current media environment especially unfortunate for the 40 million people out there today who are over 50 and still working toward retirement (and about to potentially make every investment mistake in the book). Due to unwarranted exaggerated fears, many will likely move most of their assets to bonds, underestimate their longevity, and face a diminished standard of living or risk running out of money. (Or worse yet, let their fear of the stock market push them toward other investments that sound too-good to-be-true because of hidden risks.)

Even many Americans who save enough for retirement will freeze their principal and not realize they are also freezing their income, eliminating their ability to keep pace with the rising cost of living. Too high of percentage in a fixed income strategy in the current historically low interest rate environment, with today’s extended longevity, could be the equivalent of financial suicide…on an installment plan. The longer people live, the further their income is likely to fall behind their cost of living (the same lifestyle).

The primary goal of retirement investing isn’t necessarily growth or income, it’s maintaining purchasing power to sustain your lifestyle. And one of the recipes to rescue retired Americans from a slow gradual decline in their living standards is the rising dividends of high quality US and global multinational corporations. The cost of living has increased 9 times since 1960, while cash dividends from the S&P 500 largest companies has increased 27 times. But many will be fooled into thinking all stocks are like a casino, and the only way to keep their money safe is to keep too much of it in bonds, CD’s and bank accounts.

While U.S. stock markets still look attractively priced to us, many foreign markets look significantly undervalued. Unlike U.S. markets that hit new all-time highs just a couple of weeks ago, the Euro STOXX 50 index is still trading almost 40% below its all-time high set back in early 2000, China’s Shanghai Composite Index is still 50% below its all-time high set in 2007, and Japan’s Nikkei 225 index is trading 45% below its all-time high set in 1989.

While the U.S. economy continues to give us confidence, we are also beginning to see signs of Europe’s economy perking up. Unemployment across Europe just fell to its lowest level in many years, and European stocks have begun to move higher on optimism that upcoming elections will finally bring about needed change. China’s first quarter GDP also reaccelerated to a 6.4% growth rate, surpassing analyst estimates, and many other emerging markets are also showing recent improvement.
While many potential worries remain, they still seem outweighed by the long list of reasons to be optimistic about stocks. The fundamentals remain encouraging, while investors around the world remain overly cautious and overinvested in cash and ultra-low yielding bonds (which we remain skeptical of from a long-term perspective).

As always, call or email me with any thoughts or concerns, and any time I can be of assistance.
Darren