We rarely release sequels; we don’t want to get anywhere close to Rocky 27 (or wherever we are in that long series), but we do feel the need to update and reaffirm our original commentary and the market’s current need for clarity. At any given time, the market’s value reflects the best combined knowledge of where the economy is heading as measured by the future profits of all publicly traded companies. That doesn’t mean the market is always correct; it just means it tends to be the best combined sense of where we are and where we’re going. There are times, though, when this common consensus (“the market”) is wrong.
As we wrote in our earlier economic commentary, we have “a new administration using new methods to change the economic order they inherited.” At some level, this is always what new administrations do; they change directions subtly or substantially. But this administration is upending the traditional, if unwritten, rules of how things are done in Washington. On top of that, this President’s personal style is very brash and undiplomatic, to say the least, and he negotiates hard in private and in public.
Accordingly, we see public blow ups between heads of state in the oval office, and we see tariffs thrown around in seemingly casual fashion for negotiating leverage. This last point is among the most important.
We want to be very clear in stating that a massive tariff regimen in our country and around the globe would be very bad economically. Prices increase, and economic efficiency decreases. The question, therefore, is whether tariffs are an economic goal in and of themselves, which would be harmful, or are they a negotiating tactic to force a trading partner to reduce their own tariffs?
The reverse of this is also true; free trade is extremely positive. The reality that is rarely mentioned is that “free” trade has rarely – if ever – existed. Even in what have been called free trade periods there were always some tariffs in place. Political leaders around the world sometimes get very close to negotiating a free trade environment, but there are always some protected industries where tariffs remain.
As a quick example, despite the U.S./Mexico/Canada Trade Agreement, Canada still imposed 200% to 300% tariffs on U.S. dairy products. That is not “free” trade. It might have been better than what existed before the agreement, but the negotiators did not get to pure “free” trade.
President Trump came into office with the expressed opinion that this trade deal (USMCA), along with several others around the world, was a bad deal and should be renegotiated. The outcome of all these renegotiations will have a substantial impact on the U.S. economy as well as the world’s economy.
The end result is not knowable at this time, and this President is negotiating in a manner the market is unaccustomed to seeing. Therein lies much of the volatility we are experiencing. We should expect a pattern of continued market volatility for a while as the overall direction is determined.
The Economic Data
The economic data remains much as it was when we wrote our earlier commentary. On the positive side, liquidity conditions remain good (banks have plentiful reserves), business capital investment seems to be improving, private sector employment is still growing, loan delinquencies are low, the dollar is strong, inflation seems to be under control, and promised tax reductions will spur economic activity as will reduced regulatory burdens.
On the potentially negative side, business capital investment could be stronger, public sector employment is going to decrease, recent loan delinquency rates have edged up a bit, and inflation is still slightly higher than the Fed’s 2% goal, holding them back from reducing rates further, and the reduction in government employment will reduce economic activity in some sectors.
The interaction of the positive and negative elements does not argue for a massive recession. As readers may have already concluded from the discussion above, we don’t know what the actual policy outcome will be, but we do know a couple of very critical components that influence how we recommend reacting:
Economic Commentary – Looking for Clarity (Part 2)
We rarely release sequels; we don’t want to get anywhere close to Rocky 27 (or wherever we are in that long series), but we do feel the need to update and reaffirm our original commentary and the market’s current need for clarity. At any given time, the market’s value reflects the best combined knowledge of where the economy is heading as measured by the future profits of all publicly traded companies. That doesn’t mean the market is always correct; it just means it tends to be the best combined sense of where we are and where we’re going. There are times, though, when this common consensus (“the market”) is wrong.
As we wrote in our earlier economic commentary, we have “a new administration using new methods to change the economic order they inherited.” At some level, this is always what new administrations do; they change directions subtly or substantially. But this administration is upending the traditional, if unwritten, rules of how things are done in Washington. On top of that, this President’s personal style is very brash and undiplomatic, to say the least, and he negotiates hard in private and in public.
Accordingly, we see public blow ups between heads of state in the oval office, and we see tariffs thrown around in seemingly casual fashion for negotiating leverage. This last point is among the most important.
We want to be very clear in stating that a massive tariff regimen in our country and around the globe would be very bad economically. Prices increase, and economic efficiency decreases. The question, therefore, is whether tariffs are an economic goal in and of themselves, which would be harmful, or are they a negotiating tactic to force a trading partner to reduce their own tariffs?
The reverse of this is also true; free trade is extremely positive. The reality that is rarely mentioned is that “free” trade has rarely – if ever – existed. Even in what have been called free trade periods there were always some tariffs in place. Political leaders around the world sometimes get very close to negotiating a free trade environment, but there are always some protected industries where tariffs remain.
As a quick example, despite the U.S./Mexico/Canada Trade Agreement, Canada still imposed 200% to 300% tariffs on U.S. dairy products. That is not “free” trade. It might have been better than what existed before the agreement, but the negotiators did not get to pure “free” trade.
President Trump came into office with the expressed opinion that this trade deal (USMCA), along with several others around the world, was a bad deal and should be renegotiated. The outcome of all these renegotiations will have a substantial impact on the U.S. economy as well as the world’s economy.
The end result is not knowable at this time, and this President is negotiating in a manner the market is unaccustomed to seeing. Therein lies much of the volatility we are experiencing. We should expect a pattern of continued market volatility for a while as the overall direction is determined.
The Economic Data
The economic data remains much as it was when we wrote our earlier commentary. On the positive side, liquidity conditions remain good (banks have plentiful reserves), business capital investment seems to be improving, private sector employment is still growing, loan delinquencies are low, the dollar is strong, inflation seems to be under control, and promised tax reductions will spur economic activity as will reduced regulatory burdens.
On the potentially negative side, business capital investment could be stronger, public sector employment is going to decrease, recent loan delinquency rates have edged up a bit, and inflation is still slightly higher than the Fed’s 2% goal, holding them back from reducing rates further, and the reduction in government employment will reduce economic activity in some sectors.
The interaction of the positive and negative elements does not argue for a massive recession. As readers may have already concluded from the discussion above, we don’t know what the actual policy outcome will be, but we do know a couple of very critical components that influence how we recommend reacting:
Investment Implications
As of this writing, the broad market, as measured by the S&P 500, is:
If the headlines about the budget negotiations with Congress and about the tariff negotiations were not so hyperbolic, most people wouldn’t react much to 1%, 5%, or even 9% market losses; these size corrections have occurred fairly regularly throughout history. Accordingly, most people wouldn’t be tempted to touch their portfolios.
The danger is that the press coverage does prompt investors to panic. We are very confident that market losses of this magnitude will reverses themselves and will therefore be seen in hindsight as being paper losses. If an investor were to panic and sell out, and if the market recovers as suddenly as it can do, then paper losses become “real” losses very quickly, and real losses can be difficult to reverse.
Our recommendation is to design and maintain a portfolio that is allocated to accomplish realistic growth goals, operate within a client’s defined risk tolerance (there is no such thing as 100% risk-free), and provide liquidity for projected withdrawals, then that portfolio structure should be maintained, not compromised. In fact, to the extent that significant rebalancing opportunities present themselves, portfolios should purposely rebalance into the losses.
Executive Summary
We still live in a volatile time with a new “normal” in how Washington determines policy with new rules replacing old ones. The greatest threat to the economy remains a permanent regime of high tariffs across the globe. But if tariffs are simply being used for negotiating leverage and if the ultimate outcome is a greater degree of free trade, then the long-term outcome will be quite good, even as the near-term volatility is a bit nerve-racking. It is at times like these when market timing can inflict serious damage to an investment portfolio, and the wisest strategy is to still maintain the right balance between return goals, risk tolerance, and liquidity needs.
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