Market Commentary for the week of June 25, 2018

Forest or trees?

Everyone knows the exhaustive influence that reckless impulsive rhetoric and knee-jerk political policies can wreak upon stock markets and investors' psyches.  Witness the carnage markets took last week when the topic of global tariffs was bounced between the United States and China. Market volatility skyrocketed as was to be expected.  But, believe it or not, global trade wars are likely not  to be the most severe obstacle investors will face in the months ahead.

Before the year is out, the US Federal Reserve...as well as other global central banks...will embark upon a vigorous redirection of monetary "easing" begun over a decade ago, and will pivot sharply towards addressing overcapacity, inflation, and hyper-profitability in the markets.  In the process their benign economic assessments of the past will start to look slightly more dour, which will affirm their bias proactively to continue raising interest rates.  Even as budget deals and trade pacts are hammered out later this year, monetary policy is the "elephant in the room" that could significantly shift portfolio dynamics for days to come.

It is remarkable that in spite of knowing these data the markets have been relatively slow to factor allocation and sector changes into its performance.  Whether the change in interest rates is one quarter of one percentage point...or other...the pace and direction of monetary policy is irrevocably changed for the future.  In turn, we are forecasting that the impact of these monetary policy shifts is likely to have a negative impact upon future equity performance expectations/projections.

Market definition tells us that as interest rates rise there may be an inverse effect upon upwards cyclicality in equity prices.  Whether large or small, rising rates at least offer alternative strategies to be considered as defensive options while the headwinds are building.

Additionally, trade war threats exacerbate negative outcomes for existing portfolio structure. 

Sometimes, capricious intentions have unintended effects.

Brushfires

In the wake of all things developing, our focus will be on recalibrating our portfolio allocation by sector and asset class to try to minimize any negative impact of global brushfires upon our expectations.  For example, as long as the bond market (rising rates) begins to offer significantly improved return on investment (ROI) our focus will be on capitalizing upon that opportunity to reduce portfolio volatility and risks associated with equities.  We will not abandon the significant capital gains potential of stocks, but we also believe that during times of cyclical inflection and uncertainty it is prudent to explore as many options as possible to protect capital gains already won.

Pundits might tell you that the stock market is always  risky, and should be avoided if you want to keep your money safe.  But this "all or none" approach to equity avoidance also comes with a risk...the risk of lower portfolio returns and not keeping pace with cost and inflation factors.  Our thesis is that asset classes must be blended to account for risk tolerance, time horizon, and individual preference.

Indeed, if rates push beyond the 4 percent level, we think it would take a profound amount of economic activity and output to sustain the kind of equity capital gains expectations that investors have become accustomed to, particularly in an economy that has been predicated upon growth using low-cost credit and borrowing.

In other words, higher rates will  take a bite out of equity price performance...we just don't know by how much or when.

Based upon its own forecasts the Fed is suggesting that annualized inflation, with the exception of employee wages, will accelerate at its highest rate since before the credit bubble in 2008.  That, combined with the unintended consequences of tariff "tax hikes", might impede the purchasing power of consumers, leading to a slow-down in demand and inventory expansion and, thus, profitability.

Portfolio management is an art, not a science.  Jockeying for position to gain an information or operational advantage is the essence of being a nimble investor.  I would much rather "be early" to the party than to be caught off guard or unprepared by information about which we already know the details.

Market Commentary for the week of June 11, 2018

Unraveling

Global stock markets were a bit stronger last week in anticipation of central banks getting serious about ending the era of easy money.  Both within the US and globally there finally is a sense that interest rates will rise responsibly but not necessarily become injurious to growth prospects....at least not enough to quell enthusiasm for rising profits and continued equity price expansion.  In fact, a rise in rates might create some "normalcy" to the financial markets by introducing alternative investment scenarios at just the right time that investors are becoming concerned about hyper-valuation in stock averages.

And now, news announcements over the past few weeks that Italy is "considering" leaving the European Union, have given US markets a chance to capitalize upon that scenario in particular by playing its "America First" jingoism to the hilt, concurrently crafting what some believe to be prohibitive tariff and taxation policies upon its trading partners.  What better time (sic) to unwind decades of globalism and mutual financial interest than when Europe is rife with conflict and political dissension?

Why should Italy's vocal musings become fodder for potential market capitulation and/or distress?  Because not only is this conversation an open forum about the nature of economic compatibility amongst the Union's members, but also an issue that exposes very deep cultural and social divides that exist between all  the affiliates of this tapestry.  To this day, newspapers and parliamentarians rant against the union because it eviscerates centuries of national history and pride.

Obviously, these tensions were debated and discussed well before the Union's adoption and, for most, the rewards have been worth the price.  Indeed, the European Union (EU) has done much more to avert economic calamity than to create it, with few unique exceptions.

In exchange for "relinquishing" their individual currencies, the members attempted to ensure responsibility to a code and to limit financial crises by one constituent which might affect them all.  So whereas the EU might be considered an economic "invasion" by some members, it also is a fairer vote for shared responsibility throughout the continent.

But can the agreed-upon constraints be good if members are unwilling to curb spending or raise taxes to avert their own internal struggles?  Italy, in fact, needs to add  stimulus to its sagging economy while other countries in the fellowship are curtailing their expenditures.

Does any country have an obligation to cede autonomy and control, political or financial, for the benefit of the larger common good?  After all, isn't this notion of self-governance and autonomy what the "Make America Great Again"  political movement derives from....an unwillingness to give up control for any  greater global flow?

Unlike the EU however, the US has one  currency, one  financial structure, one  flag, one  nation. The true believers in this movement ask how it is possible to justify one standard across this big nation when the rust belt differs from Silicon Valley; Michigan works differently than Florida?  This is the divisive message being sent across this land by repulsive speech and local identity branding.

Market upheaval

Investors should recognize that growth and profitability for all is far better than segmenting success into smaller geographic parcels.....by county, by region, by state.  Economics is borderless.  The best "destination" is capital gain and prosperity.  It is doubtful that innovation in medicine, foods science, technology, aerospace, etc. can successfully be compartmentalized into small artificial boxes.

Goods and services, prices, laborers and employers are non-denominational.  The entrepreneurs large and small that flourish around the world are looking for wealth-building and social tranquility.  The sparks only start to fly when the rhetoric becomes disproportionately fanatical...and unkind....and when politics is added to the economic equation.  Who "wins" and who "loses" is anathema to money flow and profitability.

The mini bursts that we have been seeing lately in the capital markets are not driven by the profit motive, in the opinion of this author, but by tribal consumerism, politics, and hateful self interest.  There is little substitute for free markets and unmatched depth of global commerce.