July wanes, and stocks remain well-bid. The Dow Jones Industrial Average is well above 25,000, and the S&P 500 is above 2,800. The yield on the 10-year Treasury remains below 3%. Earnings growth is strong. The economy is expected to grow at a 4%+ pace in the second quarter. Yet investors seem jumpy.
Perhaps it’s discomfort with the President’s style of negotiating in public, using seemingly unfiltered tweets. Perhaps it’s growing fatigue and complacency with an aging bull market. Maybe it’s the Federal Reserve’s determination to raise interest rates and the resultant flattening of the yield curve; or the sharp decline in commodities, like copper, that are seen as good indicators for future economic growth; or maybe it’s the slowdown we’re seeing in the housing market; or all the news about trade wars and tariffs. Or maybe it’s just the heat.
Worried about tariffs? Worry makes sense: a trade war is a serious negative for stocks and the economy. For starters, higher trade barriers always create inflationary pressures. As well, tariffs generally provide targeted relief for small constituencies while creating pain for a larger subset of constituents. Consider the case of Synalloy Corporation, which is a small domestic stainless-steel pipe and tube manufacturer that has long battled competition from foreign manufacturers that benefit from significant government subsidies. Naturally, Synalloy’s management, employees and shareholders are elated over the new tariffs because they instantly provide the company with a competitive advantage relative to their foreign competition. However, there are countless other US companies that depend on inexpensive, imported steel for use as a manufacturing input. These companies need affordable steel so as to keep their manufacturing costs low. If they are suddenly forced to pay higher prices for steel, they will be forced to make cuts elsewhere or raise the prices they charge on their finished products. These higher prices ultimately find their way to consumers, almost certainly offsetting any economic benefit to Synalloy and others like it. In a worst case scenario, higher prices could start to offset the stimulative effects of the recent tax cuts and spending increases.
I was quoted recently in a recent Washington Post article that discusses trade. Please click on the link to read the article. Trade War, Washington Post 2018/07/25
In general, I would summarize by saying that the implications of these trade policies are ambiguous, sometimes conflicting, and most of all, unpredictable. Whereas corporate managers and the markets dislike uncertainty, trade skirmishes represent a considerable overhang on both business investment and the capital markets. When progress on the trade front becomes apparent (like yesterday afternoon), there seems to be a sharp positive response by stock investors. This suggests to us that the trade noise is holding back an otherwise positive investment narrative, at least over the short term.
Remember the fish market rule: ignore the yelling and pay attention to the price of fish. Be wary but patient. As we watch the President go from steel tariffs on the EU to no steel tariffs on the EU to tariffs, again, on steel for the EU, take a deep breath and think about how these tariffs will actually affect your holdings. In the end, it’s possible, if not probably, that there are not too many changes you need to make. The economy continues to grow and earnings are strong – for now. Addressing trade imbalances is an arduous, uncertain process, and it is certainly a risk that needs to be accounted for. If our government gets this game of tariff chicken wrong, recession may result. The stakes are high. But what are the odds of the administration committing economic and political suicide (in an election year) by imperiling the otherwise strong economy?
In the fall of 2008, Jim Cramer and I appeared on the TODAY Show. Jim had warned investors the day before to get out of the market if they expected to need cash over the next five years. This caused a bit of an uproar, and I was brought in to counter Jim. I didn’t counter Jim, I endorsed him. Short-term funds should never be tied up in long-term investments. So, what should investors do? Take a look at your cash needs and investment horizon. If the calendar or other life events have change your horizon, it’s time to confer with your investment counsel. Otherwise, stay the course. As it says in the Desiderata, “And whether or not it is clear to you, the universe is unfolding as it should.”
*Synalloy is held by members of Michael’s family and is not recommended as a holding for client portfolios.