May 14, 2019
Dear Clients and Friends,
In the last few days there has been a change in the general tone surrounding the financial markets and we thought a few comments might be helpful.
The Stock Market
As we discussed in our recent Quarterly Comment, we have seen an incredible recovery in stock market value over the past four and a half months. Beginning from the painful year end correction that found its lows on Christmas Eve 2018, the recovery of the stock market has been remarkable. Everyone wants the market to trade higher and in the last few weeks a classic worry of not wanting to be left behind “the fear of losing out”, has pushed the market indexes up near their all-time highs.
In both our Quarterly Comment and our Q1 client reports we spoke of the danger of being drawn into the herd mentality of a bull market, as many investors have done. It is our belief that markets may have become complacent and overly optimistic and have lost the rational fear normally associated with reasonable investing.
US China Trade
The ongoing US China trade negotiations have been an underlying concern for global markets for some time. There has been much optimism that even with the rhetoric from both sides seeming to indicate a hardening of positions, the economic best interests of both country’s leaders would lead to an eventual agreement. Good news at the end of April and early May indicated a final agreement was nearly done.
In the last few days that optimism has turned to disappointment. The US position has turned confrontational and the President has increased tariffs on Chinese imports. This strategy is an attempt to put pressure on the negotiations but has instead led to a tit for tat response from the Chinese. In the past few days global markets have fallen nearly 5% as bullish investors have found themselves exposed.
Throughout the early 2019 recovery we have invested cautiously in the US stack market, aware that the same strategies that have worked in the past needed adjustment. At the same time, we reduced our exposure to US equities gradually as the market traded higher. Early last week our risk management programs liquidated the last of our discretionary positions to bring us to a neutral view. Behind this caution is our concern that the general bullish tone in the financial markets fails to seek strong reasons for the markets to trade higher.
In fact, we believe that a US China trade agreement has already been priced into the market, and the recent drop is the withdrawal of the “China premium.” Similarly, accommodative US interest rates assume that inflation will remain at bay, in spite of continued wage growth and strong employment...both good things for the economy but can lead to inflationary pressure. Low interest rates are also priced into the market.
The Next Thing
We aren’t sure what the next thing will be, like everyone else our crystal ball is a little cloudy. We do know, however, that the economy is difficult to fine tune and anticipate. Too many influences can assume prominence in the minds of investors when they try to access the future. Global trade, interest rates, inflation, employment, energy prices, and political turmoil can all create either the fear or the confidence that investors act on.
Right now, we still believe in the underlying strength in the US economy, and by extension, many parts of the global picture. There is a lot going right in the world and we are optimistic.
But we are cautious with our client’s capital. Markets never go in the same direction forever and when the outlook becomes too rosy, or too dark, it’s time to be ready for a change. A market correction may be an opportunity to find value in an overbought market, let’s wait and see. In the meantime, we are comfortable that our caution seems well founded.
Ed, Branson, and Claudia