July 17 2018 Market Update
Trade headlines have dominated business and financial news in recent months, and for good reason.
Trade wars are famously costly, and budding trade disputes bring a level of uncertainty that can make both businesses and investors a little nervous.[1]
For these and other reasons, we’ve seen more volatility in equity markets this year after a very calm 2017. The VIX, a common measure of market volatility, averaged 16.32 for the first half of 2018 – higher than it was at any time in the previous year.[2]
As a result, it’s been a stomach churning ride for investors. After hitting a record high in January, the S&P 500 delivered a softer 1.7% for the year as of June 30, 2018, with a few of those strong swings in the interim – some of them trade related.[3] The DOW Jones Industrial Average, on the other hand, was down 1.8% on June 30, 2018.[4]
Here’s why that’s important, and what we believe you need to contemplate going into the second half of the year.
Why Trade Matters
Worries about a trade war have been brewing for months, with even the Campbell’s Corporation feeling compelled to weigh in on new American steel tariffs.[5] Currently, the US is in the process of imposing tariffs or otherwise negotiating with key trading partners on three key fronts: China, the European Union, and NAFTA. [6],[7],[8]
That said, other nations have also been affected by new American steel tariffs. Russia and Mexico recently retaliated with tariffs of their own.[9] The reason this is concerning for markets is that trade disputes can escalate into all-out trade wars, which can become very expensive for everybody.[10]
Is it Just a Negotiation Tactic?
It’s possible that the tougher rhetoric coming out of the White House is intended to help drive negotiations towards better trading terms for the US. If that’s the case, American companies and the economy are on solid footing to manage any short-term fallout or uncertainty.
The US economy has continued to show steady growth this year, growing at a 2% annualized rate in the first quarter.[11] The unemployment rate rose just slightly from an 18-year low of 3.8%, reaching 4% in the second quarter as more people entered the workforce.[12] In other words, the economy is growing steadily, businesses are hungry for workers, and corporate earnings are strong: in fact, corporate earnings rose a blistering 25% in the first quarter.[13]
Altogether, this indicates that there are no obvious signs of weakness in the economy at this moment, putting the US in a good position to weather a period of negotiations or uncertainty on trade in the short run.
What About the Future?
That said, a key feature of trade disputes is uncertainty. Once tit-for-tat retaliations begin, it can be hard to see which direction things will go. This kind of approach can become extremely costly for both sides.[14] In addition, individual companies and sectors could also struggle in the wake of higher costs.
That’s why, if the US trade dispute with China escalates, it will likely be corporations which feel the effects first.[15] A few large companies have already made highly-publicized changes to their investment strategies as a result of trade uncertainty, and if the uncertainty continues we might see more of these moves.
If an all-out trade war does erupt, the markets would likely be affected. Again, only time will tell.
Managing the Unpredictable
As we head into the second half of this year, we expect trade to remain at the top of the news. Each new headline (or pithy quip by a government official) raises attention and thus questions about what’s next – particularly for investors and corporate leaders.
However, we caution investors to remember that this is one political and economic uncertainty among the many that we’ve seen in the past decade.
While the headlines might be engrossing, when it comes to managing wealth, we favor a strategic and disciplined approach. The market can get emotional – whether it’s a result of elation or fear. But taking the longer view can help you make more reasoned decisions and find a prudent path through uncertain times.
Please give us a call if you’d like to talk about your strategy, and otherwise we’ll look forward to discussing this issue, the headlines, and your personal news at our next meeting.
JSF Financial
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S&P 500 Index is an unmanaged, market value-weighted index of 500 stocks generally representative of the broad stock market.
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Sources:
[1] http://budgetmodel.wharton.upenn.edu/issues/2018/3/14/the-economic-costs-of-a-trade-war provides a useful overview of trade policy implications and literature. https://www.cnbc.com/2018/07/05/business-leaders.html highlights rising concerns about the future capital investment environment.
[2] https://fred.stlouisfed.org/series/VIXCLS#0
[3] https://www.cnbc.com/2018/06/29/us-futures-point-to-triple-digit-rally-at-the-open-despite-gloomy-mark.html
[4] https://finance.yahoo.com/quote/%5EDJI?p=%5EDJI
[5] https://www.cnbc.com/2018/03/02/wilbur-ross-tariffs-are-nbd-but-campbells-says-cans-will-cost-more.html
[6] https://www.reuters.com/article/us-usa-trade-china/dueling-tariffs-raise-fears-of-long-u-s-china-trade-battle-idUSKBN1JW07L
[7] https://www.bbc.co.uk/news/business-44567636
[8] https://www.cnn.com/2018/07/07/americas/amlo-trump-us-mexico-relations/index.html
[9] https://www.bbc.com/news/business-44742714 and https://www.cnn.com/2018/07/07/americas/amlo-trump-us-mexico-relations/index.html
[10] A historical perspective: https://www.washingtonpost.com/news/posteverything/wp/2018/03/07/actually-trade-wars-arent-good-or-easy-to-win/?utm_term=.a2dee1c0ddb2 and an example: https://www.washingtonpost.com/archive/politics/2003/09/19/steel-tariffs-appear-to-have-backfired-on-bush/f86f1307-4912-40ea-985d-71d8f423719b/?utm_term=.baed47c7237c
[11] https://www.bea.gov/newsreleases/national/gdp/gdphighlights.pdf
[12] https://www.npr.org/sections/thetwo-way/2018/06/01/615917917/unemployment-rate-drops-to-3-8-percent-lowest-since-2000
[13] https://www.wsj.com/articles/the-bull-markets-next-test-slower-earnings-growth-1529236800
[14] From the perspective of game theory: https://www.bloomberg.com/news/articles/2018-06-21/game-theory-explains-why-the-u-s-china-trade-spat-is-worsening
[15] This is already happening. For example: https://www.wsj.com/articles/businesses-voice-concerns-over-tariffs-1527807943?tesla=y&mod=article_inline&mod=article_inline and https://blogs.wsj.com/economics/2018/05/22/what-happened-in-steel-cities-after-trumps-tariff-plans-slower-job-growth/?mod=article_inline and https://nypost.com/2018/06/25/harley-davidson-to-shift-some-production-overseas/?_ga=2.221650712.109886524.1529953786-1325753039.1529437084
