June 13 2019 Market Update

Turning on a Dime: Trade Wars and the Economy

But things may have changed.

With the escalation of trade disputes between the US and two significant trading partners – China and Mexico – markets became spooked. Job growth suddenly dropped, coming in well below every major estimate. By the beginning of June, Federal Reserve Chairman Jerome Powell began offering encouragement about the Fed’s willingness to respond to the evolving situation.[1]

In other words, you could say that perceptions about the economy have turned on a dime – and so it went for markets this past month.

After a solid start to the year, the S&P 500 dropped -6.58% in May, while the yield curve again inverted, with yields on 10-year Treasury Bonds dropping below those of 3-month notes.[2] The inversion has hit its widest point since 2007.[3]

All in all, the month of May demonstrated just how closely economic expectations, Fed policy, politics, and markets can all influence each other – not to mention how quickly things can change.

But does it mean we’re heading straight into trouble? Let’s investigate.

Trade Policy Positions

Markets were understandably rattled by the rising threats of tariffs on Mexican imports.[4] Given the extent of trade between our economies and the role that free trade plays in American manufacturing, even a low tariff could have had a significant impact.

While it’s difficult to measure the specific impact of the North American Free Trade Agreement on economic growth and employment (given the overall trend towards globalization during the past 20 years), the Mexican economy is deeply linked to ours. This is particularly true for auto manufacturers – by some reports, a single car part might cross the border seven times before a car is completed.[5]

A loss of such efficiencies could put manufacturers under pressure, reducing productivity, revenue, and jobs.

But, big picture, even just uncertainty about tariffs can have a negative impact.

In this situation, it was the first time in modern politics that tariffs were linked to an unrelated policy goal – which means they could be deployed again, which could stymie investment and other goals.

Of course, the trade dispute with China is ongoing. The administration is considering tariffs on an additional $325 billion in Chinese imports, and President Trump has indicated a decision would be made after the G-20 summit meeting at the end of June. Tariffs on approximately $200 billion in Chinese goods rose to 25% in May after trade talks stalled.[6]

The Fed has indicated its willingness to respond to the evolving situation, and Fed watchers have begun to raise estimates of a rate cut in the near term as a result.[7]

The Economic Context

In the face of these possibilities, markets dropped in May as investors processed the potential for a protracted dispute with real effects on the economy. Sentiment was not improved by the most recent jobs report.

Wage gains and job growth both cooled in May: the economy added 75,000 nonfarm jobs for the month, missing all economist estimates by a long way (one survey put expected growth at 175,000).[8], [9] All in, average employee earnings rose 3.1 percent from May 2018 but also missed estimates, while the unemployment rate is unchanged at 3.6 percent.

That probably doesn’t sound all that bad, and it doesn’t spell disaster. But it does indicate that employers may be getting cautious in light of rising uncertainty about both trade and global growth.

Also, taken alongside cooling retail sales, factory output, and lagging home purchases in the second quarter, there is some indication that the rate of economic growth is slowing.

The Theme is Uncertainty

Unsurprisingly, there’s a significant amount of disagreement about what comes next. As one assessment recently put it, “In the simplest terms, bond investors are screaming recession, while equity and credit traders refuse to hear it.” The same for policy, which is caught between the potential for a global growth-slowing trade war and the possibility of a new accord and support from central bankers.[10]

In other words, we don’t know what comes next. It should be noted that we never actually do, but in this situation, with so many policy headlines in flux, it’s easier to see.

This isn’t a bad thing. In fact, the recognition of uncertainty is the foundation of our investment management strategy.

Conviction, whether about a particular stock or an entire economy, can sometimes lead to outsize bets and huge gains – but that conviction can also lead to over-confident bets and huge losses.

We take a different approach by balancing short-term news with long-term trends and an understanding of the overall math involved. We diversify because we know that taking a little less upside can deliver more protection on the downside. We adjust for the unique risks faced by individual investors in order to avoid compounding them in a portfolio.

Building uncertainty into the picture of your portfolio provides guardrails on market convictions, which can, and often do, change on a dime. When volatility or uncertainty or sentiment about the economy change, it’s our experience that the change tends to come about pretty quickly. From where we’re sitting, it’s better to be prepared than to try and adjust your portfolios after the fact.

So, while trade policy is changing and market sentiments are swirling, we’re still navigating with the even-bigger picture – your personal picture – in mind.  

If you’d like to chat about the news, discuss your portfolio or schedule a review, please don’t hesitate to call.

As the school year comes to an end, congratulations to all the graduates and the families and loved ones who have seen them through every step of the journey! We applaud you and look forward to seeing what’s ahead. Wishing everyone a wonderful kick-off to summer!

JSF Financial