20 Jun Dow Down 6 Days in a Row-Discussing Trade
The Dow Jones index has been negative for 6 days in a row, which has put it in negative territory for the year. The S&P is still up modestly and fortunately we are outperforming thus far. Most people writing about this would say the market has been down due to trade concerns, but really nobody knows why markets move on a given day. One thing that I’ve learned from being in the business for the last 15 years is that there is always uncertainty of some kind. Usually when people think markets are giving you the all clear signal, that is when the top occurs. The stories change from week to week and there are no shortage of market pundits that feel the need to prognosticate upon every issue, despite little track record of success in doing so.
The topic of trade is quite complicated. If you took economic classes, you may recall the works of Adam Smith and David Ricardo, who contributed the theories of the invisible-hand and comparative advantage, respectively. Their theories helped shape modern trade policies, which have undeniably led to faster economic growth and higher standards of living. Most people would agree that free trade is a positive ideal to strive for, but countries tend to act in their own interests, protecting industries for various social, political and economic reasons. The status quo is not free trade, as just about every country employs tariffs. Many U.S. Presidents have imposed new tariffs, including recent ones, but they got far less attention than what is occurring now.
Hedge Fund titan Paul Tudor Jones said on CNBC “If we just look at our four biggest trading partners they have a simple weighted average tariff of about 6 percent, we have one of 3.5%. So there is a 2.5% gap in unfairness.”
Addressing uncomfortable issues with partners, whether it is your spouse or a business partner, can be a stressful endeavor. Our country has massive trade deficits with just about everyone, however, we still have one of the highest standards of living in the world. Of course, China is going to be hesitant to break the status quo when the United States has a $375 billion trade deficit with them. That potentially creates turmoil as we are arguing with the second biggest economy in the world. Many of us benefit from buying cheaper goods from countries such as China, but there are also major costs as industries such as manufacturing have been experiencing decades of decline domestically.
Many of our trade policies with Europe and other countries were modeled after the Marshall Plan, which followed World War 2, where our country’s focus was on rebuilding Europe for everyone’s benefit. Sometimes this meant accepting lopsided terms because they needed more help to rebuild than the U.S. did. The U.S. benefited from Europe’s recovery as it was able to sell goods and services into those markets, so while trade agreements might have been more favorable for a given country, both parties benefited due to faster overall economic growth.
Over the last few decades, the United States has developed a very worrisome debt and deficit picture. It is not unreasonable to negotiate for more fair-trading terms with our partners. That doesn’t mean that there will be an agreement between major parties such as the EU and China, but it is in everyone’s interest to find a mutually agreeable solution. It is one thing to threaten additional tariffs and it is another thing to implement them and keep them in place for a long time. China is a member of the World Trade Organization, yet they have had no problem stealing other countries intellectual property. Why pay $1,500 for a Louis Vuitton purse, or a Microsoft software license, when you can buy a quality replica for $35 from a Chinese website? Think if that is your product and property that is being stolen. Groups such as the World Trade Organization were established to protect property and establish common and acceptable procedures. Unfortunately, the system has been abused. Addressing these issues is important and becoming more so as China emerges as the 2nd largest economy in the world.
There is no doubt that a full-blown trade war would be a major negative for the global economy and markets. We are still a good way away from that, despite how the media portrays things. China has already offered to buy nearly $70 billion of U.S. products to fend off additional tariffs, so it seems to me more likely than not that the final result will be a positive. The Atlanta Fed recently estimated 2nd quarter GDP growth to be 4.7%. That seems a little optimistic to me, but U.S. growth is very strong. Just as big of a concern as a trade war is the risk of rapidly increasing inflation. Fears of a trade war have actually had a negative impact on commodity prices, also resulting in lower interest rates. It could be argued that these are positive developments, which should benefit the market. There are so many variables that influence markets, which is why I’m always skeptical when pundits give a specific reason for market movements.
The message I’m trying to convey in this article is that it is important not to get too swept up in headlines. Investing is about identifying what you understand and what you cannot understand, and limiting your efforts around your circle of competence. At T&T Capital Management, we have very few investments that are in the headlights of any trade turmoil, as we hold very few industrials or materials stocks, because we find them to be overvalued. Increased volatility could create attractive buying opportunities for us, so if we keep our cool when others become fearful, we will be poised to benefit. Who knows, this might end up resulting in a more favorable trade environment, but we will be prepared for any outcome.
We’ve seen some really positive developments on a number of our investments, but we are still in the early innings on a few of the major stories, which will define our performance over the next year or so. A year ago, many analysts wrote off Macy’s and Teva, yet both stocks have more than doubled from their 52-week lows. We’ve had good success this year with our strategy of selling puts and time is working in our favor as we move forward. Major investments such as AGO, ALLY, and AIG are incredibly cheap offering 50% to 100% upside over the next 3-5 years. Even our distressed mall REITS have shown signs of real improvement with retail sales exceeding expectations and positive developments in their transitions to a more entertainment-centric model. Importantly, I truly feel that our portfolios are prepared to endure volatility and turmoil far better than the overall market will.
We must always maintain that vigilance when overall valuations are as stressed as they are now in year-9 of this bull market. Our primary goal is making sure that you as clients can meet your financial goals. We don’t create the market environment, but we do create the strategy to combat it and my family’s money is invested in the same manner, emphasizing our conviction in our beliefs. I can tell you that I’ve added quite a bit to my account lately as I continue to see major disconnects in price between our holdings and intrinsic value. Thank you very much and as always, please don’t hesitate to contact me if you need anything at all!