At the same time, China has made it difficult for US companies to access its market. Candidate Trump made this one of his main agenda items while on the campaign trail. As President Trump, he is merely following through on his promise.
While we applaud the Trump administration for having the courage to stand up to China (unlike prior administrations), we far prefer diplomacy to tariffs. Free trade has had a far greater beneficial impact on the global economy than nearly any other factor over the past 30 years. Tariffs have never advanced the cause of global growth. In the first quarter, there was a lot of tough talk by both the US and China on this issue and markets became a little unhinged at the prospect for an all-out trade war. More recently, the rhetoric has softened; however, until new trade reforms have been ironed out, this issue is likely to keep markets on edge.
The Federal Reserve raised short-term interest rates .25% in March and indicated that another 2 to 3 hikes were in the offing over the balance of 2018. While interest rates are still historically low, new Fed Chair Jerome Powell’s rhetoric has thus far been more hawkish than dovish. It’s not so much the general direction of interest rates that is upsetting markets as much as it is the uncertainty around the potential pace of rate hikes.
Interest rates, in their simplest form, represent the cost of money. They impact decisions such as home buying, personal saving, corporate expansions and capital expenditures. Low rates can be highly stimulative to an economy as the last 10 years have shown. High rates can be very restrictive (see 1982). There’s an old saying, bull markets don’t die of natural causes, they are murdered by the Fed. In other words, the Federal Reserve’s job is to control inflation and they do that by raising interest rates when economies are strong. The US economy is strong, and the recent tax reform act should only go to increase US growth over the coming quarters.
It should come as no surprise that after 9 years of extraordinary measures (quantitative easing), the Fed is on a mission to “normalize” interest rates. This includes raising the Federal Funds rate and unwinding the $4 trillion in bonds that it added to its balance sheet since the crisis. If done right, investors shouldn’t be overly concerned and should actually view it as a good thing. Past-chair Yellen was a known entity (and an avowed dove); Powell is a bit of an unknown and is believed to be slightly more hawkish. The pressure is on to “stick the landing”. Only time will tell, however market interest rates will offer a useful guide.
President Trump, a true disingenue, continues to bedevil financial markets, which thrive on clarity and certainty.
He seems to prefer unpredictability and disorder. Making matters worse is his penchant for communicating important messages via a 280 character tweet. On multiple occasions, his tweets have sent stocks on wild short-term rides as investors futilely try and parse his Twitter statements. For the record, we don’t encourage investors to react on what is basically short-term ”noise”.
As always, we try and refrain from making political statements in these missives. President Obama’s policies, generally speaking, were very unfriendly to corporate America, yet stock markets rose in every year of his term in office. Trump’s agenda thus far (and generally speaking), has been very business friendly. After a strong year in 2017, stocks are mixed thus far in ’18. Could it be that politics don’t matter? Or are earnings and valuations what matter the most?
You’re no doubt tired of me harping on P/E multiples and other measures of stock price value. At the end of the day, and taking in all of the above, what really matters in terms of long-term equity returns are corporate earnings and the multiple investors are willing to pay for them. By most commonly used measures of value, US stocks are expensive. If, however, the companies in the S&P 500 can grow earnings 20% in 2018, as many analysts estimate, equities appear modestly attractive. Relative to bonds, equities appear decidedly attractive.
Within the global equity arena, we continue to favor international stocks over domestic – partly based on better relative valuation and partly based upon more favorable economic growth prospects. Within the international equity market, we prefer emerging market stocks – with the caveat that in the event of a trade war, they will be hurt the most.
10-year Treasury yields remain stubbornly below 3.0%, despite mounting evidence of inflationary pressures building beneath the surface. Corporate spreads over treasuries remain tight, while the ratio of municipal yields to taxables indicates muni bonds are fairly valued. Despite the relative unattractiveness of bonds to stocks, investment grade debt is far less volatile and does promise the investor steady income and the repayment of principal at some future time. Those qualities should not be discounted in year 9 of a bull market.
For the past several years, Nottingham’s portfolios have emphasized the low-volatility factor within our equity allocations, and the high-quality factor within our fixed-income allocations. In our eyes, the incremental cost of these biases is nominal when compared to the reduced volatility these allocations provide. This late in a bull market, we’re not convinced it pays to be a hero. While our thinking and our portfolio strategies remain dynamic, we remain steadfast in our desire to minimize drawdowns during periods of market turmoil.
In some ways, the volatility we experienced in Q1 was a welcome relief. 2017 was a real anomaly in terms of the steady, relentless rise in equities. While volatility can engender investor stress, for the professional it can create market dislocations and mispricing which we enthusiastically try to identify and take advantage of for our clients. Having become more comfortable with the root causes of the markets recent liveliness, we can try and turn this to our (your) advantage via tactical trading.
As we indicated earlier, we remain bullish on stocks. Increasingly this is feeling like a real non-consensus call.
The pull-back we’ve seen from the January highs is warranted in our eyes as the geopolitical risk premium has heightened. Now, it’s up to corporate America to take advantage of lower tax rates and repatriated profits, reinvest in plant, equipment and labor, and trigger a rise in productivity. It may be a tall order to ask that it work perfectly, but we’ll need a solid effort in order to get above 3% GDP growth. If successful, stocks today appear reasonably price. If we fall short, stocks are rich and will likely shed a bit of their gains. Despite rising interest rates, we think short-term bonds are still a valuable port in the storm. And, we remain convinced that well diversified portfolios will offer investors the best opportunity to grow their capital over the coming years.