Quote of the Week
“The greatest mistake of the individual investor is to think that a market that did well is a good market rather than a more expensive market.” – Ray Dalio
Volatility returned to the markets last week and it was not good. The Dow was down 3.05%, the S&P 500 was down 2.04%, and the NASDAQ was down 1.08%.
A lot happened last week, as I am sure you were aware. The markets reacted negatively on Wednesday to Fed Chairman Jerome Powell’s assessment that the economy is strengthening and inflation could be gaining strength. The Treasury 10 year bond fell in value as the yield rose above the 2.90% level. Remember that bond prices move in an inverse direction to interest rates.
The next day, the Bank of Japan’s Haruhiko Kuroda said during his confirmation hearing for another term as central bank governor that the Bank of Japan would start thinking about how to exit its massive monetary stimulus program beginning in April 2019. This risks testing the end of their massive quantitative easing experiment.
In addition, the European Central Bank is debating how to exit its own stimulus program. Bundesbank Governor Jens Weidmann told Bloomberg last week that quantitative easing could end this year. The significant risk is that the U.S., Japan, and Europe could exit all at the same time. With record global indebtedness and higher interest rates to support the debt payments, this is not a good omen. Like periods past, rising rates may likely lead us into recession. But wait, there’s more.
On Thursday afternoon, President Trump’s pledge to impose stiff tariffs on steel (25%) and aluminum imports (10%) sparked trade-war worries and sent stocks tumbling. This triggered protests from American industries and lawmakers on Capitol Hill and prompted the threat of retaliation across the world. The risk is trade wars, price inflation, global slowdown, stagflation, and recession.
Another major development, in my view, is the resignation of Gary Cohn, the White House Economic Advisor. Cohn opposed the tariffs, and he raised his concern with the President. Trump called it a “small price to pay” and stuck by his tariff promises despite Cohn’s advice. When Trump demanded Cohn’s loyalty on this issue, Cohn resigned. President Trump doubled down on the tariffs and said there would be no exceptions including some of our most friendly allies and trading partners such as Canada, Mexico, Brazil, and Japan. The Wall Street Journal in an editorial this weekend said this is the worst decision of the Trump presidency.
The Upward Potential Indicator (UPI) remains at 18 out of 100 which is still good. Our allocation for most clients remains the same: 85% equities, 0% bonds, 10% alternatives, and 5% cash.
Larry’s Thoughts – Tariffs are Ultimately Taxes
Let’s face it; trade policy is not something in which most people are experts. I want to clear up some of the fundamentals of the brewing trade war between Trump vs. U.S. allies, Trump vs. China, and Trump vs. key members of his own party. Here are the basics you need to follow this debate:
What is a tariff? A tariff is mostly a tax on imported goods. Late last week Trump announced he would levy harsh tariffs on all steel and aluminum imports. The tariff on steel will be 25%, and the tariff on aluminum will be 10%. This was done under the guise that it was for National Security reasons. This will hurt Canada and Mexico more than other countries in that they are the largest importers to the U.S. of these metals. China, which Trump has accused of “killing” the United States on trade does not even make the top ten list as an importer of these metals.
Why are tariffs controversial? Because there is evidence that tariffs cost jobs in the country levying them. US car companies have warned that the last time there were such tariffs, in 2002, they lost hundreds of thousands of jobs because they rely on foreign steel, which the tariffs make more expensive. If the cost of the things we buy goes up, we will buy less. If we buy less, the workers get laid off. Then the government has to pay more in unemployment and social services to the unemployed. There are currently 140,000 jobs in the Aluminum and Steel industries. There are 6.5 million jobs in the industries that use aluminum and steel in the manufacturing process. We are talking about makers of airplanes, ships, tractors and trailers sheet aluminum for beer cans, and on and on, and they will suddenly be at a disadvantage with international competitors.
What is a trade war? A trade war happens when counties impose tariffs as retribution for tariffs on their goods. Europe is already threatening to impose tariffs on Kentucky bourbon and Harley Davidson motorcycles. Trump says he welcomes a trade war and it will be easy to win. He now claims if Europe follows through on the threat, he will place tariffs on imported European cars.
Why are Republicans so mad at Trump over this? Because tariffs, and likely trade war, are the opposite of the free trade policies Republicans tend to champion. Free trade in its truest form has no restrictions. Top Republicans in Congress have been negotiating with Trump behind closed doors not to impose tariffs. Now they are pleading with him to change his mind. “We are extremely worried about the consequences of a trade war and are urging the White House not to advance with this plan,” House Speaker Paul Ryan’s spokeswoman Ash Lee Strong said Monday in a remarkable public break from the president.
I obviously do not know what Trump will do, but it does not look promising for him to change his mind. He just doubled down on the tariffs with a tweet on Monday. The “conservative” Wall Street Journal in an editorial over the last weekend stated, “this is the worst policy decision of the Trump presidency.”
Just as everything in the economy and the markets was going great, this happens. Please do not shoot the messenger.
By the Numbers
IS A TRADE WAR NEXT? – President Trump announced plans on Thursday 3/01/18 to have the USA impose tariffs of 25% on steel imports and tariffs of 10% on aluminum imports for an undefined period. The tariff order could be signed into law this week. 17 million Americans are employed today by steel-using businesses, e.g., the automobile industry and the construction industry (source: National Tooling and Machining Association). – Michael A. Higley, BTN 03-05-2018
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These are the opinions of Larry Lof and Stephanie Mayoral and not necessarily those of Cambridge, are for informational purposes only, and should not be construed or acted upon as individualized investment advice. Past performance is not indicative of future results. Due to our compliance review process, delayed dissemination of this commentary occurs. The S&P 500 is an index of stocks compiled by Standard & Poor’s, a division of The McGraw-Hill Companies, Inc. The index includes a representative sample of 500 leading companies in leading industries of the U.S. economy. Indices mentioned are unmanaged and cannot be invested into directly. Technical analysis represents an observation of past performance and trend, and past performance and trend are no guarantee of future performance, price, or trend. The price movements within capital markets cannot be guaranteed and always remain uncertain. The allocation discussed herein is not designed based on the individual needs of any one specific client or investor. In other words, it is not a customized strategy designed on the specific financial circumstances of the client. Please consult an advisor to discuss your individual situation before making any investments decision. Investing in securities involves risk of loss. Further, depending on the different types of investments, there may be varying degrees of risk including loss of original principal.