Trade Wars and Media Fears
It was a disappointing February.
After a seemingly relentless and exuberant rally during January, the market stumbled in February and ultimately gave back most of its gains year-to-date, although at this writing it is slightly in the green.
However, our big-picture analysis continues to suggest that the bull market which began in March, 2009 (happy birthday, Bull!) is not over. A lot of converging data lead us to believe that a recession and the bear market that comes with it are not imminent — even though they’re getting closer. Because we are active managers, and seek to protect our investment management clients from major market declines, keeping our finger on the market’s pulse in this way is one of our primary tasks.
When the market experiences a correction, investors want to know, “Is this the big one, or just a temporary setback? Is this the beginning of a bear market?” Because if the bull market is still on, a correction actually offers an opportunity to buy good stocks at a temporary discount, which investors would be wise to take.
In our last conference call, we talked about some of the specific economic, financial, and monetary factors that have led us to conclude that the bull market that began in 2009 is still on. (If you are interested in the detailed analysis, we’d be happy to forward you the slide presentation from that call.) At present, we are paying especially close attention to long- and short-term interest rates, inflation, corporate profits, and the strength of the U.S. dollar in comparison to other major currencies.
Where the News Fits In
You’ll notice one thing that’s conspicuously absent from that list of critical variables: the news.
To clarify, we certainly pay close attention to the news. One of our main jobs is to notice and anticipate trends — social, technological, political, and economic. In order to do that, we need to read and watch news from many different sources. However, we do this with one critical insight that might be of assistance to anxious market-watchers. We understand the primary motivation of most media companies, especially in the internet age — which is simply to secure the attention of viewers, listeners, and readers so that they can generate more advertising revenue. Sadly, one of the best ways of securing that attention is to create anxiety, fear, and alarm, so time spent absorbing mainstream media and social media can often make you feel the world is a more dangerous and worrisome place than you thought before you turned on the TV, opened the newspaper, or reached for your smartphone.
At Guild, we read the news knowing that it will be full of exaggeration. We do it first of all, so we can know what other people are thinking; and second of all, so we can sift out useful information from the stream of fear and uncertainty. (Sometimes it’s a stream of foolhardy optimism, which can be just as deceptive.)
The trick is that the media’s fear and uncertainty is rarely without some plausible foundation in what’s really happening. Read enough of it, and it’s easy to start assuming that the fearful and exaggerated interpretation of current events that the media present is simply accurate. For example, Gary Cohn may have had many private reasons to resign from the Trump administration, of which the public knows nothing. He stated a year ago that he would leave after the tax bill passed. He may even be ready to return to the administration if offered a cabinet post, as some sources have suggested. However, when the media paint his departure as a victory for protectionists in a White House civil war, that alarming interpretation is certainly plausible enough.
So from that perspective, here’s our take on the market’s recent behavior and the media’s coverage of it.
Trade Wars? Not So Likely
The first thing to note is that the correction which has occurred since the highs of early February is perfectly normal. Bull markets never move up in a straight line. After an unusually long period without a correction, most analysts knew that one was due. And the presence of computer-driven algorithmic trading tends to make “herd behavior” much more violent. We saw that as a rise in market volatility handed huge losses to people who had wagered that volatility would remain low, as it had for many months.
The media found plausible reasons to “explain” the correction — in the beginning, noting wage inflation and a rapid rise in interest rates. After the first phase of the correction, when markets were still feeling jittery but beginning to recover and move up again, another “explanation” for further volatility was President Trump’s tweets about steep tariffs on steel and aluminum imported into the United States. This started a second phase of the correction, centered on other stocks — especially big U.S. companies with strong overseas sales, who could be hurt if other nations retaliated against protectionist actions by the United States. Many of these companies had seen their stocks rally strongly in recent months, since they are also bellwethers of the strengthening global economy.
All of a sudden, “GLOBAL TRADE WAR” was the headline everywhere.
We know two things. One, the market “needed” a correction, which was overdue. And two, the media will exaggerate the risk of future troubles in order to win viewers.
If a global trade war did actually develop, there is little doubt that it would be very damaging. It could derail the current coordinated global economic expansion that has been so favorable for corporate profits and for stock prices. If it were severe enough, it could even be one of the causes of a recession.
However, we believe that a damaging trade war is not likely to occur. We believe that just as other panics during the present bull market have passed and been forgotten, the current “trade war” panic will also pass. Here’s why.
First, remember who precipitated the fear with his tweets. Mr. Trump has time and again showed himself to be impulsive — even intemperate — in his public statements. But we have also observed a pattern behind those statements which reminds us of his history and style as a negotiator who has long sought to cultivate a “larger than life” image. That pattern is one that we have referred to often since the election. For better or for worse, Mr. Trump sometimes tends to negotiate in “bad cop” mode, so that later he can moderate his position and yield a compromise. In short, we believe it is likely that the threat of tariffs was a negotiating ploy, not a “final offer.” We believe he is dissatisfied with how NAFTA negotiations are going, and wanted to fire a shot across the bows of the U.S.’ trading partners to let them know he means business.
Second, such saber-rattling on trade is far from being a special tactic of the current administration. In the 90s and early 2000s, the same rhetoric was used, and actions were taken — without lasting effect on the landscape of global trade. In fact, global trade has grown very rapidly over the last 30 years.
Third, even though the media made these proposed tariffs seem terrifyingly large, in themselves, they are tiny, affecting a very small slice of U.S. imports — ultimately one that is so small as to be inconsequential. Yes, if they snowballed into reactions from trading partners, which then prompted more actions from the U.S., things could get out of hand. But that is not the current direction we see. At the moment, all of this is still in the world of bluster, show, and negotiation.
Fourth, the position of the United States is not fundamentally unreasonable. It is true that many details of existing trade pacts are unfavorable to the United States. It is true that many countries have evaded or broken rules for decades, and have faced only minor consequences; and that often, they have benefitted at the expense of the U.S. Therefore we believe that the administration’s bluster is more intended to put trade partners on notice than to indicate a precise course of action.
And fifth, the economic reality is that the United States is still the premier global economic superpower. That means that our trade partners benefit enormously from trade with us. For example, China, which has risen powerfully in economic stature since the turn of the millennium, could not have made such tremendous progress in economic development without its trade relationship with the United States. We strongly believe that the Chinese, as well as others whose prosperity depends on keeping trade open with the U.S., will ultimately be very content to address the U.S.’ demands, which are relatively minor. That is, our trade partners are rational, and will not cut off their nose to spite their face.
The Forest and the Trees
Don’t lose sight of the forest for the trees, and don’t let media fear convince you that current market jitters are fundamentally more than a normal and healthy correction.
The critical indicators — interest rates, inflation, corporate profit trends, and so on — all suggest that the bull market which is celebrating its ninth birthday this month is still ongoing. It is changing somewhat as it ages, but it is still intact.
In time, the global trade war fears now being stoked by media will very likely dissipate. We believe the market will move on to new highs after this correction, although with more volatility than we have seen in the last 12 to 18 months.
If objective analysis of the data begins to tell us otherwise — if it begins to look like a damaging trade war is really starting to develop — we may revise our view. Of course, we’ll be letting you know in these pages.
For those of you who like charts, here is one from Canaccord Genuity analyst Brian Reynolds. It shows the progress of the S&P 500 since the bull market began. The recent correction can be seen for what it is — a statistically normal variation within a continuing uptrend.
Source: Canaccord Genuity
Investment implications: The current correction, like all the others that have occurred during the bull market that turned nine this month, is “normal, natural, and healthy.” Markets have become more volatile, and are likely to remain so. Still, the objective data continue to suggest that a recession is not imminent, and therefore that corrections provide buying opportunities. As it stands, a global trade war does not seem actually to be in the offing. Take the news with a grain of salt, and look for bargains in the stocks you like the most.