Posts made in July 2019

“Investing When Money Markets Moves Our Way”

The last several years, and even the last several months, have been a microcosm of the money markets. The 7% drop in the month of May set off by one of Trump’s tweets was followed by an almost immediately 7% upswing in the month of June and continuing into early July. In the year 2018, we had two different 20% downturns, each of which were promptly followed by strong market upturns. As most of our clients know, and have come to accept, this level of market fluctuation is normal but unpleasant. Our strategy to deal with these market fluctuations is to acknowledge that they will continue to occur, but it is the price that we must pay for the higher equity market returns that we receive and expect to receive in the future. That the new market records would be a good time to address a couple of changes in the markets. First, I have finally decided that it’s time that for me to get on Twitter. Our president has decided that he’s going to, generally speaking, bypass the normal press release mechanism and release new information to the public through Twitter. I understand that Twitter is used for all kinds of purposes other than general policy announcements. It also seems to be used for sparring with your enemies, and it’s certainly being used to communicate directly with the US citizens and bypass the Washington Press Corps. I don’t want to spend too much time on the technical details of our work for you, but I can’t help but notice that the equity market mutual fund ETF purchases by the general public has been running at very low levels with bond fund purchases outrunning them throughout the month of June. That is, most of your fellow investors were selling stocks and buying bonds during the June period when the market was setting market records, unfortunately we cannot help them because they’re not our clients, but it is an indicator to us how many people are poor investors.

It has been and continues to be our recommendation to you that you maintain your investment in these wonderful multi-national rational companies in which you have invested.  The value of these companies may fluctuate dramatically in the stock market.  Your fellow investors may sell out at the latest whim or presidential tweet, but you know and we agree with you, that all of these changes and the daily press fixations on one matter or another all pass very quickly and it becomes insignificant to the long-term health of these rationally run companies.  This is a wonderful time for you to point out to your family that market ups and downs change very quickly, change unpredictably, but that we believe the long-term trend is up and that the 20% up and down turns, the 7% up and down months, are part of the cost of being a good long-term investor.  Please note that during all of last year with its ups and downs and this year with its ups and downs, the dividends in your account have continued to come into your account and to rise.  If you come across any of your good friends or family who are complaining about and concerned about market fluctuation, market volatility, please give them our name and we would be happy to talk to them and see if we can help them.

A final point that I would like to address, because I hear it come up from time to time are various market strategies that fall into the category of technical analysis, sometimes the “trend following,” sometimes they’re called market momentum play.  All of them are designed to offer an investor the possibility of avoiding large market downturns and yet participate in the upside of markets.  Many times, their components will argue for loss protection analysis or plan to protect capital.  We believe that all these technical analysis type programs sound great, a program which avoids serious market downturns.  But unfortunately, we can’t, because they don’t work.

The market technical analysis for rules-based investing is designed to help you stay invested in investment programs that are working well now and avoiding programs that are not working well.  The idea being that the recent past can indicate and predict what the future will be.  Our argument is that the future is unknowable, and that we have faith that capitalism will, and the investment markets moving cycles, will fix any problems that they’ve had in the past, any excesses that they’ve had in the past.  We will move forward, solve our problems, and figure out a way to increase earnings going forward.

The market analysts offer you the possibility and pretend that they have a system whereby they can avoid these losses.  It sounds very enticing because it’s exactly what you would like to hear, that losses can be avoided, and gains realized.  This is not possible, so our strategy to deal with market downturns is for you and your spouse to fully acknowledge that they’re coming, to embrace them, to treat them as part of the entire process, and then to teach your children the exact same formula, so that they don’t make the mistake of getting involved in any one of these market time schemes that promise to have you out of the markets and selling before a downturn, and yet somehow magically getting you back into the markets in time for an upturn.

The last two years are just further evidence and a career’s worth of evidence, that these programs don’t work.  That they have you sell to late, have you buy back into an investment program too late as well, so that you realize a lot of the loss don’t get the gain get the market gets her upturn, and are disappointed anew with significant transition cost all along.  Our approach to dealing with market downturns is to understand that they’re coming.  This is not a prediction for the future, but we understand that they will come.  They will come at an unpredictable, unknowable time, that it’s part of the process.  Both you and your spouse should understand that.  You should explain it to your children so that they can become effective investors as well.

If you, your spouse, or any family members have any questions, please give us a call.  We continue to be optimistic about the future.  Your prosperity is our business.  Thank you.  Contact me with any questions.

Very truly yours,
James Vaughan III

Please open your economic textbooks to page forty-seven, class, because it’s time to talk about something you probably haven’t thought of since college: tariffs.

On Thursday, March 1, President Trump announced a new plan to institute a 25% tariff on steel imports and a 10% tariff on aluminum.¹ Like so many things these days, the response was radically different depending on who you talk to.  More on that in a moment.

Traditionally, tariffs are something most of us don’t have to think about, especially as tariff levels in the United States have been low for decades.  But for investors, President Trump’s announcement has the potential to be very significant.  Why?  Because of the possibility that it could spark a trade war.

Should a trade war actually happen, it could have a major impact on investors.  To understand why, let’s have a short Q&A session.

What are tariffs and why do they matter?

Since it’s probably been a while since your Economics 101 class, let’s quickly cover a few basics.

To put it simply, a tariff is essentially a tax on imported goods and services.  Tariffs can be levied on almost anything: metals, foodstuffs, products, etc.  Historically, tariffs are most commonly used when a country wants to protect certain industries within its own borders.  For example, the Tariff Act of 1930 was designed to protect farmers by increasing the cost of importing agricultural products.  By making it more expensive to import crops from other countries, people would be forced to buy mainly from American farmers.  This is known as protectionism.

Once upon a time, tariffs in the United States were both high and common.  But after World War II, average tariff rates dropped significantly, and have stayed low ever since.  In fact, since the 1970s, the average tariff rate on imports has been well under 10%.²

So are tariffs good or bad?

Remember how I said the response to President Trump’s announcement was radically different depending on who you talk to?  That’s because a tariff’s effects can vary wildly, too.

Tariffs can bring two major benefits:

• Because tariffs are a kind of tax, they can bring more revenue to the government.
• Tariffs, and protectionism in general, can be a major boon to certain industries – including the workers within those industries.  In this case, the U.S. steel industry would benefit from a 20% tariff on steel, because it means more people are buying from them instead of their competitors overseas.

You can see why the idea of tariffs can be attractive for many people.

Unfortunately, tariffs can also cause some very negative side effects.  Specifically:

• Tariffs can make life more difficult for consumers, whether they be individuals, families, or businesses.  That’s because higher tariffs often lead to higher prices, which in turn lead to higher expenses.  For example, if companies must pay more for the steel they need, that could significantly eat into their own profits.
• Higher tariffs can lead to trade wars.

Okay, so what is a trade war, anyway?

We live in a global, interconnected world.  Toss a stone into the water off one shore and the ripples can be seen near another.  In this case, higher tariffs can cause some very large ripples.

When one country raises tariffs on a certain kind of product, other countries that depend on exporting that product won’t take to it kindly.  As a result, those countries might retaliate by increasing tariffs on their imports, thereby harming the first country.  Before you know it, tariffs become weaponized and a trade war breaks out.

Trade wars are risky things, because they can quickly jump from industry to industry.  Let’s take the current situation as an example.

After President Trump announced his plan to raise tariffs on steel and aluminum, the European Union threatened to do the same to U.S. imports – everything from motorcycles to bourbon to bluejeans.³  Other countries like Japan and Canada, which are both major steel producers and important trading partners, have threatened similar measures.  Should all this happen, the currents of international trade will quickly become choked.  That would lead to higher prices on many goods and services, which in turn would lead to lower profits, higher costs of living, and even – potentially – higher unemployment.

Should all those things happen, the markets will surely suffer.  As an investor, you don’t need me to tell you what that means.

So why did President Trump decide to raise tariffs?

For decades, the United States has seen a worsening trade deficit with many countries.  In other words, we pay more for importing their goods than they do for ours.  According to the Wall Street Journal, the U.S. “ran a global goods deficit of $810 billion” in 2017.⁴  One of the president’s most long-standing campaign promises was to address that deficit.  It appears that tariffs, along with renegotiating certain trade agreements, like NAFTA, are his tool of choice.

Geopolitical economics is a loaded topic, and there’s a lot of disagreement out there about causes and effects.  Again, tariffs can unquestionably bring lots of advantages, and there’s no question the United States is on the lower end of a trade imbalance with many countries.

At the same time, there’s also no question that Trump’s announcement has spooked both the markets and the global economy.  The Dow fell more than 400 points on the day of the announcement, and continued to fall the next day.⁵  Many world leaders have already warned about a trade war being a very real possibility.  Even many Congressmen in President Trump’s own party have spoken out against the prospect of higher tariffs.  This isn’t surprising, because the Republican party – or at least a large percentage of it – has traditionally been very much in favor of free trade.

As I’m not an economist, it’s not really my place to decide whether protectionism is good or bad.  It’s worth noting, however, that a trade war did break out the last time the U.S. raised tariff rates this high.

The Tariff Act of 1930, or Smoot-Hawley Tariff Act, raised tariff rates to their second highest level in U.S. history.  These days, economists generally agree that the resulting trade war worsened the Great Depression.  (What no one seems to agree on, though, is by how much.)  On the other hand, the United States is in a very different position in 2018 than it was in 1930.  Back then, the Great Depression had long-since started.  These days, our economy is much stronger.  That makes it hard to predict how hard a trade war will hit.

What happens now?

There are still so many things we don’t know.  For instance, we don’t know if President Trump will actually go through with his plan.  If he does, we don’t know if the tariffs will apply across the board, or if they’ll only be levied against certain countries.  (This is something many of his advisers are recommending.  If our closest allies are exempted, then the effects of a trade war would likely be minimized.)  And we don’t know what other nations will do in response.

What we do know is that the possibility of a trade war can have a substantial impact on the economy and the markets.

At the moment, I don’t believe we need to take any action. Back in February, the markets took a hit due to the threat of inflation and rising interest rates – and then recovered.  While the markets dipped slightly in response to President Trump’s announcement, it’s far too early to make any changes to your portfolio.

However, this is why my team and I keep such a close eye on what’s going on in the world.  Part of my job is to keep you informed of any ripples in the water so that you always stay afloat.  It’s impossible for me to say what’s going to happen next, but I’ll tell you this: We’ll always be here keeping our hands on the tiller.

In the meantime, please contact me if you have questions, or if there’s anything I can do for you!

Sources
¹ “Trump to Impose Steep Aluminum and Steel Tariffs,” The Wall Street Journal, March 1, 2018.  https://www.wsj.com/articles/trump-wont-quickly-announce-new-tariffs-on-aluminum-steel-1519921704
² “Average U.S. tariff rates, 1821-2016,” U.S. International Trade Commission, https://www.usitc.gov/documents/dataweb/ave_table_1891_2016.pdf
³ “U.S. allies around the world steel for Trump tariff tussle,” The Wall Street Journal, March 2, 2018.  https://www.wsj.com/articles/asian-allies-steel-for-trump-tariff-tussle-1519977304
⁴ “Trade Wars Are Good, Trump Tweets,” The Wall Street Journal, March 2, 2018.  https://www.wsj.com/articles/trade-wars-are-good-trump-tweets-1519996161
⁵ “U.S. Stocks Tumble After Trump Announces New Import Tariffs,” The Wall Street Journal, March 1, 2018.  https://www.wsj.com/articles/global-stocks-struggle-after-bad-month-1519868670?tesla=y