Look, I’m all for companies growing as our domestic economy has shown expansion decade by decade; however, when you start diving deep into who really has been rising and how fast, it seems to be tough, from a risk reward perspective, to justify putting new money to work.
In making a baseball analogy, we entered the seventh inning stretch when the first volatility struck earlier in the year signaling that markets do really, in fact, have the ability to go down!
In present day, the second strike is showing that we got up, stretched our legs, and sat back down waiting for the first pitch in the top of the 8th inning to be thrown. We are seeing volatility spike and a sharp down move has occurred similar to this past Spring. It would be foolish to not at least pare back risk and increase portfolio diversification.
There is no need to run for the hills and sell your entire portfolio, but be cautious that if you are long equities- you need to make sure to understand where the risk lies in your portfolio and the implications the current market environment can have on your gains from this bull market.
We are seeing a couple of potential triggers in the current market.
To start, if we are going to go through with these tariffs on China, that is going to have a trickle-down effect on the market. Typically, the market acts as a discounting mechanism, however it is truly hard to discount the long-term effect of tariffs to this degree. Secondly, we are seeing rates rise with the 10-year yield surpassing 3%, which could also dampen the upside growth of the market. After all, the stock market and the bond market both compete for the investment dollar.
So, why do we think that the overall economy may sustain an upward trajectory, but the market may remain dislocated from reflecting the direct economic growth?
Simply distilled, is that the market has begun discounting any negatives of the trickle-down effect of the tariffs. I’m all for renegotiating trade deals that have been doing a great job of collecting dust, however there are short term consequences in doing this. Many countries (if not all) have priced in their discounted cash flow of their current businesses domestically.
They are not properly equipped to have a large wrench thrown at them that can not only cut into thin margins, but make those margins disappear overnight.
Let’s take an example of the retail space. “The current average duty rate paid for all goods the United States imports is 1.4%. Average tariffs on travel goods and footwear is about 11%” (American Apparel). In general, the retail space has not grown as fast as many sectors during this most recent bull market. As you start piecing together the math, the end conclusion is a lower stock market.
What typically happens is a set of several waves of categorical tariffs that start repeatedly taking a toll on growth. We shall see the ramifications, but in the meantime look out for consistent volatility as the next several quarters come to a head.
In terms of our internal portfolio we remain cautious per usual, in having low exposure to equities, a diversified set of strategies, and plenty of cash so that we can take advantage of buying quality companies over blindly throwing dollars at technology companies going to the moon. Our current portfolio construction allows us to be nimble in this increased volatility, which creates opportunities for much less volatility and downside risk compared to the overall markets.
Source: American Apparel & Footwear Association.