During the selloff which took place at the beginning of February we highlighted our view that volatility would persist for quite a while. Indeed, it has but we remind everyone that this level of volatility is more normal than the unprecedented period of calm which preceded the selloff. So, we want to set the tone for clients that choppy, yet rising, equity markets should be expected for some time to come.
A couple of events over the last week has contributed to the volatility and I would like to offer our view on them. Keep in mind our view is without a political bias as our task is to navigate markets for our clients and not let dogmatic political views interfere with our decisions.
In many cases, our view on how the market will be affected by political events is shaped by the “loudest” reaction by the public. The market tends to move in the direction that delivers pain to the largest (and loudest) group of investors. If we are to determine who is the loudest, it is important to stay silent and observe. This is what we try hard to do.
The first event was testimony from Jerome Powell who is the newly-confirmed chairperson of the Federal Reserve. The market’s initial reaction to his testimony in front of the House Banking Committee was negative. Powell hinted (or so the market thought) that he saw enough justification for more interest rate hikes than the market had baked into its expectation. The following day he testified in front of the Senate’s committee. The market interpreted his comments during this testimony as more “dovish” which sent stocks higher. Clearly the market was confused, and this usually leads to volatility.
Our initial read on our new Fed chair is that he is uniquely in tune with the retail banking industry. In fact, he is a former banker and not an economist by trade. We do expect the Fed to “over tighten” monetary policy by raising interest rates too far too fast. However, we expect this chairperson to respond more quickly to the market’s response than his predecessors. This is a good thing. Regardless of our view on monetary policy’s direction, we expect stocks to move significantly higher over Powell’s tenure.
The second event, President Trump’s announcement of steel tariffs, put Powell’s testimony on the back burner very quickly. Mr. Market is still trying to sort out a direction and we do not expect any resolution for a while. Nonetheless, we want to offer our view of what might be ahead for stocks.
As indicated above, we pay close attention to the reaction of investors to events and try to move in the opposite direction from them. In other words, we try to “zig” when everyone else is “zagging.” The loudest reaction to the announced tariffs has been decidedly negative. So, we expect this negativity to lead to a buying opportunity as investors realize that the world is not ending and something other than the worst-case scenario plays out. Whether Trump pulls back on the tariffs, tweaks them, or even goes through with them, our expectation is that the economic expansion currently under way will not be derailed.
Make no mistake. We completely understand, and agree, that tariffs can have a very negative effect on trade, and therefore the economy. The Smoot-Hawley tariff of 1930 almost single-handedly brought about the Great Depression. We see absolutely no chance of such a result from the current tariff proposal.
Smoot-Hawley affected over 20,000 goods while Trump’s affects 2. While Wall Street and, more importantly, the banking industry was brought to its knees, the economy was already slowing dramatically before Smoot-Hawley took effect. What Smoot-Hawley effectively did was pull the economic “knot” so tight there was no way for the economy to recover.
In contrast, the current economy is in the late stages of recovering from the Financial Crisis having just been given a “sugar boost” in the form of a massive tax reform bill. So, while much will be made of the potential impact of said tariffs, we believe the impact on the economy will be modest at most.
We do not lose site of the fact that politics does not happen in a vacuum. Politicians, especially our current President, understand well how to use the media to their benefit. We think it is no coincidence that the following sequence of events has occurred;
- Trump campaigns on protecting American economic interests, delivering a massive tax cut and the need to renegotiate NAFTA.
- Trump, based on both Republican and Democratic observations, has established that he will at least try to accomplish everything he put forth in his campaign.
- Trump initiates a massive tax overhaul which passes the House and Senate.
- The stock market (which the president frequently cites as his favorite measure of his success), roars higher following the passage of tax reform.
- NAFTA negotiations, by many accounts, have not delivered the desired results the President has set out to accomplish. Approximately 60% of imported steel comes from Canada.
- A new Federal Reserve chairperson is nominated. Only Supreme Court justices have more autonomy and control than the Federal Reserve chairperson.
- It is clear the Federal Reserve is eager to “normalize” interest rates, which has the effect of slowing the economy. The President might just be worried that the Federal Reserve, which has a dubious record when it comes to raising interest rates, could derail the roaring stock market if they raise rates too much too quickly.
- The fear of negative effects from a tariff-led trade war just might influence the Fed Chairperson to hold back on aggressively raising interest rates and thereby slowing the economy.
- The President recently announced (earlier than any other president in history) that he is running for election.
- Pennsylvania, among other manufacturing states, has been leaning “blue” in recent elections while having a significant steel-producing electorate.
- The European Union has suggested that Kentucky bourbon and Wisconsin-made Harley Davidson motorcycles are likely targets of a retaliatory tariff if Trump follows through with his tariff. The leader of the Senate and the House, potential influencers of the President’s decision, are from Kentucky and Wisconsin.
Whether these observations line up with reality or not is unclear. Yet, we believe the President is playing a game of politics more than a game of economic brinkmanship.
To us, it seems clear that the US economy is strong, corporate profitability is rising and more people are working than at any time in the last decade. These, among many other factors, is what investors should focus on. The stock market is poised to rise for many years to come despite the political rhetoric. Unlike the last 17 years, stock selloffs (which will come and go) should be bought rather than sold.
Kessler Investment Group, LLC