The performance derived from individual stocks can be amongst the most rewarding portions of an investment portfolio. However, whereas a highly curated and diversified stockread more
Living in the Silicon Valley probably makes it easy to forget just how much technology, and the speed at which information is disseminated, has changed our lives over the last several decades. When I first started in the finance business, most of the information used to make investment decisions came via regular mail, fax machine or phone. In fact, delivering the daily mail to employees was someone’s full time job, and we even had an internal library, with a full-time librarian, that housed company annual reports and related publications. Back during this era, I couldn’t imagine that an off-the-cuff comment made by the President would ever make it to the press. Or, if it did, we would have learned about it several days later in the printed newspaper or the nightly news, and it likely wouldn’t have had the same immediate impact on financial markets that it frequently does today. These days, we seem to learn about things instantaneously, often before they have been fully vetted for accuracy or intention. Furthermore, we are bombarded by these constant updates via devices that never leave our pockets or desks, making it nearly impossible to take healthy mental breaks from usually emotionally charged “news”.
In turn, it’s not surprising that this results in increased anxiety and the feeling that current times are particularly troubled. However, compared to history, one could argue that economically-speaking, things aren’t so bad. The unemployment rate is at a 50-year low, wages have been increasing at a pace faster than inflation for the last several years, corporate profitability is near all-time highs, both the stock and bond markets have generally delivered positive returns over the last decade, and low interest rates are benefitting both consumers and businesses alike.
Still, following a decade of steadily improving economic conditions, some signs of weakness have begun to surface; and this realization was met with rising financial market volatility during the recent third quarter. At times, markets seemed to move on just the headline of the day and while some of this news was noteworthy and potentially impactful, other stories appeared to have little merit. In our view, the most important developing domestic economic news has been that the manufacturing sector is beginning to contract. This is being caused by global trade tensions, company-specific disruptions at companies such as Boeing, and general weakness in the worldwide auto sector. Globally, economies with greater dependency on manufacturing, such as Germany, are being adversely impacted even more.
Meanwhile, the consumer continues to exhibit strength and, for the time being, weakness in the manufacturing sector does not appear to be spilling over into this significant part of the economy. Clearly, consumers are blocking out some of this noise, possibly because the general media has been chanting about potential looming recession for the better part of the last year. Indeed, the biggest question that investors and economists are pondering is whether this trend, of the generally upbeat consumer, can continue.
Looking back at recent history in the U.S., the manufacturing sector contracted for four months in a row in late 2015 and early 2016, and this contributed to an earnings recession in the U.S. that spanned most of 2016. This was primarily driven by a significant drop in oil prices and a strong U.S. dollar. Over time, oil prices recovered, and the U.S. dollar stabilized, allowing the sector to grow once again. This time, the uncertainty that global trade tensions has caused is weighing on the sector and if some resolution, or at least clarity, on the U.S./China trade relationship is reached, it would make planning for the future a much easier exercise. Furthermore, if tariffs were eliminated on some goods, this would directly and positively impact the profitability of many companies.
Throughout this current period of heightened trade tensions, we have held the view that an ultimate resolution would be in the best interest of both parties. However, both parties appear to be more tenacious than we initially assumed. Nevertheless, the upcoming presidential election is a defining moment, in our view. For the Chinese, negotiating with a sitting U.S. President who is seeking re-election is probably better than potentially negotiating with a re-elected President in his final term. And for President Trump, a trade agreement perceived as being beneficial for the U.S. would likely boost his re-election hopes. Hence, we believe that an agreement is highly probable. This outcome would provide needed clarity to many companies and industries and serve as a platform for meaningful future economic growth.
Still, the news cycle over the coming months will surely be dominated by politics and is apt to be more disruptive than normal given the added complexity of potential impeachment. Tuning out this constant commotion and focusing on economic fundamentals will be more difficult, but also more important, than ever when it comes to making sound investment decisions. Typically, politics don’t impact financial markets as much as everyone fears it might. Even previous impeachment proceedings were mostly overshadowed by the prevailing economic health of the country at the time. Regardless, this next election cycle is likely to be a real doozy.
Having said all this, throughout this year, we have modestly and opportunistically reduced exposure to overall equity. Despite our anticipation of an eventual trade resolution and our recognition that central bank efforts to stimulate economies globally should begin to bear fruit in the coming quarters, our preference is to take a slightly more cautious approach at this point. And we’ve already had a very solid year in the equity markets, too. As always, we will be focusing on fundamentals, doing our best to block out the noise, and working to make ongoing thoughtful decisions on your behalf.
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