“Dear Mr. Fantasy, play us a tune…something to make us all happy…do anything, take us out of this gloom…sing a song, play guitar, make it snappy…”
It’s hard to believe that Traffic recorded this song over 50 years ago. It was a combined 1967 effort with Stevie Winwood and Chris Wood writing the music, and drummer Jim Capaldi penning the vocals. Like many old chestnuts that I use to start my monthly missives, this one has tremendous applicability to today’s market environment.
August was a negative month for equities, but the final week of trading ameliorated some of the losses. Major averages are still nicely in the black for the year. Fixed income and gold continue to work for investors as well, and our domestic overweighting has remained a good macro call. That being said, August experienced a significant rise in day-to-day volatility as talk of a looming recession heightened. What happened and where are we heading?
To many observers, the bond market has been giving pundits a historical omen that soft times are approaching. The inverted yield curve in Treasuries (meaning short-term instruments are yielding more than long-term) has been a somewhat reliable indicator of a recession within the next 12-24 months. Keep in mind that the classic definition of a recession is negative growth for only two quarters. Yesterday’s revised second quarter GDP reading was 2.0%, so we’re a long way from a current recession. Let’s also remember that the inverted yield in prior years (2007, for example) occurred when rates were much higher than today’s levels. As of this writing, the 10 year Treasury yield is roughly 1.5%, and the 30 year is slightly below 2%. The dividends paid on S&P 500 stocks are similar, and their income is tax-advantaged. Low rates are positive for the housing industry, consumers, and corporations that are either expanding or buying back shares. I’m frankly not buying this harbinger yet, but it has made many folks uneasy.
The trade war with China shared the financial headlines with the inverted yield curve. The on again, off again, ratchet up and down, increase tariffs or delay cycle is dizzying. Wall Street has been reacting with swiftness on nearly every tweet from President Trump. It’s honestly at the point where the uncertainty makes one’s head spin. Trump’s direct order for American companies to leave China stretched credulity even given his loose relationship with the truth. It’s difficult to know where and when this battle will end, and so volatility seems assured.
Other newsworthy topics for August included North Korea, the relations between Iran/Saudi Arabia and India/Pakistan, the G7 conference, mass shootings in El Paso and Dayton, fires in Brazil, protests in Hong Kong, and Hurricane Dorian. Each one of these subjects can induce angst and angina pain on its own, and the combination isn’t conducive to investor confidence.
The counter-balance to this state of world affairs is the fact that the American consumer continues to be alive and well. This quarter’s retail earnings, other than mall-oriented big box companies, were surprisingly strong in virtually all sectors. Folks are traveling in record numbers, and restaurants are thriving, even on week nights. While Europe struggles with moribund or negative GDP prints, the US keeps chugging along. If corporate earnings can be maintained, equities seem a logical choice, particularly given the low interest rate environment.
I remain cautiously optimistic for the next several months due to one overriding factor – President Trump is obsessed with getting re-elected in 2020. While installing conservative judges and deregulating many industries has curried favor with his base, the string of broken campaign promises is a long one, regardless of the spin. Not one mile of the border wall has been built (as reported by Shepard Smith of Fox), and Mexico hasn’t paid a dime of repairs for the portions that have been repaired. The Washington swamp hasn’t been drained. Over a dozen Republican congressmen have decided not to run for another term. Racial animus and gun violence have become part of our daily lives.
My point here is that the wealth effect of a rising stock market during Trump’s first two-thirds of his term is arguably his strongest mandate for re-election. My supposition is that if we are in a recession next year at this time, with the markets down double digits from their present levels, he’ll lose support. Of course, we don’t know who his opponent will be, and that will have a large bearing on the 2020 outcome. Regardless of his foe, the performance of stocks will be important during the cycle. Therefore, I believe that he will do anything within his power to prop things up. He’s already floated the idea of a payroll tax holiday. He’s also relentlessly pressuring his Federal Reserve Chair appointment, Jay Powell (called an enemy of the American people equal to China’s President last week), to lower interest rates further. Trump could advocate additional monetary easing despite the negative effect that it would have on long-term US debt stability. I’m not so sanguine about post-election performance, but Wall Street in the President’s mind needs to do well for the next fourteen months. The artificiality or fantasy of how we get there will be immaterial.
I wish that I had a better sense of clarity, but it’s impossible right now. We’ve been receiving quite a few e-mails and phone calls asking our opinion. All I can say is to try to divorce yourself from the headlines and concentrate on what American companies are doing and how the consumer is faring. There’s a great disconnect between Wall Street and Main Street, and don’t think that it’s not intentional. Purveyors of fantasy use diversions, smokescreens, and subterfuge to create their version of (alternate) reality. It’s imperative that we as investors try to cut through the clutter so that we can make informed decisions.
RC, Kelley, Christie, and I are watching the proceedings closely, and are here to discuss your holdings with you. As always, we appreciate your continued trust and support. We look forward to hearing from you soon.
|The opinions expressed in this letter are those of William Schiffman and should not be construed as specific investment advice. All information is believed to be from reliable sources; however, no representation is made to its completeness or accuracy. All economic and performance information is historical and not indicative of future results. Diversification cannot assure a profit or guarantee against a loss. The S&P 500 Index is a broad based unmanaged index of 500 stocks, which is widely recognized as representative of the equity market in general. Indices are unmanaged and do not incur fees. One cannot directly invest in an index.
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