by Brad M. Weafer, CFA Chief Investment Officer
Key Points
The stock market reacted swiftly this week to the growing threat of a prolonged trade war with China.
History suggests overreacting to headlines is a bad course of action.
Avoiding overreaction does not mean ignoring risk. We manage this risk through careful individual stock selection.
Numerous times over the previous two years we have highlighted the risk that policy errors pose to the U.S. economy. Over the course of the last week an escalating trade war with China again reared its ugly head. President Trump announced on Twitter plans to impose a 10% tariff on $300 billion of U.S. imports from China that will go into effect on September 1. Many of the affected goods target consumer-oriented products including apparel, footwear and electronics. The Chinese response was swift. The Chinese Ministry of Commerce instructed state-owned companies to halt purchases of U.S. agricultural products. On Monday China also allowed its currency, the Yuan, to weaken, drawing criticism from the U.S. for manipulation. The impact on the economy from these announcements is clearly negative (for the U.S. and China) but difficult to accurately quantify. Second quarter GDP growth was 2.1%, so there isn’t significant room for error. The U.S. Federal Reserve moved last week to lower interest rates, in part due to trade uncertainty.
The U.S. stock market weighed in on the growing tension and sent stocks lower six straight days. The S&P 500 Index fell nearly 6% over that span (through Monday, August 5). We often caution that with equity markets there is always something to be worried about and this week’s news is the latest in a long running list of worrisome events that have potential to affect the economy. Investors, however, are prone to short-term overreaction. To put that in perspective, there have only been five other instances of six straight daily declines in the last 10 years.
In all those periods stocks were higher one month and six months later. Stepping back from the recent shift in sentiment, the S&P 500 now sports a higher yield than the 10-Year U.S. Treasury bill, suggesting there is some value in stocks relative to fixed income.
At BFM, one of our core beliefs is that the key to healthy long-term returns is a focus on managing risk. While we advise clients to not overreact to recent headlines, we must not ignore the impact that shifts in the economy due to a trade war can have on earnings per share, the lifeblood of stocks. Recent economic data indicates a late cycle economic environment and the potential for decelerating economic growth. This has manifested itself into slower earnings growth in 2019 (see Figure 1 below) Fortunately, to date, trade policies have not had a large enough impact to tip the U.S. economy into a recession. Better than expected economic growth in 2019 has helped stocks rebound off the December lows with the S&P 500 up almost 15% year-to-date. The trade disrupt presents uncertainty in the form of what actual policy will be, how businesses will react, and what the ultimate impact will be. It’s times like these we feel fortunate to invest in individual companies. On a company by company basis, we have a better opportunity to assess the risk facing each and manage the positions accordingly. In addition, we feel fortunate to invest in talented and savvy management teams that can also manage what evolving risks come their way. We acknowledge the risk to the economy and markets, but continue to believe that a balanced allocation to high-quality stocks and fixed income offers the best change for attractive long-term, risk adjusted returns.
Market Commentary Disclaimer: This publication is for informational purposes only and should not be considered investment advice or a recommendation of any particular security, strategy or investment product. The information contained herein is the opinion of Boston Financial Management and is subject to change at any time based upon unforeseen events or market conditions.