- Banks Pass Fed’s Doomsday Stress Test
- Trade-War Fears: Prices on Foreign Goods Could Rise up to 10%
- Housing Market’s Growth Problem: Too Many Qualified Buyers, Not Enough Houses
- Dividend Growth Stocks—Download Our Latest Report
This week, while heart-wrenching scenes of children being separated from their border-crossing parents moved emotions, the investment markets were moved by broader “border” issues, thanks to the escalation of trade-war rhetoric and actions.
You can call the current imposition of tariffs and threats of more to come a dispute, a skirmish or a conflict. But from our perspective, it’s getting harder not to call it at least a battle… and can you have a battle without a war? We don’t think we’re in a trade war just yet, but the probability of one has increased.
Crafting portfolios that can take advantage of others’ fear-driven selling is a hallmark of our long-term investment approach.
For the year through Thursday, the Dow Jones Industrial Average has returned 0.1%, as the huge multinational companies that comprise that index have been hampered by threats of tit-for-tat tariffs. The broader S&P 500 has felt the reverberations less and is up 3.8%. The MSCI EAFE index, a measure of developed international stock markets, is down 2.5%. As of Thursday, the yield on the Bloomberg Barclays U.S. Aggregate Bond index has climbed to 3.33% from 2.71% at 2017’s end. On a total return basis, the U.S. bond market has declined 1.9% for the year.
Trade-War Fears Rise
It’s still too early to sound the bugles, but saber-rattling may well give way to a full-on trade war if cooler heads don’t prevail. We continue to hope that economic self-interest will eventually trump political self-interest; all countries and trade zones would benefit more from negotiating than fighting.
While many claim to know where the current road will lead, nobody actually knows for sure how to price in the implication of an actual, protracted, sizable trade war. One figure we saw this week estimated that prices on the foreign goods Americans buy (or goods made with foreign components) could rise by as much as 10%. How’s that for inflation?
As we’ve said, we aren’t there yet. For now, the headlines are all about milk tariffs in Canada and aluminum and steel in the U.S. But dig a little deeper and you’ll see the average tariff in the U.S., Britain, France, Italy and Germany was, according to The World Bank, an identical 1.6% in 2016 (the most recent numbers available). Tariffs in Japan were 1.4% and just 0.8% in Canada.
We don’t believe there is lot to be gained by provoking a trade war when tariffs are already near zero, and there is much to be lost. Our expectation is that the product-specific, anomalous and highly politicized trade tariffs won’t spread.
The Housing Market’s Growth Problem
Tight supply continued to weigh on the housing market in May—a growth problem. There simply aren’t enough houses to meet the demand of qualified buyers. Prices for what little inventory hits the market tend to be bid up, pushing many homes out of reach despite the fact that would-be buyers are well-employed and seeing their wages rise.
This lack of inventory has homebuilders scrambling. In May, builders broke ground on new homes at the fastest pace in nearly 11 years—up more than 20% over the same time a year ago. And there are more houses to come as issuance of building permits was 8% higher last month than in May 2017.
While it’s good to see builders working to sate demand, new homes still make up a small percentage of the overall market for sales. More important is the economic shot in the arm home construction provides: More construction jobs, more business for banks, more appliances and furniture sold, and of course the knock-on impact on sales of, say, light trucks.
Leading Banks Perform Well in Stress Tests
Each year, the Federal Reserve stress-tests 35 of the largest banks to see how prepared they are to withstand a severe economic downturn. All 35 banks passed this year, though several were weaker than expected as loan losses for these banks rose in 2018 compared to 2017. The overall results of the test, however, paint a picture of a stronger and healthier financial system.
Speaking of financial health, in a move that was not completely unexpected, the committee that determines membership in the best-known U.S. market index, the Dow Jones Industrial Average, booted GE from that elite group of 30 stocks and replaced it with retail giant Walgreens Boots Alliance. The move speaks to the ongoing change in the makeup of the $20 trillion U.S. economy. The companies that support our economy have shifted from industrial conglomerates to a service-oriented, consumer-driven marketplace. After a run of 111 years, GE’s businesses have declined and the company has lost its cachet as an economic and market leader. We still believe that the much broader S&P 500 index remains a better measure of U.S. stock-market health, but as the granddaddy of indexes, the Dow will always be the go-to index for commentators and pundits, hence the significance of the change.
Fundamentals Remain Strong
Despite continued uncertainty about a host of fiscal and political issues, fundamentals—earnings, interest rates, economic data—remain solid. That said, good times inevitably lead to less good times. When things are going as well as they are, we don’t let our guards down. Instead, we use the good times as the opportunity to prepare for all circumstances in consideration of risks, opportunities and your goals.
While the next economic or market downturn could be years away, it’s a case of when, not if. We know that the best time to plan for managing through such times is now, and not after the tide has turned. That’s why we encourage you to stay in touch with your portfolio team so that we are always cognizant of any changes in your financial status or objectives, as well as your comfort with the current investment course we have set.
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Next week brings more reports on the health of our economy and its driver, the consumer: New home sales and housing prices, consumer confidence and consumer sentiment, durable goods orders, the final revision to first-quarter economic growth, personal income, spending and savings, and a core inflation gauge.
Please note: This update was prepared on Friday, June 22, 2018, prior to the market’s close.
This material is distributed for informational purposes only. The investment ideas and expressions of opinion may contain certain forward-looking statements and should not be viewed as recommendations or personal investment advice, or considered an offer to buy or sell specific securities. Data and statistics contained in this report are obtained from what we believe to be reliable sources; however, their accuracy, completeness or reliability cannot be guaranteed.
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