After a long period of unusually low volatility, significant price swings in the equity markets have returned. There are many reasons for this, but chief among these are the possibility of a trade war, expected increases in interest rates, and the popularity of indexing.
- Trade- This does not appear to be the beginning of a global trade war such as what was experienced after the passage of the Smoot-Hawley Tariff Act in 1930. As far as aluminum and steel, broad exemptions have already been granted. The big issue for the developed world is China. In fact, in an article published by the Globe and Mail by former trade negotiator and executive fellow at the University of Calgary’s School for Public Policy, Andrei Sulzenko “Canada and other Group of Seven countries should be quietly applauding.”1 It seems that most developed nations have a similar problem with China, which is China’s demanding free trade abroad while maintaining state ownership of industry at home. Further, advanced nations such as the United States, Canada, France, Germany, and Japan are losing valuable intellectual property to what is essentially the Chinese government. Any country daring to take on China faces the problem of other nations rushing to exploit the gap. Only the United States has the financial wherewithal to take the lead. Mr. Sulzenko believes that “the U.S. threat of trade action against China will be looked back upon as a seminal event in 21st century international economic relations, with long-term implications for the global community. The possibility of those relations becoming fairer and freer compared with the status quo is worth the effort.”
- Interest rates- Rates are the greatest problem with the valuation of the market. Higher interest rates make bonds more competitive with stocks. How much of a risk this is depends upon your individual situation. We don’t believe that short-term volatility is the big problem. If you are young and putting money away regularly, declines are good for you. If you are retired and need income, rising interest rates are a good thing. As is always the case, we need to maintain the right portfolio allocation. The biggest challenge for those at or near retirement is not volatility, but the expected long-term return from a market that has high valuations. We have said this for some time. See The Current Global Expansion in our January 11, 2018 newsletter. Click Here
- Indexing- Indexing has an important place in portfolio construction. We use it ourselves. However, as noted by Michael Wursthorn in the March 19 Wall Street Journal “the so-called FANG shares have grown to such a size, $2.2 trillion collectively, and have been responsible for such a large proportion of market indexes’ gains over the past year that some investors are worried that their decline could rattle sentiment anew.”2 FANG stands for Facebook, Amazon, Netflix, and Google (Google is now Alphabet, Inc.) People who buy indexes for diversity have often unknowingly participated in riskier and more concentrated positions, largely in technology. The recent political problems for Facebook only fan the flames of uncertainty for index investors. For the vast majority of our clients, this should not be a serious concern.
Please feel free to call us with you concerns, and most of all thank you for your business.