Tariffs have become an issue this quarter.
Investors’ confidence has been shaken by the escalating trade tension between the U.S. and our trading partners: China, the European Union, Canada and Mexico. The U.S. has imposed 25% tariffs on steel, 10% on aluminum and specifically $200 billion of imported Chinese goods. Our trading partners are retaliating with new or increased tariffs of their own.
While at Samara Capital, we don’t believe these tariffs will escalate into a trade war, this global tit-for-tat is a dangerous path for financial markets. Tariffs act like a tax on consumers and manufactures by increasing costs and creating a drag on economic growth.
A clear reaction can be seen in the stock market as trade tensions are bad for companies by putting pressure on their supply chains, revenues and profits.
Apple is a perfect example of these trade complications: Their costs on products assembled in China and sold to U.S. consumers could increase by 9%. They could also be vulnerable to Chinese retaliatory tariffs as 20% of their revenue is attributed to selling to the Chinese consumer.
The U.S. and the world economy have benefited tremendously from trade:
“In fact, it was America’s willingness to open our markets after World War II that not only helped rebuild the countries that had been destroyed by war but arguably introduced a middle class for the first time in many of the world’s countries and was responsible for pulling billions of souls out of poverty in the decades that followed.”
We hope to see a level of cooperation develop. In general, anything that inhibits trade will decrease global prosperity for everyone.
The Fed & Economy
The U.S. economy has some wind at our back pushing us toward further economic growth. With the approved $1.5 trillion tax cuts, $300 billion in increased government spending and unemployment at historical lows, it’s hard to imagine too much economic slowing in the near future.
Fed officials have grown increasingly confident in the health of the U.S. economy and recently upgraded their assessment of economic growth from “moderate” to “solid”.
In June, the Fed raised interest rates for the seventh time since December 2015, with another rate hike possibly occurring in September.
The Fed’s goal is for modest growth without spurring inflation. The Fed increases rates, as if tapping a brake pedal, to keep growth from accelerating too fast. If they are successful in increasing rates, without choking off growth, they will have room to decrease rates, a gas pedal, if the economy falters.
Our last newsletter shared the importance of paying attention to a flattening yield curve, when short and long term rates are the same. A flat yield curve is highly predictive of recessions and significant market declines. While there has been some tightening it is not flat. We will continue to closely monitor this indicator.
Consistency of Returns
These two graphs present the same information, expressed in a different way; the first graph shows 1-year returns and the second shows 5-year returns.
Even though both have produced similar returns, the 1-year returns “feel” wild and scary versus the 5-year returns “feel” less risky. Those feelings can impact decisions a person makes with their investments.
Relying on the 1-year return data could influence an investor to avoid or sell investments that would have been appropriate given a longer term view.
As an investor, having a long term perspective will provide a sense of calmness and help you maintain your investment objective. Investors have a compelling success rate because of their focus on long term value, giving them patience and confidence during short term fluctuations.
The first six months of 2018 brought split returns.
Large U.S. companies that make up the S&P 500 have done okay, +2.7% year-to-date.
The winners in economic sectors were Consumer Cyclical +11.37% and Technology +9.36%. While others struggled: Consumer Defensive -8.22%, Industrials -4.58%, Financials -3.97% and Basic Materials -3.25%.
There were companies that stood out: Some with great performance: Amazon +45%, Nike+28%, Microsoft 16%, Apple +10%. Others faced issues: GE -20%, Kraft -17%, 3M -15%, Starbucks -14%, Goldman Sachs -13%, and Walmart -12%.
Small and medium sized U.S. companies performed well with Small-Cap +9.33% and Mid-Cap +3.32%.
Outside the U.S., international stocks did poorly, with Developed International -2.84% and Emerging Markets -7.44%. In particular, China has suffered large declines since January and is in “bear territory” down nearly 20% for the year.
When interest rates are low, it doesn’t take much of a rise in rates to create a negative return. Bond returns this year have been generally negative.