Fearful of that all-time high?
Both the Dow and the S&P 500 made all-time highs this week. For some, this is big news and maybe even a cause for concern about investing in the market (“I don’t want to come in at the all-time high …”). We have a little problem with this logic and this math, though. The market has made 215 new highs since November of 2009. Let me state that again: 215 times over the last decade, the market has made a new high. Could it be that 214 times investing after an all-time high was a good idea, but the 215th time it became scary? I want to gently, intelligently, and clearly expose the problem with the thinking that an all-time high tells you anything whatsoever about what happens next. It is stupefyingly bad logic, and I cannot begin to calculate how much damage it has done to people to play into this thinking 214 times over the last decade.
Checking in on the trade deal …
The evidence of cooling tensions is best reflected in this chart showing the Yuan’s exchange to the dollar, where one can see that efforts for the Chinese to weaken their currency relative to the U.S. dollar have come down substantially since the big escalation of such currency interventions in August, and in fact the low-level of Dollar/Yuan exchange has now been reached (since that escalation). President Xi’s comments this week in Shanghai indicated this phase one deal is prepped for signature, and the request for the elimination of $110 billion of tariffs imposed in September, plus a lowering of the rate on $250 billion of tariffs imposed last year, will seemingly be the next big question in this trade war saga.
I am hesitant to be excessively optimistic, yet confess that things really do feel to be different this time, and really do seem to be on a very good track for the sake of the global economy.
The September tariffs, by the way, if they were to come off had been imposed on clothing, appliances, and flat-screen TV’s. It really is worth noting that the phase one deal we appear ready to get is basically the same as the May 2018 deal that was at the finish line, only without underlying structural reforms that the U.S. has wanted. Oh, and also, there are $400 billion more goods being tariffed now than then. So a structural phase two deal does have the capacity to actually undo some of the damage that has been done, if both parties can get there. Undoing some September tariffs for deeper reforms (phase two) would be a big deal for global growth, and has not been, in our opinion, priced into markets. More on the developments around repealing other tariffs below …
Reminder why it matters
There are people far smarter than I am who are reminding the President of this early and often, but I want to keep reminding you why it matters: A trade deal is needed to re-establish business confidence, and business confidence is needed to re-establish business investment.
Refresher on the August escalation
When you go back to August when the trade war issues escalated substantially, and at different parts of the month showed signs that they may utterly spiral out of control, the three issues that were on the table were: (1) China purchases of agricultural products from the U.S.; (2) Fentanyl enforcement; and (3) Calming down the China response to protesters in Hong Kong. All three of these matters have either improved, or are specifically addressed in the nearly signed phase one deal, So that explains why the “August heat” has come off, but it also explains why the issues above and beyond these three (admittedly, lesser priority issues in the big picture) are not yet front and center.
President Xi’s speech this week talked about the need to tighten protection of intellectual property, of increasing imports to boost Chinese domestic consumption, and to facilitating more foreign investment (i.e. access).
And then Thursday morning …
I woke up Thursday morning to the news that “China and the U.S. have agreed to roll back tariffs on each other’s goods in phases as they work towards a deal between the two sides.” The announcement is that as phase one is completed, both sides would then “roll back existing additional tariffs in the same proportion simultaneously based on the content of the agreement, which is an important condition for reaching the agreement.”
So look, it is hardly specific but markets did move up on the news, and it really is exactly what this policy situation needs right now (see the chart below). The removal of 2018 tariffs (even if in phases) from the trade landscape as we get to a fuller deal would be huge for global trade, economic activity, and that aforementioned business investment I talk about so much.
State of the Economy – Manufacturing
The ISM Manufacturing index for October signaled further contraction in Manufacturing, There have been three other times since the financial crisis that this data point signaled contraction, and all three times the economy continued in its recovery. This measurement is generally considered “soft data” in that it is very impacted by sentiment, but it will continue to warrant monitoring until we get some confirmation of whether or not this signals other negative things in the economy or a short-lived transitory data point.
State of the Economy – Non-Manufacturing
Now, the ISM Non-Manufacturing Survey (so, Services) expanded above expectations in October, with business activity and new orders both particularly standing out. This does go a long way towards alleviating the concerns we had after the contractions in these measures in September.
Navigating credit risk
Credit conditions are always and forever vital, and two things are simultaneously true but at odds in forming actionable plans right now:
a. When we do tip over economically and in equities, it will be preceded by a credit market revulsion
b. That credit market tip-over could be a long way off, and only a fool does not respect the Fed’s capacity for kicking the credit can further than we may believe
Credit conditions everywhere right now scream: Not very good, and yet not imminently bad. Excesses in the corporate sector are there, will come, and will come to roost. And yet, that time is not yet.
Therefore, Underwriting matters. We want to take credit risk only where real bottom-up risk mitigation through proper underwriting can be done. That eliminates some aspect of credit risk, but not all.
Adding to last week’s theme about markets …
Outside of that silly and really indefensible argument about “markets being at all time highs,” what are the good reasons to be negative on equities right now? We have addressed the relative improvement in U.S./China trade talks. We know the extraordinary accommodation to risk that the Federal Reserve has created. Oil prices are neither too high for consumers nor too low for producers. Europe is in an awful place but some of its “wheels off the bus” scenarios have been alleviated. I would say that more macro tail risk exists out of Europe than U.S./China right now, and that most risks that bite or the ones no one is talking about.
We are optimistic on U.S. equity markets, selectively, favoring individual high quality names that are reasonably priced if not attractively priced. And at the same time our optimism is restrained, humble, and even-weighted, not given to a tactical overweight at this time.
What does the IPO chatter teach us about, well, everything
Ten very high-profile, name-brand companies have gone public this year, and eight of the ten have gotten pummeled since trading began (in some cases, down over 50%). One if barely up, and one is up a lot. So one out of ten success in “high flying IPO’s” in 2019 (actually, not so fast – that one company that is up big since its IPO is itself down 66% from its high!). Well, in some years where the IPO markets flop it is because the whole market is suffering, but of course the S&P 500 is up ~20% this year! No, the reasons for this year’s IPO meltdown are not market related – they are deeper, wider, and actually very important to understand.
I have been wanting to write a white paper for some time on the changing dynamic around private equity, around private transaction valuations, and around the objective companies now have with public markets versus years and decades gone by. I believe an understanding of why companies go public, when they go public, and how they go public matters for investors, and I want to do it more justice than I can do it here in the Dividend Cafe. But what I will say the behavioral and evergreen lesson for investors is the allure of “free and easy” money was always a myth, and markets now are punishing people more severely than ever before for buying into the myth! Believing that a company whose name you hear a lot and whose services are well known must be a good value, or must be an attractive opportunity when presented to you, defies the testimony of history, logic, and economics. The companies in the list we are talking about, much like the dotcom era of twenty years ago, are money-losing companies whose investor popularity was driven by rank and naive greed, not legitimate business opportunity. I am all for intelligent greed. But the thoughtless greed that believes one can eat whatever they want and not gain weight is destroying investors, just like the comparison in the analogy destroys waist lines.
Politics & Money: Beltway Bulls and Bears
- Elizabeth Warren released her Medicare-for-All funding proposal last week, stating that (a) It would cost $52 trillion over ten years (more than the entire funding of government would run for that decade), and (b) That it could be entirely funded by tax increases on high earners and businesses, Those assertions have been mostly mocked by even left-wing pundits, and it remains to be seen how this will impact her in the polls.
- Media reports are now indicating that the deal terms of NAFTA 2.0 should be announced by Thanksgiving and a vote will happen by the end of the year. Both parties seem to be indicating this is correct, yet of course caution that something could still keep it from getting done.
- An interesting thought about China’s increased willingness to get a trade deal with the U.S. done … at the height of their push-back on U.S. requests, the overwhelming belief was that Joe Biden was going to be the Democratic nominee in next year’s election. The logic at that time was many felt China was weighing “waiting it out” with Trump, believing that if he lost the election they would have a friendlier foe to negotiate with. China’s appetite for a trade deal has seemingly doubled in the last two months, as Biden’s polling and betting odds for winning the Democratic primary have been cut in half … In other words, perhaps China is just as attracted to the idea of Trump losing in 2020 that they were a couple months ago, yet not confident enough that it would be Biden they would be negotiating with? Warren’s views on China and trade are not driven by the same forces of Trump, but could be just as unfriendly to China. Bottom line – with multiple potential political outcomes looking unattractive to China in 2020, not just one, they have come back to the table with the U.S. and the whole picture looks much better.
Chart of the Week
I have spoken a lot and written a lot about the long-term portion of equity total return that has come from dividends (vs. price appreciation), and what that looks like now. I found this chart powerful in reinforcing the reality that (a) Dividends are historically a very large portion of the return stock investors should expect, (b) When markets go bad, dividends are the entire portion of total return, and (c) They are a historically low portion of returns now, meaning, that it either needs to come higher, or returns need to come lower...
Quote of the Week
“Compound interest is the eighth wonder of the world. He who understands it, earns it; he who doesn’t, pays it.”