Market movements in August and early September provide important guidance on how an investor should react to market volatility caused by tweets and tariffs. A brief recap of events since August 1st will provide an important backdrop for this discussion.
An overview of recent history
Throughout August, virtually every financial asset class experienced substantial volatility including equities, fixed income, commodities and currencies.
Aug. 1: President Donald Trump tweets that beginning on Sept. 1, the U.S. would impose an additional 10 percent tariff on $300 billion of Chinese goods (see chart below).
Aug. 3: While the U.S. equity markets turned negative on Aug. 1, a more significant equity market decline occurred the following Monday when China appeared to retaliate by allowing its currency (the yuan) to significantly depreciate and announcing that it would not purchase U.S. agricultural products. This caused a 3 percent sell-off in the S&P 500 and a rally in safe-haven assets including U.S. Treasurys, with yields on U.S. 10-year Treasurys tumbling below 1.7 percent (yield and price on bonds move in opposite directions — when yield goes down, price goes up).
Between Aug. 3 and Aug. 22: No significant trade-related tweets or tariff “tit-for-tats.” The yuan stabilized, as did U.S. equity markets, which rotated between positive and negative days.
Source: Strategas
Aug. 23: President Trump tweets that he will raise the existing 25 percent tariffs on $250 billion in goods imported from China to a 30 percent tariff on Oct. 1. The equity markets sell off, and the yield curve inverts.
August 28: The Chinese government states that China will not retaliate for the new U.S. tariff increases. Equity markets rally, and bond yields rise.
From Aug. 28 to the present: The rally in equity markets continues, with the S&P approaching all-time highs. On Sept. 3, the yield curve inversion ends.
As this background indicates, the overriding issue causing market movements is whether the trade dispute with China will escalate and thus cause further deceleration of already slowing global growth.
In responding to these events, it is important for investors to discern noise from signal. It is our view that the best way to do this is to focus on fundamental data to determine what the real impact of the escalating trade dispute will have on the U.S. and global economies. So far, the biggest impact has been on business confidence and on the manufacturing sector. To date, the trade dispute has not impacted the U.S. consumer (the largest driver of the U.S. economy) or employment data. While it is our view that it is important to evaluate a variety of economic data, The Conference Board's leading economic indicators (LEIs) have been a good predictor of recessions historically. They occasionally produces false positives, but historically the U.S. has not had a recession without the LEIs turning negative. As you can see from the chart below, the LEIs are still positive, but are at an inflection point.
Source: Advisor Perspectives
In analyzing whether to reduce risk in a portfolio as a result of increasing trade tensions we think an investor should focus on whether those tensions translate into fundamental economic data.
One of the biggest mistakes an investor can make is to get caught up in the emotion that comes from market movements. An investor can protect against this in two ways. First, as discussed above, follow the data. Second, maintain a diversified portfolio regardless of the emotion of the moment. Historically, diversified portfolios allow investors to participate in equity market upside while cushioning equity market drawdowns. This scenario played out in early August as bonds rallied while the equity markets sold off. Accordingly, regardless of the cycle we are in, we think that maintaining diversification in your portfolio is a key to successful long-run investing. An investor (with guidance) could also consider using alternative investments that are not correlated to the equity or bond markets as another way to diversify a portfolio.
Sudden market movements (either up or down) often cause investors to overreact. This is one of the most critical mistakes an investor can make. We are believers in always maintaining diversified portfolios and not reacting to the crisis of the day.
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About the Author
Howard Coleman joined Coldstream Wealth Management through the company’s acquisition of Genesee Investments in 2011. With a varied background, Howard brings a wealth of legal and investment expertise to Coldstream.
Beginning his career at the Seattle firm of Riddell, Williams, Bullitt and Walkinshaw, Howard focused on securities-related litigation and regulatory issues and became a partner in 1991. In 1997, he went to work for Genesee Investments as its managing director and general counsel assisting in the analysis and negotiation of its hedge funds' private investments in public companies. By the early 2000s, Howard transitioned away from his legal role and began evaluating hedge funds for Genesee’s three fund of funds. Having evaluated well over 2,000 hedge funds during his career, Howard found that his legal background dovetailed nicely into hedge fund analysis and strategies that involved real estate, debt instruments or bankruptcy. In 2014, he became Coldstream’s chief investment officer, working with the Investment Strategy Group to develop strategic and tactical asset allocations and fund due diligence.