Will The Trade War Further Diminish Economic Growth?

Investors have witnessed a number of strange occurrences in recent months, if not years. Though stocks have staged a big rally this year (most of it in January), this has merely been an attempt – unsuccessful as of yet – to recover from 2018’s 20% decline that stocks experienced towards year’s end. Even more interesting and odd is the fact that stock prices are lower today than they were in January, 2018 – over 16 months ago! What gives? Why are stocks stuck in this long trading range and when will markets allow us to get back to making significant long term returns?

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Source: Bloomberg[/caption]

As we have said many times in past Strategy Updates, global stock markets are tied to economic growth and corporate profits. One need look no further than 2017 as a reminder – a period when economic growth exceeded 3%, corporate profits skyrocketed and stock indexes and your portfolio of stocks soared upwards of 20%. Those were the days! However, as we review the past few quarters, economic growth rates have decelerated from over 3% to something closer to 2% or less. The Atlanta Federal Reserve Bank GDPNow model’s most recent estimate is that the US economy is growing at just a 1.3% annual rate in the current quarter. And the Atlanta Fed’s model is not alone: our friends at the Economic Cycle Research Institute run an historically reliable Weekly Leading Index that also shows the US economy is slowing to a stall. Lastly, the decline in long term US Treasury yields (lowest level in 2 years) and falling commodity prices are signs that the economy is not on solid ground. Investors would be wise to keep these facts in mind.

The slowdown in global and US growth is largely attributable to the Federal Reserve’s rate hikes in 2018 which in turn led the punishing 20% decline in stocks. Add to that the month long US government shutdown and the now real effects of tariffs and it is plain to see why the economy has drifted to a slower pace. In the meantime it is quite clear that corporate profit growth is feeling the effects of this slowdown. Though some companies such as MasterCard, Unilever and NextEra, which you own, have been able to generate respectable growth in this slowing economy, many others have missed earnings growth expectations – most specifically in sectors that are sensitive to the economy such as the industrial and consumer discretionary sectors. If the economy continues to slow – or more importantly recede (as in recession) – earnings and stock prices could be in for a further downside slide. Therefore, the key to managing our way through a slower economy is to make sure your portfolio has companies that can generate profits regardless of the economy and also to be flexible about your level of stock exposure.

Just because the economy has slowed doesn’t mean that the market needs to spiral into a wicked bear market (more than the last 20% decline). If the economy can maintain this slower than normal growth rate, there are plenty of companies we can add to your portfolio to potentially make handsome profits this year, particularly in the healthcare, select technology, financial and consumer staples sectors. We have a list of these companies and are eager to purchase them on your behalf at appropriate valuations.

As you know, in an effort to put the odds in your favor for a good year of performance, we have been patiently waiting for stock prices to experience a normal correction after the big rebound in January. That correction appears to be underway as of this writing (~4% off high) – this should give us great opportunity to add more stock exposure in companies we feel can generate profits in this slower than normal part of the economic cycle. Of course if the correction appears to be gaining steam on the downside (which would probably be due to negative news about the economy, profits or further tariffs) we may slow such purchases. Remember: when economies – particularly those threatened by tariffs – are weak, stocks can really take it on the chin.

Throughout history stocks go up about 80% of the time – so we picked a great business to be in. However, the 20% of the time stocks are not going up is usually tied to the economy – and this time appears to be no different. The stock market doesn’t deliver consistent year-to-year returns and never has. The important part for investors is to dodge the grizzly bear markets (declines of 35-60%). Successful long term investing takes patience and discipline and a keen eye for what the market has done recently (in this case nothing for almost 18 months); and as well an eye for where the economy and profits will take us as we go forward. Once this period of economic weakness stabilizes or even contracts, we could have many years of bull markets and profits to look forward to in the “80% of the time” mode. The stock and real estate markets have been and, as far we can see, will continue to be the best places to grow wealth over the long term.

As you know, our team is dedicated to delivering long term upside performance and have proven to do so over multiple decades. In addition, we are diligent about protecting you from the catastrophic declines that are usually associated with economic recession through our Active Risk Management process. Protecting capital in bear markets allows you to reach your long-term goals, whether those goals are to retire, meet your organization’s spending policy guidelines or leave a greater legacy for the next generation. In that spirit, we will continue to monitor the global economy, the effects of continued tariffs and to manage the risk of your portfolio through your allocation to stocks, sector management and the use of carefully placed stop loss orders.

We hope this update finds you well and that you enjoyed the Memorial Day Weekend. If you have any questions about your portfolio, wealth plan or have experienced a significant change in your finances please feel free to contact us.

Thanks again from all of us for your continued vote of confidence!

Your Team at Main Street Research

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