Trump’s Tariffs

On March 1st, 2018 President Trump announced his intention to impose significant tariffs on steel and aluminum imports. The announcement sent stock and bond prices falling, stoking fears of higher prices and slower economic growth. Protecting domestic industries like steel and aluminum may have raw appeal, but tariffs are flawed in theory and have a history of hurting economic growth. History shows a link between tariffs and populism which last flourished in the 1930’s. President Trump’s proposed tariffs threaten the post WWII global trade order and stock and bond markets are now paying attention.

Tariffs are bad policy

Basic economics instructs that tariffs benefit a select few producers and harm consumers through higher prices as they reduce competition and allow less efficient producers to continue to operate. In 1776, Adam Smith wrote of comparative advantage stating that countries should focus on their low cost production and trade for goods where their costs of production are relatively high. In general, society benefits from trade as wealth rises everywhere.

Tariffs have a consistent history of reducing economic activity and hurting growth1. The clearest example is the infamous Smoot Hawley Tariff Act of 1930, which essentially doubled tariffs on over 20,000 imported goods to an average rate over 50%. While this was one of many policy errors that contributed to the depth and length of the Great Depression, there is general agreement that these tariffs made matters worse. The effect of these tariffs on global trade are clear – from 1929 to 1933 world exports collapsed by roughly 55%. Continue reading

Volatility is Back!

Stock markets around the globe have sold off over the past few trading days, giving back most of their gains for 2018. Notably, the S&P 500 was down 4.1% yesterday and 6.1% over the past two days, a level of volatility not seen since 2011. This sharp downturn has increased fears of a looming bear market. While we cannot predict where the market goes in the coming days and weeks, today’s market has key fundamental strengths most bear markets lack.

Economic Indicators are positive
The main differentiator between a stock market correction and a prolonged bear market is that bear markets are normally associated with a recession. During a recession, consumption, the main driver of the U.S. economy, falls for an extended period as unemployment rises. Stock markets don’t react well to recessions because earnings across sectors can decrease meaningfully. The fortuitous cycle that helps stocks during periods of earnings increases, improved outlooks and higher valuations reverses as earnings fall, outlooks dim and stock values plunge. Recessions are painful to stock investors.
Unemployment today stands at 4.1%, the lowest level in 17 years! In January, the U.S. economy continued its steady improvements, adding another 200,000 jobs, which marked the 88th consecutive month with U.S. job growth, the longest stretch since 1939. The U.S. economy is unlikely to fall into recession with such strong job growth. Continue reading

Predicting the stock market is a bad idea

With the benefit of hindsight, few tasks look easier than pointing out a market peak. Looking at a price chart of the stocks market, it is easy to point to the top and say, “Here is where to sell stocks.” Unfortunately, there are few indicators that help anticipate market tops. While market valuation is useful over 10-year periods, it is a poor indicator over a 1-year period. At Crestwood, we believe that trying to beat the market by attempting to anticipate the stock market’s ups and downs is a fool’s errand due to the sporadic nature of returns, importance of tax-deferred compounding and irrational behavior of investors.

Every day matters
Over the past seven calendar years, if you missed the best 5 days in the stock market your return drops significantly, falling from 132.7% to 87.6%! The below chart shows the outsized effect of missing days in the market can have on long-term returns: Continue reading

“Wake Me Up When September Ends” – Green Day

September is historically the worst calendar month of the year for stock market returns. Since 1950, the average September return for the S&P 500 index is -0.7%.  Additionally, negative news which could affect stocks appear to be piling up including the impacts of Hurricanes Harvey and Irma, North Korea nuclear tests, the now extended deadline for debt limit talks and the continued Washington gridlock.  The strong stock market optimism from the beginning of this year seems to have faded and, with stock market valuations above historical averages, the fear is “what goes up must come down”.

We don’t dismiss any of these risks but, as investors, we understand that predicting near-term movement of markets is impossible. Most bear markets are accompanied by a recession and, importantly, current indicators of the economy show we are still in a modest and steady expansion.  The stock market’s performance this year has been driven more by strong earnings and economic strength than the promise of stimulus from President Trump’s agenda.  This year has been a good reminder that politics makes for good headlines and feverish emotions, but policy change in Washington moves slowly.  Additionally, while President Trump’s executive changes have been grabbing headlines most will have little to no immediate economic impact. Continue reading

A discussion of “Liquid Alternative” Investments

Throughout financial history, every bull market seems to be characterized by some new investment product or vehicle that captures investors’ fancy. Like housing bonds in the early 2000’s, mutual funds in the 1980’s, and junk bonds in the 1970’s, liquid alternative assets appear to be that vehicle of the current bull market.

Prior to 2008, alternative investments were primarily available to only endowments and institutional investors. However, in recent years, investment companies created mutual funds with the promise of bringing similar strategies to all investors. These funds have seen tremendous growth and broad acceptance as many investors and advisors have allocated to these liquid alternatives in an attempt to build more diversified, sophisticated and endowment-like portfolios. Unfortunately, performance of liquid alternatives funds over the last five years has broadly disappointed investors. Continue reading

Crestwood Perspectives: Trump’s Impact on Investment Markets

Yesterday’s unexpected election result causes investors to wonder what can be expected over the next few years from a Trump presidency and a divided country. This election has been highly emotional and personal, leaving many of us bleary-eyed and uncertain about the future. The high level of emotion in this election is reflected in global stock markets, which initially sold off on Wednesday following Trump’s victory only to recover strongly as the day progressed. At Crestwood we know that emotions and investing don’t mix well. We try to look past the rhetoric to analyze potential long term outcomes of the election.

Uncertainty

Markets don’t like uncertainty and global stock markets initially sold off in reaction to Trump’s surprise victory. Adding to investors’ unease has been Trump’s avalanche of eye-popping rhetoric throughout the campaign. Trump wants to fire Janet Yellen, Chair of the Board of Governors of the Federal Reserve, tear up the North American Free Trade Agreement (NAFTA) and even suggested renegotiating the U.S. debt obligations. These comments are a small sample of his suggested changes that concern investors. With all of these comments long on rhetoric and short on details we are left speculating, for the moment, on how a Trump presidency will affect the markets. Continue reading

Implications of Populism

Why the anger? It’s the economy

One of the many notable characteristics of this unconventional presidential race is the broad-base populist uprising from both the left and right.  Across the U.S., pockets of workers are fed up with dead-end jobs and stagnant wages.  This anti-trade theme has resonated across both parties and will likely force changes in government policy, no matter who wins the election.

The primary cause of frustration is that workers across the U.S., especially those younger and less skilled, have faced falling standards of living since the Great Recession.  A McKinsey report[ref] Poorer than their parents? A new perspective on income inequality
By Richard Dobbs, Anu Madgavkar, James Manyika, Jonathan Woetzel, Jacques Bughin, Eric Labaye, and Pranav Kashyap, McKinsey Global Institute, July 2016 [/ref] estimates that 81% of the U.S. population experienced flat or falling incomes from 2005 to 2014.  The report shows similar results internationally with over 65% of households in 25 developed economies facing flat or decreased real income during the same time period. This equates to over 540 million people worldwide whose quality of life has not improved, many of whom are voicing their anger in elections.  As we see in the U.S., these concerns are being integrated into both parties’ platforms.  One only needs to look at Britain’s surprise Brexit vote to understand that these ‘new’ political forces should not be taken lightly. Continue reading

Investing Through Recessions

The U.S. economy has now grown for 69 straight months, making this the sixth-longest period of economic expansion since the 1850s. The stock market has climbed apace—albeit with plenty of volatility along the way.

Still, the law of gravity hasn’t been repealed. Economic growth and contraction have always alternated, and at some point we’ll experience a recession. That, of course, will impact stocks.

Recessions’ Toll on Stocks 

Recessions are defined as periods in which Gross Domestic Product—a measure of trade and industrial activity—shrinks for two successive quarters. Slowing economic activity typically coincides with lower corporate sales, earnings and profit margins, higher unemployment, as well as higher levels of bankruptcy. Typically, equity indexes will fall in advance of and during a recession. Often a bear market, a period when stock prices drop by at least 20%, and a recession, will overlap one another. Continue reading

Quality Bonds: an Underappreciated Role in Portfolios

Stock markets across the globe fell sharply during the first few weeks of 2016. After years of strong stock market performance, downturns like these remind investors of the importance of diversification and disciplined portfolio construction. Even though interest rates remain near historic lows, bonds remain an important part of this diversification as adding them to portfolios lowers volatility (i.e. risk). Historically, high quality bonds, that is those with lesser credit risk, proved an important source of diversification during periods of equity market stress, offering lower correlation while their lower quality brethren tend to have returns more highly correlated to stock market returns. Lower quality bonds imply greater credit risk, which is the risk of not getting paid because the issuer goes bankrupt.

Whenever the outlook for the stock market is threatened, investors will sell risky assets to buy safe investments. This ‘flight to quality’ behavior is a well-known herding reaction to bad news. Historically, owning high quality bonds provides a diversification boost during periods when portfolios need it most. At Crestwood, we include high quality bonds in portfolios to provide a ballast against equity risk which helps to offset periods of stock market stress.

Despite these attractive qualities, concerns over lower expected returns and potential interest rate increases have reduced the appeal for quality bonds. Unfortunately, the near historically low current yields for bonds is suggestive of low future returns (see Perspectives 5/1/15). In addition, the Federal Reserve is on a path to reduce their aggressively stimulative policy of near-zero interest rates. In December 2015, they increased the federal funds rate for the first time since 2006. When interest rates rise, bond prices fall, because most bonds have fixed interest payments and higher rates make these fixed interest payments less valuable. So, not only are lower returns expected, but depending on the pace of future increases in interest rates, it is possible that returns for some bonds could be negative. Continue reading

Profiting from an Emotional Market

The human race’s evolutionary wiring is a marvel: it has enabled us to avoid predators, feed ourselves and thrive in even the least hospitable parts of the planet. Unfortunately, the same wiring has made humans struggle as investors. Following age-old impulses of fear and greed, our species consistently behaves in a manner that often reduces our investment returns.

Ironically, our tendency to commit behavioral errors provides opportunity for disciplined investors to perform better and helps to inform Crestwood’s investment process. Crestwood’s investment process seeks to outperform the market over a full market cycle – with less volatility – by understating, and avoiding, common behavioral errors in the market. Indeed, our investment approach is designed to take advantage of the predictable, self-defeating behaviors of so many market participants.

Behavioral Finance 

Let’s look at a small sampling of the many innate hurdles to successful investing that typical investors must contend with:

Overconfidence: Investors systemically overestimate their knowledge and their ability, and the results can be unpleasant. In 2014, the S&P 500 index returned 13.7%–but the average equity mutual fund investor earned just 5.5%, according to research firm Dalbar. The discrepancy is explained by investors’ well-documented tendency to sell low and buy high. Additionally, high rates of “turnover”—holding investments for a short time, and then dumping them to buy others—demonstrates overconfidence that one investor knows more than others, even though historically low-turnover portfolios have outperformed high-turnover portfolios.

Continue reading