Vigilare Wealth Management Q1 2018 Commentary
The markets were off to a riveting start for the month of January. This ended abruptly in early February when the January Employment report showed a 2.9% year over year increase in wage growth. This was the highest wage growth reported since the beginning of the recovery, and it was accompanied by the first inflation-induced sell-off to sweep through the markets in over a decade. In our past writing we highlighted “inflation” being the most important variable driving the markets in 2018, and boy is that the case.
Since this January Employment report, the market volatility has exploded higher as anxieties continue to brew about what the implications of higher rates will be on economic growth and ultimately, market returns. Add to this, privacy and regulatory concerns ailing the market-leading tech titans, and a new zest for economic nationalism showcased with the introduction of new trade tariffs targeted at China. All of this has the markets on edge.
The good news is the economy is still growing at a brisk pace, confidence is high, and earnings growth is projected be in the double digits for the next few quarters. This supports higher equity prices. We are however concerned that if the Fed raises rates too quickly, it could stall the recovery and cause stock prices to fall. For example, there is close to $10 trillion in debt tied to short term rates in the U.S. These rates have moved up from under 0.4% to over 2% rather quickly, after being at historic lows for almost a decade. Adding to inflation fears, the U.S. Treasury will have to raise $1 trillion in debt this fiscal year, about double the amount from last year. It will be a balancing act for the new Fed regime to keep interest rates in equilibrium (in the Goldilocks zone). We continue to believe this will be the primary driver of volatility and valuations for the markets in the foreseeable future.
The recent trade negotiations with China could also escalate into something disruptive to global growth. Please google “Smoot-Hawley” for some history on past trade war escalations to understand why markets can get a little nervous. For a contemporary comparison, China is our 3rd largest export partner (8% of total exports) with over $100 billion in exports primarily in agriculture (soy), machinery, aircraft, and vehicles. China is our largest importer of goods, with electronics, machinery, furniture, toys, sports equipment, and footwear leading the way. Chinese imports to the U.S. have exploded since China’s World Trade Organization (WTO) acceptance in 2001, many argue at the expense of some of our domestic industries. There is also a belief that China has illicitly appropriated billions in intellectual property from U.S. corporations over the last few decades. This trade debate is a much more complex subject than simply measuring surpluses and deficits. China does have the advantage at the negotiating table of having a “command-economy” and a Chinese President (Emperor) with no term limits. An escalation of tariff actions could hurt our stock markets because U.S. multinational corporations have evolved into complex global supply-chain behemoths with diverse global customers (many in Asia). An aggressive move to de-globalization could be very disruptive to these interconnected business models and hurt global growth.
The historically calm stock market of 2017 is a now fading memory and we should expect heightened volatility through the spring and into the summer given these headwinds. We remain overall optimistic about markets given the momentum in the economy and strong earnings growth, however we do not take these risks lightly and will be monitoring developments closely and if necessary taking appropriate actions to protect portfolios.
Thank you for your trust.
The Vigilare Wealth Management Team
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