The Man Behind the Curtain: Welcome to Oz, Folks
If you just started paying attention to the news recently, you’re probably wondering what exactly is going on here: trade tensions, yield curve inversions, near-miss geopolitical crises...oh my! But the stock market continues to march up the proverbial “wall of worry,” albeit with some recent volatility, as the whirlwind of concerning news events unfold at an exceedingly fast pace. Yes still, it would almost seem that someone, or something, is operating behind the scenes to keep the façade of a harmonious investment market in play.
It is true that the length of the current bull market in the US is hitting a record, and akin to an aging human, it would be reasonable to ask the question: “when shall poor old Mr. Market bite the dust?” Fortunately, we were taught at an early stage in our investment careers that “a bull market doesn’t die of old age, it dies when the Federal Reserve takes it behind the woodshed and…” (we’ll save you the gory details).
Our last letter already addressed the interest-rate setting activity of the Federal Reserve, so we’ll spare you from the agony of reading about yield curve inversions again, but we will comment on one thing: and that is how much of a 180-degree turn the Fed has made over literally just the last six months. We went from being on pace to raising short-term rates to “normal”1 levels (thus indicating the US’s ability to sequester itself from the life-supporting stimulus of the post-recession decade), to cutting rates last month for the first time since 2008. This is essentially a tacit admission by the Fed that the tightening had gone too far, and that the economy is not as strong as thought, thus meriting a decrease in short-term rates to bring the punch bowl back to the party (because no Fed Chair wants to be the party pooper, just ask Alan Greenspan).
And here we are, back to being party animals, it seems. Yet, there is something still quite unsettling lately: ongoing trade frictions (namely, the Sino-US relations). We don’t think we need to spend time convincing you that trade wars aren’t good for either contender, but the truth is that while some businesses will be disadvantaged, others will actually benefit. The stock market seems to be “pricing in” a relatively higher probability that a deal will get done eventually2, which is why we recommend just buckling your seatbelt in case the ride is longer and bumpier than expected. But of course, there is always a risk of a miscalculation by either side and we drive right off the cliff of enacting tariffs (possibly on up to $300B of Chinese imports, but this could also apply to the EU, Mexico or Canada as well). What we have to say here is that we are glad to be individual stock and bond pickers, and therefore, have the advantage of evaluating our exposures and potential risk, company-by-company, in case this were to occur. Rest assured, having a dedicated research and investment management team allows us to continue being diligent about evaluating and mitigating risk.
Another market concern that seems to get a lot of people nervous is politics. With 2020 being an election year, the campaign cycle is coming out of the gate in full force. Politics continues to become more and more polarized and it’s no wonder why some people are nervous about where the next round of leadership could take our country. What we will say is that when it comes to the stock market, political inactivity sometimes creates the best foundation for market gains. Even a split government can be positive – as gridlock leads to less uncertainty. Uncertainty regarding the direction of policy is one thing that stifles business investment and growth. But the reality is that there will probably always be a certain degree of unpredictability; and even if new policies are technically “less positive” for businesses on a whole, at least those things can be planned for and managed around by savvy companies. Again, our ability to evaluate individual company strategies is an advantage when the world constantly shifts around us.
Lastly, when it comes to things that might keep investors up at night, the recent influx of “hot IPOs” (Initial Public Offerings) is reminiscent of the 2000 Dot-Com Bust when less-than-profitable (we’re being generous) companies could reap millions of retail investment dollars just by adding “.com” to their name (now the trick is using terms like blockchain or cryptocurrency). While we continue to hold our view that participating in these IPOs at issuance tends to work out better for the founders/early investors and their helpful investment bankers (on average), many of these companies do seem to be more viable than their dot-com-era counterparts (with some notable exceptions, of course). This is partly because many have a more established track record as private companies before going public. Nonetheless, it is still something to watch as the frothiness becomes more apparent.
So perhaps there isn’t a benevolent puppeteer keeping the market chugging forward while the world seems to be falling apart – the truth is that the global economy is actually still humming along, albeit at a relatively slow rate. And while there is plenty to be worried about, new risks are constantly presenting themselves in the marketplace. It’s usually the risks that we haven’t thought about that catches us by surprise and causes disruption, as the market does a pretty good job weighing the probability and impact of most known risks. So, our job as investment managers is to constantly navigate through the world of uncertainty by establishing the right balance of risk and potential reward for our clients’ portfolios while always seeking to buy the highest quality investments available. This, in addition to proper diversification, is the right defense for managing risk. We are pleased to do this hard work for all our clients and will be ready to help you navigate through any curve balls the market throws our way.
Thank you for your continued trust and confidence. Please feel free to send us a message or give us a call anytime. Enjoy the rest of the summer!
Norris, Perné & French