First Quarter 2018 Singles and Doubles, Not Home Runs

2018 began much as 2017 ended, with steadily rising equity markets, low interest rates and burgeoning market optimism. Indeed, investors were increasingly convinced that the lowest stock and bond market volatility since 1965 was set to continue in 2018. Who could blame them? Already, there was strong economic growth against a backdrop of moderate inflation set to get a boost from the successful passage of the Trump administration’s tax cuts, not to mention continued monetary accommodation from global central banks. On Jan. 4, the American Association of Individual Investors Sentiment Index showed that bullish responses to their market survey hit a high last seen in 2010 – and before that, 2004.

Just then, a couple of strong economic data reports perversely caused investors to question whether the economy was beginning to overheat and inflation was beginning to rise. Quickly, the narrative shifted to a fear of rising inflation, increased central bank tightening and, most importantly, rising bond yields. This change caused previously (over)emboldened investors to quickly reposition for a shifting environment. Much as we opined in our fourth-quarter commentary, as bond investors pushed yields higher, stock investors pushed equities lower. Why? Because equity markets are trading at today’s elevated levels due to bond yields trading at such low yields. Put simply, if bonds offer low future return possibilities, investors are often willing to bid equities up because they are relatively attractive. With bond yields moving up during the quarter, stocks sold off.

After a few weeks of rumbling and investor repositioning, this selling eventually subsided only to see the market be hit once again after President Trump announced tariffs on imported aluminum and steel. As the quarter drew to a close, these actions caused equity market weakness as fears of a global trade war – possibly leading to a global economic recession – intensified.

The Art of the Deal

Investors continue to react – and, in some cases, overreact – to the president’s tweets and “opening bids.” To state the obvious about a man who is the subject of a book titled “The Art of the Deal,” the president views himself as a negotiator. And we believe that in any negotiation, the conversation starts with an opening bid or anchor from which to negotiate. Indeed, the aluminum and steel tariffs were initially broad based in their application, but over the past few weeks they have been winnowed down. After initially being subject to the tariffs, Australia, Canada, Mexico, the European Union, Argentina, Brazil and South Korea are now exempt, as they are allowed to negotiate a different path forward. And while China is not on the above exempt list and has since been subject to more potential tariffs, we continue to believe that the United States and China will eventually find common ground.

Most importantly, we believe the market’s overriding worry that these tariffs will cause a recession and falling inflation – a la the Great Depression – is overstated. Many point to the Smoot-Hawley tariffs in 1930 to make their recession case. We believe that the economic conditions today are much better than those during the Great Depression.