China has introduced a new weapon to use in the trade war with the United States. That weapon? Its own currency.
On Thursday, August 1, President Trump proposed a new slate of tariffs on Chinese goods. In response, the Chinese central bank devalued its currency – the yuan – to more than seven to the dollar. Read more>>
When Twitter first launched back in 2006, its creators probably never imagined that a single “tweet” could make the stock market plunge. But that’s exactly what happened on Thursday, August 1, when President Trump tweeted the following:
“…the U.S will start, on September 1st, putting a small additional Tariff of 10% on the remaining 300 Billion Dollars of goods and products coming from China into our Country. This does not include the 250 Billion Dollars already Tariffed at 25%…”1
Before the tweet went out, the Dow was up over 300 points. The S&P 500 was also having a good day. By the late afternoon, however, the Dow ended up down almost 300 points.2 That’s quite a swing.
Of course, it wasn’t really the tweet itself that made the markets dip, but the news it contained. As usual, the markets reacted to the announcement of more tariffs with a fit of violent sneezing. So, investors must now ask themselves, “Is this just a brief allergic reaction…or the first symptom of a market cold?”
Let’s break it down.
The “what” and “why” of tariffs
Here’s a quick review of the basics. A tariff is essentially a tax on imported goods. The business doing the importing will pay the tariff, usually as a percentage of the goods’ total value.
Many economists believe, however, that it’s consumers – people like you and me – who end up paying the cost of tariffs. For example, back in 2018, President Trump placed a tariff on imported washing machines. One study found that consumers “bore between 125 and 225 percent of the cost of washing machine tariffs”, mainly because the companies that sold the machines ended up charging far more for them to make up for what they lost in tariffs.3
So, why impose tariffs at all? Some economists argue there are lots of reasons. For instance:
Protecting domestic industries. When imports are more expensive, the thinking goes, consumers – both individuals and other companies – are more likely to buy from domestic companies that produce the same goods at a lower price. For instance, the U.S. has put tariffs on sugar imports dating all the way back to 1789!4
Revenue. Historically, tariffs were once one of the nation’s largest sources of revenue. However, tariffs-as-revenue have largely been replaced by other taxes, especially income and payroll taxes.
Geopolitical negotiating. Tariffs – or at the least, the threat of them – can sometimes be used to drive countries to the negotiating table. That’s probably the single biggest reason President Trump has relied on tariffs so much, as he has persistently used them to persuade countries like China, Canada, and Mexico to negotiate more favorable trade deals.
So, are tariffs good or bad? It’s unclear. Some economists claim they’re worth the cost. Others believe tariffs aren’t effective at doing what they’re supposed to do and just end up hurting consumers far more than they help. And since the American economy is based largely on consumer spending, these economists believe tariffs ultimately do more harm to the economy than good.
Since I’m a financial advisor, not an economist, I won’t come down on one side or the other. Far more pressing for me – and for all investors – is how tariffs affect the markets.
Tariffs and the markets
Since 2018, President Trump has announced new tariffs on Chinese goods on several occasions. Each time, a market drop has typically followed. You only have to look at the most recent announcement to understand why.
As the President tweeted, the U.S. is imposing a new 10% tariff on $300 billion in Chinese goods. This new list includes everything from smartphones to toys to shoes.5 It’s no surprise, then, that the stocks sold off on August 1 were largely for companies that sell these products. As we just discussed, companies must pay more for the goods they need or sell, which can significantly eat into their profits. This, in turn, can lead to shipping delays, supply chain problems, higher prices for consumers, a resulting loss of business – you name it. All these issues, of course, are then reflected in the stock prices of the various companies affected.
Despite this, each of the market drops I mentioned earlier tended to be mere blips on the screen. Some blips lasted longer than others, but in each case, the market sneezed, then moved on. (Or upwards, as the case has been.) The world we live in moves with astonishing speed, and for the markets, the next bit of news often seems to crowd out the previous bit. Those who have predicted doom and gloom with each new round of tariffs are still waiting. Since the overall health of the economy remains strong, it will likely take more than a few tweets, or even a few hundred billion in tariffs, to make the markets truly sick.
The danger of complacency
All that said, there is a danger here. It’s the danger of becoming so accustomed to these here today, gone tomorrow blips that we forget to remember it’s the long-term health of the markets that matters.
Every day, we’re bombarded with short-term news stories that cause short-term reactions. The fact that a single tweet can move markets is proof of that. But repetition often leads to desensitization. Sometimes I wonder if investors will become numb to events like we saw on August 1st. We sneeze, and when nothing else happens immediately, we move on.
As always, though, the long-term is more important than the short. In this case, it’s possible we haven’t actually felt any long-term effects yet, just as we don’t usually feel the symptoms of a cold until the virus has been inside us for some time. Are there long-term effects to come? I don’t know – nobody does. It is important to note, however, that this round of tariffs is a little different than the previous ones. Older tariffs were largely on products like plywood and polyethylene. Important, but not very conspicuous. The newest tariffs President Trump has proposed involve more of the things we use on an every-day basis. Smartphones, for instance. Shoes. Clothing. Things we tend to notice and appreciate just a bit more. What happens if they go up significantly in price? Would that mean anything in the long run?
It seems needlessly pessimistic to say that it definitely will. On the other hand, it also seems hopelessly naïve to say that it definitely won’t.
It’s also possible that older tariffs will become more painful the longer they go on. Some data suggests that many companies have decided to eat the higher costs that come with tariffs rather than passing them onto consumers. But how long will that last?
The point of saying all this is not to suggest that these new tariffs, or tariffs in general, will bring a definitive end to the bull market we’ve enjoyed for so long. In fact, I think the chances are high that the markets will once again absorb the news, sneeze, and move on. Tariffs, as important as they are, represent only a small portion of the total economy – and the economy still looks strong. And of course, President Trump’s strategy could yet pay off and lead to a new, more favorable trade deal with China.
As your financial advisor, though, I am adamant that we avoid feeling complacent about it. (Or rather, that I avoid it. It’s my job to worry; you should enjoy the rest of your summer!) While it’s a mistake to overreact every time the markets dip, it’s also a mistake to stop paying attention.
My diagnosis, then: A sneeze is usually just a sneeze. And the August 1st market dip is likely just a market blip. But I will keep paying attention to everything I can – the markets, the economy, and yes, even Twitter if need be – in case a blip ever turns into anything more.
As always, please let me know if you have any questions or concerns. I love to hear from you. In the meantime, have a wonderful rest of your summer!
1 Twitter account of Donald J. Trump, August 1, 2019. https://twitter.com/realDonaldTrump/status/1156979446877962243?s=20
2 “Trump Threatens New Chinese Tariffs, Rattling Investors Across Markets,” The Wall Street Journal, August 1, 2019. https://www.wsj.com/articles/trump-to-impose-additional-10-tariff-on-chinese-goods-11564681310
3 “The Truth About Tariffs,” Council on Foreign Relations, May 16, 2019. https://www.cfr.org/backgrounder/truth-about-tariffs
4 “The Taxation of Sugar in the United States, 1789-1861. The Quarterly Journal of Economics. https://www.jstor.org/stable/1882993?seq=1#metadata_info_tab_contents
5 “Trump says he will go ahead with new China tariffs that would hit iPhones and toys,” CNN Business, August 1, 2019. https://www.cnn.com/2019/08/01/economy/new-china-tariffs-threat-trump/index.html
In the past, retirement has been portrayed as an ending, a grand exit from your years in the workplace. But the rules are shifting. Labor force participation among those aged 65-74 is predicted to reach 32 percent by 2022, up from just 20 percent in 2002.
This July 4, I hope we all can take a moment to reflect on the meaning of the Declaration of Independence. It goes beyond politics and partisanship. It’s more than a historical artifact. It’s the foundation upon which our nation rests.
What if I said that people who try to invest for retirement on their own have almost 50% less in their accounts than those who use an experienced financial advisor? Would you be surprised? The proof is in the numbers.
Over the past several months, you’ve most likely heard or seen some combination of the following predictions:
If someone was forced to do nothing but read headlines and predictions, they would probably get whiplash. That’s because there’s always so much conflicting analysis and information out there about what’s happening, or what’s going to happen. The result is a lot of uncertainty – and if there’s one thing the markets hate, it’s uncertainty.
In this letter, I want to briefly recap a few of the stories behind that uncertainty. Then, I want to tell you exactly what my team and I are doing about it.
Trade War
The long-running Trade War with China blew up in a big way last month – and then expanded into a twofront war with our neighbors to the south.
Early in May, President Trump placed a new 25% tariff on all Chinese imports that had been previously been spared.1 Soon after, China responded with more tariffs of their own. Then, just as the smoke started to clear from that announcement, the White House announced a new set of tariffs – this time on Mexico.
Why does this matter to the markets? In the short term, it all goes back to uncertainty. Remember, a tariff is essentially a tax on imported goods. With over $50 billion a month moving back and forth across the border every month, higher prices on Mexican products could potentially have a major impact on the economy.2 After all, American businesses rely heavily on everything from Mexican cars to Mexican cables; from food to appliances. Tariffs could lead to longer and more costly supply chains, which in turn can eat into corporate profits.
When that happens, the markets hurt.
On the other hand, recent history suggests the markets can be remarkably resilient to the Trade War’s effects. Often, when new tariffs are announced, the markets will dip and then rise again. Furthermore, the news broke out on Friday, June 7, that the tariffs on Mexico will not come to pass – at least for the time being.3 That’s why the only thing we can be certain of is, well, uncertainty.
The Economy
After roughly a decade of growth, signs of a slowing economy continue to stack up.
Economists use various indicators to forecast where the economy will go. One indicator is the job market. While the nation’s unemployment rate remains historically low at 3.6%, fewer and fewer new jobs are being added. In May for example, the economy added only 75,000 new jobs, which seems like a lot but was far less than the 180,000 most experts predicted.4
Another indicator is the yield on U.S. Treasury bonds. To put it simply, the yield is the return you get on a bond. Bond yields will fall when bond prices – the amount you pay when you purchase a bond – go up. Bonds are often perceived by investors as being less risky than stocks, so during times of uncertainty, more and more investors will pile into bonds, driving up the price and driving down the yield.
Got all that? If not, that’s okay, because here’s what really matters. When the yield on short-term Treasury bonds rises higher than the yield on long-term bonds, economists tend to sit up and push their glasses further up their noses. That’s because this “inverted yield curve”, as it’s often known, is rare, and sometimes signals an impending recession.
An inverted yield curve is happening now.5
I could go on for pages and pages on how bonds and the overall economy intersect, but time is precious, and you shouldn’t have to spend yours reading about things like inverted yield curves. (That’s what you pay me for!) The point is, there are a number of indicators suggesting that the economy is weakening. On the other hand, optimists can point to other, equally compelling data – like the unemployment rate, the country’s GDP, and high consumer confidence reports – that says the economy is doing just fine.
So, how do we know what’s going to happen?
We don’t. Nobody does. Experts can make educated guesses. Analysts can make data-driven predictions. Some of those will undoubtedly come true. Most will be wrong. Nobody has a crystal ball. The greatest financial advisor in the world can’t tell you what will happen in the markets tomorrow, let alone next month or next quarter.
In the world of finance, uncertainty rules. Sometimes its influence is greater or lesser, but it’s always there.
But that doesn’t mean we can’t do anything about it.
I said at the beginning of this letter that I would tell you what my team and I are doing. I can sum it up in two words: Risk Management.
Risk management is the process of identifying, analyzing, accepting, and then working to mitigate the risks that come with uncertainty. It’s one of the most important things I do for clients like you!
Standard disclaimer: All investing involves some risk. It’s impossible to get rid of it entirely –nor would we want to! (It’s a truism that no risk means no reward.) But we can take steps to manage your risk, and that’s what my team and I do every day.
It’s true, I can’t tell you exactly what the markets will do. So, here’s what I can do instead:
Use rules-based investing and a sell-side discipline
These are just fancy terms for something very simple. While many investors practice something called “buy-and-hold”, where they pick some investments and then hold onto them no matter what, we put rules in place that determine when to sell an investment if it falls below a certain price, or is likely to. While we can’t control whether an investment will grow or not, we can take steps to protect you from losing your principal. The ancient Greek physician, Hippocrates, had a maxim: “First, do no harm.” I take a similar view. While we want to help you grow your money, we’re dead set on protecting your money.
Monitor trends by tracking supply and demand
Risk management is sort of like buying strawberries. When you go to the store, you might ask yourself, “Is it worth it to buy strawberries today?” The answer would depend on lots of things. Are strawberries in season? Are they more or less expensive than usual? Do they look ripe?
That’s how you determine whether buying strawberries is worth the risk or not.
We do the same thing with the investments in your portfolio. We look at whether there’s more supply or more demand for an investment – more buyers or more sellers – to determine whether that investment is trending up or down. We look at how strong or weak an investment is relative to other investments that are similar to it. We look at how close it is to the buy/sell price we’ve already established. (That’s rulesbased investing.)
That’s how we determine whether the investments in your portfolio are worth the risk or not.
Here’s why I’m telling you all this. While we can’t know for certain how the Trade War will affect the markets, or whether the economy will veer into a recession, that doesn’t mean we’re sitting idle. I want you to know that my team and I are working constantly to analyze how these stories could affect your hard-earned money. We’re always working to manage the risk in your portfolio. To keep you on track to your financial goals. Sometimes, we try to speed up the journey. Sometimes, we may slow down, or move off the road entirely. But we always try to keep you pointed in the right direction.
If you ever have any questions or concerns, please contact us. In the meantime, I hope you enjoy a wonderful summer!
1 “Trump Renews Trade War as China Talks End Without a Deal,” The NY Times, May 10, 2019.
2 “Tariffs on Mexican imports will ripple across the US economy,” CNN Business, June 3, 2019.
3 “US, Mexico Reach Deal to Avoid Tariffs,” The Wall Street Journal, June 8, 2019.
4 “U.S. Added 75,000 Jobs in May as Hiring Slowed,” The Wall Street Journal, June 7, 2019.
5 “Bond Yields Extend Drop Toward 2%,” The Wall Street Journal, June 7, 2019.