My Comments: Whether you’re already retired and relying on saved money to pay your current bills, or only thinking about a future retirement and how to pay for it, how the markets behave greatly influences what you do and the peace of mind you have or don’t have.

In a way, it’s like a broken clock. It’s accurate to the second two times every 24 hours. The rest of the time it tells you nothing. Being wrong and being right is just a guess.

Before you read these words from Harry Ren, please remember that what happens to your investments on a daily or monthly basis is not necessarily correlated with what’s happening to the economy. The economy can be doing great and something, somewhere, triggers a warning, and the market freaks out with more people selling instead of buying.

It’s easy to hear trump talk about how great the economy is and think it’s now OK to put your money to work in the stock and bond markets. What’s really happening is this: the markets respond primarily to the future expectation of earnings or some other metric for return on investment. Somewhere in a recession the perception will grow that it will end and people start putting their money back to work. Which in turn causes the DOW and the S&P500 etc. plus the bond markets to start climbing.

by Harry Ren \ August 26, 2019 \ https://tinyurl.com/y3nxn4sk

Situation

Xi Jinping, being the tough leader that he is, wasn’t going to lose face in front of China and the rest of the world. That’s part of the reason why he announced on August 23, 2019 that he was going to set tariffs of 5% or 10% on $75 billion of U.S. goods. Trump responded by “hereby ordering” American companies to look for alternatives to China and threatened to raise existing tariffs on Chinese goods to 30% on October 1, 2019 and increase tariffs on another $300 billion in products to 15% from 10%. And the market responded accordingly with the S&P 500 (SPY) sliding 2.6% intraday to post weekly losses for the fourth straight time.

I understand where Trump is coming from. He wants to solve the trade deficit and IP problem that no other president has ever wanted to tackle. From the looks of it, he’s willing to accept short term volatility to achieve long term results. But what isn’t going to work is thinking that China will cave into these one-sided demands that they mentioned were brought up in previous trade negotiations that broke down back in May 2019. China will not lose face in any event, especially not when they think that they’re being short changed and put into an unfair spot after the previously proposed deal.

Three Scenarios

From the way I see it, the market can go in one of three ways:

Scenario 1 (Good Case): Xi and Trump agree to restart talks before the tariffs go into effect, coming to either a ceasefire again or a deal of any sort. Markets rally 5% in a ceasefire and 10% in a deal. The Fed announces in September a 25 basis point cut and likely will not have to use another one in the short term or revert to a period of easing in the longer term.

Scenario 2 (Base Case): The existing tariffs, mentioned above, go into place on their respective dates and global markets await for next round of tit-for-tat responses. Markets sell off another 5% on uncertainty regarding global supply chain turbulence, pullback in corporate investments, and fears of recession. The Fed announces in September a 25 basis point cut and leaves the rest open for Trump to ease on his rhetoric and solve the trade problems without relying on monetary or fiscal policy.

Scenario 3 (Bad Case): The tariffs go into place with no deal being reached and continued escalation of rhetoric and tit-for-tat trade war. Trump taxes American corporations or incentives them in other ways to force them to move operations out of China as global supply chains falter, triggering a short term 15-20% correction and likelihood of imminent recession. Fed policy is too little too late when they announce a 25 basis point cut or a period of easing.

My Take: Scenario 2

Both leaders have reached a point where neither are going to back down. Trump will likely go through with his tariffs unless there is concrete progress like the removal of tariffs by China. In that case, Scenario 2 will most likely come to fruition. I expect a moderate sell-off (5%-10%) in the short term as the markets price in the effects of a full blown trade war. Then, in the longer term, as corporations cut back on investments in domestic/foreign countries and supply chains struggle when companies are restructuring their operations while bringing back some of them to the US, the market will see a consistent sell-off from weaker earnings and guidance. As it becomes more expensive to purchase American goods including cars manufactured in US and sold in china, iPhones, laptops, sneakers and clothing, consumers will also start to cut back on discretionary spending. In that case, it’s possible we have a slow sell-off to a recession. Come next few Federal Reserve meetings, if we see a slowdown in consumer spending which has shown nothing but strength recently, that may be a sign that monetary stimulus may be too late. That’s why if Scenario 2 does happen, it’s crucial for the Fed to act accordingly even if they have repeatedly hinted that they act independently from any political pressures. Now keep in mind that this economic cycle can be prolonged along the way if any trade progress is made or if the Fed can act appropriately before the fact of any contractionary economic news.

Conclusion

Now that the trade war is officially underway, there doesn’t seem to be an end in the near future to this continuous back and forth between US and China. My word of advice is to err on the side of caution in the US markets. However, I’m not suggesting a complete pull out of stocks and into bonds yet for a couple of reasons. One, the US economy is still showing signs of strength: low unemployment, strong GDP growth, inflation was the target, and interest rates remained stable. Two, the Fed has placed sustaining the economic expansion as their top priority and will utilize monetary or fiscal policy to stimulate the economy. Nevertheless, the economy is showing signs of weakness or else President Trump wouldn’t propose tax cuts. Also, cutting interest rates would be nowhere near the table if the economy was really in the healthy state that we want it to be. All eyes are on the trade war and what the Fed can do to stall the recession that looms over our heads. In the meantime, focus on companies with minimal cross border exposure and business models with diversified revenue streams to weather the storm.