Dividend Café

Making Bad Policy Matter Again - March 9, 2018


Dear Valued Clients and Friends,

It should be no surprise that what has dominated markets this week has been trade policy, the outlook for economic growth in light of potential global trade disruptions, and the changing composition of economic leadership in the Trump administration.  The bulk of this week’s Dividend Cafe addresses these topics and their related cousins, and we believe you will find it to be comprehensive, actionable, and comprehensible.  So let’s dive in, and see what the Dividend Cafe has to offer this week.  You will pay no tariff to enter!


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How to make Washington D.C. matter to markets – start a trade war!

It is difficult to find the words to describe the policy blunder that a sweeping 25% tariff on imported steel represents (and another 10% on aluminum).  We published the following article at our Market Epicurean site this week, and the Advice & Insights podcast above is dedicated to an elaborate treatment of the subject.

This week, the markets opened way down on Monday (exacerbating last week’s 1,200 point loss), but then rallied back to roughly even on the day, and it stayed about flat on Tuesday as well. On Wednesday, markets dropped well over 300 points throughout the day before largely rebounding by the end of the day, responding to the resignation of National Economic Council Director, Gary Cohn.  We shall see where things go from here (more on Cohn’s departure below).  And at press time markets were roughly flat/slightly down in the futures market Thursday morning.

Our application of the development is as follows:

(1) The equity valuation premium warranted by growing and synchronized economic expansion is vulnerable.  Corporate tax reform and deregulation have been huge and justifiable catalysts to market optimism.  A sustained move towards protectionism that embraces tariffs and suppresses trade will hurt equity valuations, period.  But I have to make clear – it is not “headline risk”or “event risk” we are talking about. A big market rally does not mean all is back to normal.  If we proceed with a protectionist policy and personnel paradigm (accidental alliteration), the slowing of growth takes place over time.  The efforts of foreign trading partners to curtail their purchases from us takes time.  This is what we would expect – a slow but real compression of what growth could otherwise be, and therefore, a compression of equity valuation.

(2) We see this overall category of risk being problematic for the U.S. dollar (trade wars create less dollars coming into the U.S., which suppresses savings & investment).  For a variety of reasons, we could see the relative beneficiaries being Japan, and certain emerging markets.  Crucial caveat: This does not mean Japan and/or emerging markets will benefit from a trade war; no one wins from a trade war (by definition)!  But relatively speaking, if nothing else, the currency impact would likely bode well for those markets.

Breaking it down for you

So why are markets puttering around right now with this issue?  Simply put – markets know the stated bad news of last week (the tariff intentions), but have absolutely no idea if the President will really go through with this, what “this” will end up being, and how intent the administration is on additional levels of protectionism.  The market can’t react with any conviction or magnitude at this point because on one hand there is the potential for a really destructive play-out of this, and on the other hand there is daily messaging that feels like “walk back” etc.  Market actors simply cannot respond because where all of this is really headed is so uncertain.

Bluffing and leverage

Will the European Union be content to see new tariffs put on them without retaliation?  The U.S. sends an awful lot of shirts, jeans, cosmetics, peanut butter, motorcycles, boats, orange juice, bourbon, corn, and many other consumer and agricultural products into Europe.  They have explicitly stated their intent for “tit-for-tat” tariffs should this steel/aluminum threat go through.

* Jones Trading Institutional Services, LLC

Grown-up Supervision

The resignation of National Economic Council director, Gary Cohn, former #2 man at Goldman Sachs and a steady, competent voice in this administration, sent shockwaves through the market Wednesday.  The Dow futures quickly dropped 300 points, though closed down just 80 points after trying to rally a bit during the day.  Yes, markets always overreact to things like this, but that is not to say this is not a real story.  It is, and perhaps for bigger and different reasons than people realize.

First of all, it likely means the direction of this trade/tariff/protectionist “stuff” is going to get worse, not better, in the weeks ahead.  Losing a persuasive and respected voice in the cause of free markets and free trade is not going to bode well for the cause of, well, free markets and free trade.  I have said plenty about the concern for investors the present steel/aluminum tariffs represent.  But with a voice like Cohn’s gone, will the direction of U.S. policy in trade and tariffs get even worse?  That is the market’s fear.  That is my fear.

The replacement to Cohn at NEC matters a lot, both in terms of the position itself, and what it indicates to markets about what lies ahead for this administration’s policy towards economic growth.  At press time, clarity is not available on what direction the President is going with this position.

Knock-on effects not covered on the press

Proponents of what President Trump is proposing downplay the idea that there will be backlash (“the cost is overblown”; “other countries need us more than we need them”).  We think this is wrong.  There will be backlash.  But many critics of President Trump’s tariff policy state that the risk in knock-on effect is retaliation from other countries.  We think this is true, but a tad incomplete.  From my perspective, it is what the U.S. will be emboldened to do, in response to the various retaliatory efforts of other countries, that will really let the genie out of the bottle.  From the ramifications to NAFTA negotiations, to issues with China on intellectual property, to trade agreements with UK post-Brexit, a lot of complications can come in the 3rd and 4th dominoes that go beyond just the initial retaliatory domino.

Americans feeling Europeans pain

So what happens if President Trump carries through on his threat to throw tariffs on European automakers?  Is this a further leverage point the U.S. has on Europe, or vice versa?  Well, German carmakers alone actually built 854,000 cars in the United States last year.  The European car business is now a huge U.S. manufacturing story.  Messing with that will be worse for U.S. jobs than it would be for European car companies (by the way, 62% of those cars are exported out of the country so benefit the U.S. side in trade deficit).  The complexities of the global supply chain have categorically re-framed the old understanding of how goods are made around the world.

Who cares about the price of steel?

The average auto loan hit its highest level in history last quarter.  The average length of loan hit its longest level in history.  The average price paid for a new car hit its highest level in history.  Steel is a huge input cost for automobiles.  Enough said.

Change at the Federal Reserve

Hawks, Centrists, and Doves – Tight money, Easy money, or in between.  I have written already how Powell likely represents a continuation of the dovishness of Janet Yellen, with a slightly more centrist leaning.  And we have not yet added more hawks to the Federal Reserve board.  But several “doves” are leaving, and the balance of composition here has to be monitored if we are to stay faithful to our dictum that “personnel is policy”.

* JP Morgan Asset Management, March 5, 2018

The carnage extends to the nonsense too

We know that equities and bonds are well off their highs in the last five weeks, and we have abundantly discussed the reasoning and outlook for that in both stocks and bonds.  But for those following certain other “manias,” it has really not been a pleasant month at all.  That crypto-currency mania is over 50% down from its recent highs.  Half of the value of the “medical marijuana” space has deteriorated. And the inverse-volatility product suite was taken out behind the shed and shot.  These are all niche products but they became speculative little bubbles and manias in their own right, and gave ample opportunity to witness the folly of investor behavior (always and forever, greed or fear driven).  Investor behavioral laws apply to conventional assets; they apply in spades to non-conventional ones.

Chart of the Week

I apologize in advance if this seems esoteric or complex, but it is a big, big deal.  Please note how strong the correlation has historically been between the 10-year treasury yield, and U.S. dollar strength relative to Japanese Yen.  Since 2018 began, our bond yield has gone straight up, and yet the dollar has dropped over 5% relative to the Yen (you are welcome to, instead, say that the Yen has increased relative to the dollar).  The Bank of Japan is hardly working on making this happen, so what gives?  A number of possibilities exist as to what is happening, and why, and what will happen from here.  One plausible theory is that the Yen is modestly appreciating just in response to the weakness the BOJ successfully created in in the last year or so, and that after a little “breathing” things will return to normal trajectory.  But another very distinct possibility is that it is not Yen driven at all, but simply a reflection of the over-valued U.S. dollar coming into 2018.  Our view is that the actual currency value is not fundamentally important for our positioning, especially when gradual.  But I bring all this up to point out – there are some odd economic relationships forming right now that bear watching.  I lack clarity and understanding as to what it all means, but I don’t lack awareness that it is important.

Quote of the Week

“Trade protection accumulates upon a single point the good which it effects, while the evil inflicted is infused throughout the mass. The one strikes the eye at a first glance, while the other becomes perceptible only to close investigation.”
~ Frédéric Bastiat

* * *
There was a predominant theme in this week’s Dividend Café about trade, global markets, and administration policy.  If some of you detected that I am miffed at the President about this, you detected correctly.  But I cannot emphasize enough how fluid this is, and how subject to “walk back” most of what the President is saying and doing is.  So we are not doing anything crazy, though we are concerned, and we are grateful that we have a very disciplined asset allocation process for our clients, that defines in each and every case the appropriate bandwidths of allocation to each asset class, so that we do not over-stretch on the high side or the low side.  This discipline is the cause of all sorts of mistake avoidance.

Mistake avoidance – to that end, we work.  Perhaps the President could be so convinced …

With regards,


David L. Bahnsen, CFP®, CIMA®
Chief Investment Officer, Managing Partner

The Bahnsen Group is registered with HighTower Securities, LLC, member FINRA and SIPC, and with HighTower Advisors, LLC, a registered investment advisor with the SEC. Securities are offered through HighTower Securities, LLC; advisory services are offered through HighTower Advisors, LLC.

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