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By: Ivan T. Thornton, CEO of Fiduciary Management Group, LLC Published: October 15th, 2018
That is how we describe the activity in the third quarter that just ended. The trade “skirmish” with China has taken hold and is starting to hurt some core positions near term. We have been net bullish on the Chinese market for some time now and have been rewarded nicely for this call. We have long suggested that the two largest economies in the world – United States and China – benefit greatly from one another and that a protracted trade war would be damaging to both. As it turns, China is being hurt more so with the Hang Seng Exchange down some twenty plus percent from its 12 month high. Meanwhile, the U.S. market is humming along…..with the exception of the Technology Sector. Therein lies our challenge: We have been, and continue to be overweighed in Technology and China! Needless to say, we are not enjoying the trade war! Although a protracted trade war would be damaging to several U.S. based industries including the likes of agriculture, aircraft manufacturing, automobiles, retail, etc., it takes awhile before the negative aspects to begin to take hold in these industries. Technology however is almost immediate, as we have seen. The aforementioned industries have historically been subsidized by the Government during these types of skirmishes and so price devaluation does not occur as quick or severe. Clearly that is not the case with Technology. Although we continue to enjoy long term profits from both our China and Technology positions, we are experiencing some near term pain as these two sectors have pulled back. Being the contrarian, adding to these positions at this time would be a good idea. However, no one knows how long this skirmish will last or perhaps turn into a full blown trade war. With that said, we will continue to hold these positions for the long term and would consider adding to them only when we sense this trade war is coming to an end. With a settled negotiation of NAFTA with Mexico and Canada, we only hope that all attention will now be focused on China and the two countries will be back in business.
As it relates to the economy, the second quarter economic reports continued to gush with good news. Unemployment reached a 49 year low and economic output is reaching an all time high. Consumer confidence is high and the retail store cash registers are ringing. The tax cuts are helping to push corporate profits higher. All bodes well with the exception of one key indicator: Interest rates. In an effort to ward off inflation from all of this good economic activity, the Federal Reserve has been forced to increase interest rates. The economy, and in particular the markets, have enjoyed a favorable rate environment for many years. That is starting to change. Both the economy and markets will have to digest higher rates and we don’t think that is going to be easy. Clearly a higher interest rate environment will pose some challenges to the markets in the near future.
Historically speaking, September and October have been the toughest months for the markets. This year is proving to be no different. Frankly, near-term we are not very bullish. Actually, we are skittish as we now believe that both China and the United States are digging in on their respective positions as it relates to the trade war. The effects are now beginning to show up in stock market performance as we are now experiencing a long overdone market correction, something that we have long been calling for. As well, we believe that the Fed will grow even more aggressive with interest rate hikes, which will also negatively impact the markets. We will make adjustments to positions that we believe will be adversely impacted in an effort to protect portfolios. On the positive front, we believe strong consumer confidence as a result of low unemployment and a vibrant economy will find its way to retailers in the form of a strong holiday selling season. We remain constructive on the Technology industry. Tech companies will continue to go through growing pains and perhaps heightened calls for additional oversight, but we believe that Technology will continue to be the growth engine of the United States for many years to come.