Market Fundamentals vs. Scary Headlines

As we enter the all-star break, heart of summer for baseball and the 2nd half of the year for the Market, at a critical juncture, this famous quote by Yankee legend Yogi Berra sums it up pretty well:

“It’s Déjà vu all over again”

Last night at midnight Eastern Standard Time, $34 Billion worth of tariffs were placed into effect by the United States against China and this move was immediately reciprocated by the Chinese. There are another $16 Billion in additional expected tariffs to go into effect in 2 weeks by the U.S.

That’s where we stand today. People’s Bank of China (PBOC) has told citizens that the impact of the $50 Billion in tariffs between the U.S. and China will have a limited impact on the economy and be largely digested by the market. Many analysts estimate the $50 Billion in tariffs to be worth 0.2% of China’s GDP. A mild impact by many standards, which is exactly what the markets are saying this week. They have priced in this initial bout of tariffs and are looking at the strength in the economy and valuations in the market.

The U.S. economy continues to show strong resilient signs. Another 213,000 jobs were created in June. The unemployment rate actually rose to 4% from 3.8%. How does that work? Well it’s actually a good thing. It means that more people are looking for work, than previously. Therefore, the denominator rose, pushing up the unemployment rate. It’s a major positive, let us explain:

Our economy has been running so hot that we were set to run out of people to hire by the middle of next year! When you have an economy growing at our rate, or 3-4+% GDP, a major catalyst to continue that pace or rate of growth is employment. But when an economy gets to full or maximum employment, there is no more marginal help to GDP growth. This in a sense creates problems, because labor gets bid up, new businesses cannot open or be started because they can’t hire people (thus growth has to slow or cool down). So getting an uptick in the participation rate from the 25-54 age group over the past month is quite constructive.

So why is this Déjà vu all over again? Well we have a case of two distinct paths that are at an impasse: we have a very strong economy, strong sales, strong earnings, and strong prospects at reasonable valuations in the market place. VS. the Headline Scare of a Trade War. We have seen many times since this Bull Market began out of the 2009 financial crisis, where Scary Headlines created buying opportunities, as they ultimately don’t affect fundamentals.

The U.S. falling off the “fiscal cliff” in late 2012, the “PIIGS Debt crisis” of 2011 are quite similar to today. They were huge attention grabbers. The PIIGS (Portugal, Italy, Ireland, Greece, Spain) debt event had potential for deeper systematic or ripple effects for contagion. The fiscal cliff in the U.S. did too, just not as large. Ultimately, the economy was unaffected by these EVENTS. They created opportunities as the markets recovered quickly and trudged to new highs.

Will this time be different? Our sense at the moment is No. These initial tariff bouts are digestible by the market and economy. There are a lot of green shoots we are seeing to get this market back up in earnest. However, the major pause we have is: the next round of tariffs threatened against the Chinese if they retaliate jumps to a staggering $500 Billion. Simply put, that is the Market overhang here.

Just like the 2 examples above in ’11 and ’12, if the news or fears don’t hit (i.e. affect the fundamentals) the market will be more than fine, and likely soar to new highs. But if this is the time the headlines do start to hit the fundamentals, the market likely has downside back to where we were in early February and potentially a bit lower.

As investors, nothing we do strategy wise is in absolute certainties. We invest strategically in probabilities. We weigh them all out, make decisions and act for a Plan A, and behind the scenes methodically and diligently plan for a Plan B. When the facts change, so do we.

Have a nice weekend. We’ll be back, dark and early on Monday.

Mike Harris

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