Market Update | Page | Fall 2019

Billings: (406) 655-3960 Helena: (406) 447-9050 Missoula: (406) 258-1450

| Fall 2019 |

DOUBLE, DOUBLE TARIFF AND TROUBLE

“Trade war is the most stupid thing in this world.”1

—Jack Ma, founder and executive chairman of Alibaba

Last quarter we wrote about the bond market, and how we currently live in the upside-down world of the

inverted yield curve. Not that it is unprecedented that people are willing to earn a lower rate when

lending for 10 years—or even 30!—than for a few months.

This, as we pointed out, has happened numerous times,

often with unsavory consequences for the economy.

The key takeaway is that such an inversion reflects a

fundamental lack of confidence in the long-term

prospects for economic growth among bond investors:

they are not bullish. Such an inversion is not an infallible

indicator, but these investors-cum-lenders are voting

with their pocketbooks, and they’re often right.

There are many reasons why bond investors are so risk averse now, and trade trumps them all

(intentional). Indeed, the last time America saw trade tensions this pronounced was in the aftermath of

the stock market crash in 1929, when the Smoot-Hawley Tariff Act helped extend and exacerbate the

Great Depression in the U.S. and around the globe. The tariffs averaged 20 percent and were met with

reciprocal duties from primarily European countries. The resultant trade wars reduced global trade by

two-thirds over a four-year period.

The 1930s are not completely analogous to the 2010s, but there are parallels. Smoot-Hawley was a late

chapter in post-World War I isolationist policies that included the Fordney-McCumber Act of 1922, which

raised the U.S. import tax to around 40% and sparked a wave of European retaliation. Today’s isolationist

David Morgenroth, CFP®, EA Wealth Management Advisor David.Morgenroth@stockmanbank.com

Market Update | Page 2 | Fall 2019

and nationalist sentiment has its origins in growing inequality and caught fire in the Great Recession of

2008-09; the Trump presidency and the ensuing trade policies are products of a larger and longer trend. In

both time periods, trade conflagrations appear to have hit their low near or at the end of extended

expansions.2

Source: HA.com. Donna H. Smith editorial cartoon, ca. 1930.

This time around, though, we probably haven’t hit bottom quite yet. The uncertainty of a trade policy that

increasingly appears arbitrary is forcing the hand of business owners, small and large alike. Take Win

Cramer, CEO of JLab Audio, maker of wireless ear buds and headphones in Carlsbad, California.3 “It’s the

most frustrating time I’ve ever had running a business, and I’ve been doing this for 20 years,” he claimed.

Twice this year he has tabled searches for new employees due to the trade war with China, the second

time on the heels of the August 1 Trump tweet on plans to add a 10% tariff on $300 billion of Chinese

Market Update | Page 3 | Fall 2019

goods. Cramer’s business will be hit in September, despite a subsequent announcement that some of the

new tariffs would be delayed until December 15.

“We put hiring on hold again after the tweet came out,” Cramer said. “We’re in a business where we need

certainty. We can’t make investments because we don’t know if those investments will have to be ab-

sorbed or dissolved.” Cramer’s sentiment is shared by CEOs and COOs around the country. CEO Jim Fitter-

ling of Dow echoed Cramer, “This is not the time to invest,” and last month cut $500 million from Dow’s

capital spending plans.

I’m going to keep it tight until I get better visibility on the market. I think we need to get a trade

deal . . . to get some confidence back in this market, at least on the industrial side . . . I don’t think

we’re in a recession. It doesn’t feel like we’re in a recession. I do think a trade resolution will bring

some confidence back and brighten the outlook, and confidence is huge in these markets.4

Fitterling identified the largest and most overarching issue: confidence. The consensus acknowledges that

the economy is slowing, but other than the early indications of the inverted yield curve (which is forward

looking), the economy is actually quite stable and not in a recession. But we can certainly talk ourselves

into one. As Dr. David Kelly, Chief Global Strategist for J.P. Morgan Asset Management, said on a call re-

cently, the occurrence of “recessions are at least half due to confidence.”5 So, what do the current senti-

ment numbers tell us?

The U.S. consumer remains undaunted by tariffs and tweets. Both the Conference Board Consumer Confi-

dence Index and the University of Michigan Consumer Sentiment Index are near highs for this cycle. In fact,

in addition to massive government deficit spending, we as consumers are actively driving this economy.

The fly in the ointment is on the business side. The Conference Board stated, “The percentage of consum-

ers expecting business conditions will be better six months from now decreased from 24.0 percent to 21.9

percent, while those expecting business conditions will worsen increased from 8.4 percent to 10.0 per-

cent.” The Expectations Index overall (consumers’ short-term outlook for income, business and labor mar-

ket conditions) dropped nearly 5% from July to August.

That’s the consumer talking – we’re collectively spending like there’s no tomorrow, while looking over our

shoulders at what’s coming down the pipe. What about business owners and managers, on the ground

running their businesses and making short- and long-term strategic decisions for their respective compa-

nies?

Recent issues of Market Update can be found online at the Stockman Wealth Management page of www.stockmanbank.com. To be included on the email distribution list (four issues per year, plus special updates as

necessary), please contact us at: Eric.George@stockmanbank.com - thank you!

Market Update | Page 4 | Fall 2019

Source: businessroundtable.org. The CEO Outlook Index is the lower, red-dotted line; the upper, green-dotted line represents GDP growth.

Above is a chart reflecting surveys by the Business Roundtable of CEOs on their expectations for sales and

plans for capital spending and hiring over the next six months.6 Sentiment among CEOs came out of a shal-

low trough with Trump’s election and appears to have peaked with the passage of last year’s tax bill.7 The

Roundtable’s accompanying headline tells the story:

Business Roundtable CEO Economic Outlook Index Decreases in Q2

CEO Economic Outlook Healthy; Unease About Trade Policy Mutes Enthusiasm

As Joshua Bolten, Business Roundtable President & CEO, states, “Business leaders are ready and eager to

invest and hire in the United States. Yet, the uncertainty over trade policy is making it more difficult for

companies to invest and operate confidently.” Jamie Dimon, Chairman and Chief Executive Officer of

JPMorgan Chase & Co. and Chairman of Business Roundtable, adds: “CEO plans for hiring and capital in-

vestment remain healthy, but uncertainty about U.S. trade policy, softening global growth conditions and

inaction on other pressing public policy issues are a concern.”8

Peak Q1 2018

Market Update | Page 5 | Fall 2019

Here is the Business Roundtable’s Capital Expenditures chart, a sub-index of the CEO Economic Outlook;

Capex appears to have peaked in Q1 2018 as well:

Source: businessroundtable.org. The Capital Expenditures Index is the upper, red line; the lower, green line represents quarterly percent change

in Capex growth.

We could distill this information into a few points (and a few extrapolations):

1. A Presidential Twitter holiday would be welcomed by (almost) all.

2. The economy is healthy, if showing a few signs of wear. In other words, we’ve got a pretty good

thing going here – let’s not talk ourselves into a recession.

3. Of course, just as the leaves will fall, a recession will come eventually. But let’s reframe what a

recession really means: a natural part of the cycle of living and doing business.

4. Trade is good; fair trade (inasmuch as we can define it) is even better. Trump was right to go

after the Chinese regarding a number of issues, especially intellectual property rights. But his meth-

ods are gradually leading to a paralysis of business and lack of stability, threatening to wreak havoc

What would you like to learn about in the next edition of Market Update?

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Market Update | Page 6 | Fall 2019

on our economy and our general psyche.

5. Jerome Powell, beleaguered Federal Reserve Chairman, must know from both observation and

personal experience that there is nothing he can do to mollify the President. It is incumbent upon

him and the Fed Governors to keep the Fed independent and inured to politics. Expect a 0.25% rate

cut this month.

6. Federal deficits are on track to cross $1 trillion annually. Treasury Secretary Mnuchin just an-

nounced that a 50-year bond could be issued next year.

7. Meanwhile, the larger, macro environment continues into uncharted territory. There is now

about $17 trillion in global government and corporate debt trading at negative yields, and some re-

al yields (adjusted for inflation) are -2%.

FedEx CEO Fred Smith summed up the macro environment on a recent call:

Most of the issues that we are dealing with today are induced by bad political choices, making a bad

decision about a new tax, creating (a) tremendously difficult situation with Brexit, the immigration

crisis in Germany, the mercantilism and state-owned enterprise initiatives in China, the tariffs that

the United States put in unilaterally. So you just go down the list, and they're all things that have

created a macroeconomic slowdown.9

With all of that, markets are still going up, with many of the broader indices pushing toward new highs:

Source: Morningstar.com. TR = Total Return (includes dividends). PR = Price Return. NR = Nominal Return. EAFE = Europe, Australasia, & the Far East. MSCI = Morgan Stanley Capital International. *Annualized figures.

A collective sigh of relief will be heard across the land if we finally consummate a trade deal with China,

and the effect on markets will far outweigh any additional interest rate cuts or fiscal stimulus such as tax

relief. Confidence is the name of the game. Without it, productivity and investment will drop, and we’ll

surely talk ourselves into a recession.

Winston Churchill spoke often on trade, and he regarded commerce as “utterly different from war,” and

that “the phraseology” of war “should never be applied” to trade. Churchill said that in war, “both sides

EQUITIES 9/13/2019 4 Weeks Year-to-Date 1 Year 3 Years* 5 Years*

S&P 500 TR 3.01% 21.73% 5.69% 14.52% 10.92%

Dow Industrial Avg TR 3.92% 18.83% 6.65% 17.04% 12.61%

Nasdaq Composite PR 2.00% 15.39% 2.03% 16.62% 12.35%

Russell 2000 TR 4.64% 18.17% -6.60% 14.52% 10.92%

MSCI EAFE NR USD 5.18% 14.34% 2.48% 7.56% 2.98%

Market Update | Page 7 | Fall 2019

lose whoever wins the victory, but the transactions of trade, like mercy, are twice blessed, and confer a

benefit on both parties.”10 As trade talks between China and the U.S. are set to restart next month, let’s

hope to hear more about ”trade gestures” and “tariff exemptions” and especially “trade parties”. A good

party or two would be healthy for all.

Enjoy your autumn, truly a beautiful time of year! Let us know if you have any questions or comments –

we are always here to help.

1 “Jack Ma, speaking at the China International Import Expo, Shanghai, Nov. 5, 2018. See https://www.cnbc.com/video/2018/11/05/jack-ma-trade-war-is-the-most-stupid-thing-in-this-world.html. 2 https://www.britannica.com/topic/Smoot-Hawley-Tariff-Act. 3 https://beta.washingtonpost.com/business/2019/08/13/us-businesses-are-taking-down-job-listings-trumps-trade-war-grows/?noredirect=on. 4 https://www.icis.com/explore/resources/news/2019/07/26/10396674/dow-slashes-capex-500m-on-challenging-macro-outlook. 5 Dr. David Kelly, “3Q19 J.P. Morgan Guide to the Markets Call,” live call, July 2, 2019, access: https://am.jpmorgan.com/us/en/asset-management/gim/adv/insights/market-insights. 6 The Business Roundtable is an association of chief executive officers of America’s leading companies working to promote a thriving U.S. economy and expanded opportunity for all Americans through sound public policy. https://www.businessroundtable.org/about-us. 7 The Tax Cuts and Jobs Act (TCJA) passed on December 22, 2017, cutting corporate income tax rates permanently to 21% beginning in 2018. 8 https://www.businessroundtable.org/media/ceo-economic-outlook-index. 9 https://www.houstonchronicle.com/business/columnists/tomlinson/article/We-may-be-talking-our-way-into-a-recession-13552843.php. 10 https://link.springer.com/chapter/10.1057%2F9781137326836_7.

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