Bob’s Journal for 8/8

Investors quickly need to develop a process and policy for dealing with events and issues that are well outside the usual economic and market changes.

Most investors have plans for dealing with changes in Federal Reserve policy and tax policy. They know what to do, or not do, when a short-term event or new news causes markets to change direction quickly.

Now, we’re facing a range of issues and problems that aren’t strictly economic or financial but can affect the markets for more than brief periods. Plus, we seem to have more of those types of issues on the front burner than in the past.

Foremost right now are the rising trade conflicts between the United States and China. For more than 18 months, markets have popped up and down based on the latest tweets, news and rumors about the conflicts. It appeared that things would settle down not long ago when both sides declared a truce that seemed like it would last through the 2020 election.

All that changed last week. President Trump announced he planned to impose a new series of tariffs on Chinese products due to a lack of progress in the recent trade talks. China followed by allowing its currency to decline significantly against the dollar and prohibiting the purchase of U.S. agricultural products.

Stock prices and interest rates dived after these announcements. Many analysts are describing this as the second Cold War and worry that it might develop into a military conflict at some point. Even if it doesn’t, the conflicts are disrupting international trade and supply chains.

At the same time, China is dealing with protests in Hong Kong that have persisted and could escalate. That conflict could lead Chinese leaders to feel a need to prove their strength and resist compromising with the United States. Such intransigence by the Chinese government would continue the ongoing trade dispute that includes the key and unresolved issue regarding China’s theft of U.S. intellectual property.

Meanwhile, disagreements between the U.S. and the rest of the West on one side and Iran on the other have escalated to the point that Iran is seizing commercial ships and taking other actions.

The United States and Russia have several conflicts, but the biggest is an escalating cyberwar.

Turkey is in engaged in a conflict with the Kurds, and that dispute is also escalating. Decades-long tensions between India and Pakistan are becoming worse, too.

Europe is facing a series of problems as economic growth there has declined all year. Germany recently reported some of its worst economic data since 2009. The government in the United Kingdom changed and increased the uncertainty about “Brexit” and its consequences. At the same time, the fiscal crisis in Italy has continued and soon will reach a point where action will have to be taken or else the consequences for Europe will be dire.

These are only the main problems around the globe. A host of others could escalate to the point that they will affect markets and the global economy.

We’ve seen problems similar to these in the past, but they were often resolved or faded into the background.

However, we’ve rarely had so many problems with major spillover potential at one time. Often, I say that such problems are known and priced into the markets. Today, however, it appears to me that investors have largely downplayed these global issues. As long as the Fed is loosening the money supply, investors seem unconcerned.

A basic truth is that most investors project what has happened in the recent past into the future. That is what they’re doing now. Often, that’s a big mistake because trends in the investment markets won’t be sustained indefinitely.

I recommend you don’t try to forecast how any of these events will evolve. There are too many unknowns, and none of us is an expert in all these issues.

Instead, consider the probabilities. In this global economic and political environment, there’s a higher probability than normal of more than one of these issues escalating into a serious crisis that will disrupt markets and the global economy. I don’t believe that has been priced into the markets.

The inclination of too many investors is to hunker down in cash until the turmoil is over. I don’t recommend that. Though risk is higher than in the past, there still is a reasonable probability the issues will be resolved without doing a lot of long-term damage. There’s also the potential to profit under different scenarios.

Instead of withdrawing from the markets, I recommend you have a well-diversified portfolio such as the one I’ve been recommending in Retirement Watch.

Major stock market indexes haven’t done well through the recent turmoil. We’ve seen recent declines in the stock-based funds in our portfolios. But we’ve also had strong positive returns in long-term treasury bonds, gold and other positions.

When all our funds are combined into one portfolio, the aggregate return is much better than most investors have experienced, and the volatility is much lower. Our prospects for the future are better than most, regardless of what happens in these problem areas, because of diversification.

Diversification and balance, with a margin of safety, is how to deal with this high-risk, high-uncertainty environment.

The Data

Growth in the services sector might be slowing. The PMI Services Index for July was 53.0, compared to 51.5 in June. That indicates higher growth, but the employment component of the index wasn’t as strong as in June. Plus, optimism regarding the future declined for the sixth consecutive month and is a record low for this index.

Meanwhile, the ISM Non-Manufacturing Index, which is based on a larger and broader sample, declined to 53.7 from 55.1. This is a three-year low and well below expectations. Even so, a 53.7 level indicates a solid growth rate.

Consumer credit increased in June but was also below expectations. Credit card debt declined as consumers appeared to pay credit card balances that were incurred in the retail spending surge of the last few months. Despite the one-month decline, credit card balances increased 5.3% in the second quarter, which is the highest quarterly growth in more than a year.

Factory Orders joined the data indicating that the decline in manufacturing might have reversed at least until the latest trade conflict escalation. Overall orders rose 0.6% in June, compared to a revised 1.3% decline in May. Core capital goods, a key indicator of business investment and optimism, increased 1.5% in June.

Consumer Sentiment, as measured by the University of Michigan, was unchanged from June to July at 98.4. Consumer expectations for the future increased after declining in June.

The Employment Situation reports last week continued to show a strong labor market, as expected. New jobs continue to be created, though at a lower rate than in the last few years.

In July, 164,000 new jobs were created, compared to a revised 193,000 in June. Average hourly earnings increased by 0.3%, for a 3.2% 12-month growth rate. A negative component of the report was a decline in the average hours worked in manufacturing.

The JOLTS (Job Openings and Labor Turnover Survey) report also showed some moderation in the labor market. JOLTS is a more detailed report and is a month behind the Employment Situation reports, so the latest JOLTS is for June.

The latest JOLTS found job openings declined by 0.5% for the month and hiring declined 1.0%. Job openings now are 0.6% below the June 2018 level. The number of job openings are still much higher than the number of new hires.

New unemployment claims declined by 8,000 to 209,000 in the latest week. The four-week average is 212,500, which is about 5,000 lower than a month ago.

The Markets

The S&P 500 fell 3.18% for the week that ended with Wednesday’s close. The Dow Jones Industrial Average declined 3.08%. The Russell 2000 dropped 4.62%. The All-Country World Index (excluding U.S. stocks) lost 3.20%. Emerging market equities fell 4.74%.

Long-term treasuries rose 5.58% for the week. Investment-grade bonds increased 1.60%. Treasury Inflation-Protected Securities (TIPS) added 1.21%, while high-yield bonds lost 0.62%.

In the currency arena, the U.S. dollar declined 0.97%.

Energy-based commodities dropped 6.55%. Broader-based commodities fell 3.14%, while gold jumped 5.77%.

Bob’s News & Updates

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