The US/China Trade War: A.K.A. “You (almost) sunk my battleship!”
4 min read
What’s going on in the current markets, and what’s the smartest move for investors in response? From the slowing economy to the effects of the ongoing (and likely not ending soon) US/China trade war, here’s what you need to know about the current state of the market.
As the economy slows down, the bond market is pricing this in.
The investment markets seem to have stalled: The S&P 500 has made a round trip from its high between October 3, 2018 and May 3, 2019. In the past few weeks, the market has drifted down and as of May 23, lost approximately four percent. In other words, if your portfolio has not practiced active management, then your stocks were probably flat for eight months!
The bond market seems to a have a slightly more negative view on the near-term future of the U.S. economy as compared to the equity market. The yields for U.S. debt has been coming down recently and this curve has become slightly inverted. On May 23, the yield on the U.S. ten-year Treasury Bond reached its lowest level since 2017. This can be interpreted as the bond market believes that the Fed will have to cut rates in response to a softening economy.
Why the U.S./China trade war matters
This stall in the investment markets seems to have developed due to its myopic focus on the lack of a solution on the U.S/China trade war. This may not be as narrow-minded as it seems. The following facts merit some consideration.
First, China's economy has grown exponentially in size. In 2002, China was 14 percent of the US's GDP. It is now 67 percent the size of US GDP. Second, China's exports to the US have declined from 7.3 percent to 3.8 percent of their GDP in just a few years' time. We must also consider the possible side effects of a continued trade war, such as increased inflation. A large percentage of materials used in U.S. manufacturing are made in China.
In summary, not only has China's economy grown, but they are less dependent on our country. China may not be as desperate for a deal as we may think and a resolution to this issue may take some time.
The markets are expensive
The markets are not cheap from a historical perspective. The ratio of the market's price to its expected earnings for next year (i.e.. the forward P/E), is about 17 times. The twenty-five year average for this ratio is 16 times. The price-to-cash flow ratio is 12.50 times as compared to its 20 year average of 10.67. Domestic large capitalization stocks are selling for 109 percent of their 20 year average. Domestic small cap stocks are selling for 124 percent of this average.
At both month ends of October 2018 and January of 2018, the equity markets stood at similar levels before giving up nine percent or more.
What can investors expect for the remainder of 2019 and even the next few years?
So far this year, the GDP has been very healthy and is expected to increase by 2.9 percent on an annualized basis. However, growth of GDP is also expected to slow. Expectations for GDP growth are 1.8 percent and 1.6 percent for 2020-2021 and 2022-2023 respectively. And this assumes that we do not have the recession that most investment strategists and economists expect during this timeframe. Also, if there is no solution to the trade situation, the U.S. and the world economies could slow down even faster.
Knowing what you know now, how are you going to meet your goals? Be active and smart. And that doesn't mean cash.
Once the trade war is resolved, what can an investor expect? Despite the markets giving back more than three percent over the past two weeks, the S&P 500 is up almost 15 percent year-to-date. Combine this with the fact that most well-respected investment strategists expect the domestic equity markets to return roughly 5.5 percent per year in the next 10 years. This last fact is very startling when one is reminded that these same markets returned on average nine percent/year for the past 50 years.
Individual and institutional (foundations, endowments and foundations) investors will be need to be creative and active if their long-term investment goals are to be met. While many investors may think that the answer to the current market risk and uncertainty is taking their entire or the majority of their portfolio to cash, which could result in a much larger cost. Just remember that if you sit in cash for even 10-60 days, you risk decreasing the return of your portfolio from four to 12 percent on an annualized basis. (This is based on last 50 years of historical returns.) Given the lower returns that are expected, this potential damage could be higher. Instead of sitting in cash, look for lower valuation asset classes of publicly traded assets and/or consider the plethora of options available in the private markets.
About the Author
Michelle Connell, CFA is the President and Owner of Portia Capital Management, LLC., the only registered investment management firm in the Dallas/Fort Worth area owned by a female Chartered Financial Analyst (CFA). The CFA designation is considered the highest designation in the investment management profession, and fewer than three percent of all CFAs in Texas are women. Ms. Connell is also one of highest-rated finance professors in the United States, currently serving as an adjunct professor at The University of Texas and instructing CFA candidates through the CFA DFW Society. For her clients — including the underserved markets charities, foundations and high-net worth women — Ms. Connell crafts personalized solutions that include conventional products as well as rare access to alternative assets, including private equity, private debt and real estate, and allows investment portfolio creation with greater downside protection and more consistent returns. Through her philanthropic initiative, “Portia’s Children,” 10 percent of the firm’s profits are donated to charities working to improve the lives of children of single-parent homes.
