Please enjoy market commentary each quarter from Chief Portfolio Strategist James W. Underwood, CFA.

Tariff Threat

August 2018

Free trade, driven by the law of comparative advantage, works perfectly in theory, but misplaced workers are the practical complication to a theoretical win-win solution. Consequently, countries have historically used various forms of trade restrictions to protect select industries, employment or longer-term objectives deemed important to future prosperity/security. Despite the practical shortcomings, trade over the last generation has been less restrictive and the global economy has been the beneficiary.

Since his election, President Trump has been aggressively reviewing the United States’ trade policies, serving as the defining global economic development over the first half of 2018. The market easily digested new tariffs imposed on washing machines and solar panels to begin the year. The new tariffs on steel, aluminum and newsprint created more headlines, but investor anxiety remained generally contained. However, investors’ dismissive reaction abruptly changed in mid-March when President Trump threatened China with additional tariffs and China countered with similar threats. Investors fear this tit for tat trade spat between two economic superpowers could escalate, sending shockwaves across the entire economic landscape.

President Trump highlighted unfair trading practices and theft of intellectual property when he announced these proposed tariffs on China. Many have asked–why now? The U.S. has maintained a sizeable and growing trade imbalance with China for decades and concerns about the security of intellectual property are certainly not new.

In mid-2015, with very little fanfare, China announced its Made in China 2025 policy. This 10-year strategic plan provided a blueprint for transforming China from a labor-intensive economy specializing in low tech manufacturing to a dominant leader in manufacturing high-quality and high-technology products focused on ten priority sectors: (1) Next-generation technology; (2) High-end numerical control machinery and robotics; (3) Aerospace and aviation equipment; (4) Maritime engineering equipment and high-tech maritime vessel manufacturing; (5) Advanced rail equipment; (6) Energy-saving and new energy vehicles; (7) Electrical equipment; (8) New materials; (9) Biomedicine and high-performance medical devices; and (10) Agricultural machinery and equipment.

Many people point to this policy and China’s state-sponsored subsidies to build leadership within these ten primary sectors as the catalyst for Trump’s tariffs. It’s one thing to have a massive trade deficit with China that is concentrated in labor-intensive low-tech manufacturing, but something dramatically different to potentially contribute funding (trade deficit) that puts at risk one of our primary assets – our technological competitive advantage.

Regardless of the reason, this is not the first time investors have fretted over a U.S. trade dispute with China, nor do I anticipate it will be the last. Despite the cyclical rhetoric, the net effect of trade between China and the U.S. has been a win-win relationship. While the connections have softened, the two global economic engines remain intricately linked making a meaningful separation essentially impossible over the foreseeable future. Consequently, headlines and tweets will continue to contribute to near-term investor anxiety, while both sides negotiate and position themselves for the next phase of this trade relationship.

Against this backdrop, a closer look at the second quarter capital market environment follows.

Developed Equity Market Review

Equity investors across developed markets attempted to balance the elevated risks associated with a potential disruption in global trade against continued strength in corporate earnings. During the second quarter, earnings strength was the victor as most developed equity markets ended the period higher.

Reviewing the U.S. markets, the S&P 500 ended the second quarter up 3.4%. The quarterly gains fully offset the losses over the first three months of the year, resulting in a modest 2.6% mid-year return. For the quarter, soaring oil prices provided the fuel to propel the Energy sector to the lead, posting a robust 13.5% return for the period. Other notable second quarter outperformers were the Consumer Discretionary (Amazon) and Technology sectors, bringing their year-to-date gains into double-digits. On the opposite end of the spectrum, four sectors have experienced back-to-back negative quarters with the Financials and Industrial sectors experiencing the largest declines during the second quarter.

Evaluating the U.S. market by style and capitalization, the growth style continued its dominance within large cap as market leaders Amazon, Microsoft, Apple, Netflix, Facebook and Alphabet have accounted for the majority of the market’s 2018 return. Reviewing performance by capitalization, smaller-cap companies generally outpaced their larger-cap counterparts during the quarter, partially insulated from the headwinds associated with the strengthening U.S. dollar.

Outside the U.S., most developed equity markets ended the quarter in positive territory, but rising U.S. interest rates and the possibility of a smaller U.S. trade deficit going forward sent the dollar sharply higher, offsetting all of the foreign equity market gains for U.S. dollar-based investors.

Fixed Income Review

The Federal Reserve continued their rate normalization process by increasing the Fed Funds target 0.25% in June. Longer-term yields also advanced in April and early May, but retreated over the second half of the quarter as risk aversion climbed higher. The result was further flattening by the yield curve with the spread between 10-year Treasuries and 2-year Treasuries ending the quarter at 0.33%, a level last seen in 2007. This flattening by the yield curve presents challenges to the Federal Reserve’s plan to continue raising the Fed Funds target. The question is will the Fed purposely invert the yield curve with policy decisions, knowing that an inverted yield curve has historically preceded economic slowdowns?

Within this fluid yield environment, U.S. Treasuries inched higher while corporate bonds posted modest losses. The net effect was a -0.2% decline by the Bloomberg Barclays U.S. Aggregate Bond Index.

Satellite Strategies

In an investing world where most risk assets are valued above their historical averages, select satellite asset classes are the exception, priced below historical norms. Despite this valuation advantage, the combination of rising trade anxiety and a strengthening U.S. dollar resulted in significant losses across certain areas. Hardest hit were emerging market equities, which declined 7.9% during the quarter, as measured by the MSCI EM ($) Index. Gold was another weak performer, as the historical dollar hedge declined with the dollar’s upside move. The lone exception to an otherwise terrible quarter were master-limited-partnership, which saw their prices rally 11.8%, but remain in negative territory year-to-date.

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Viewpoints are a series of white papers on the way we see life in this financial world we live in today. We hope you will enjoy.

Off to the Races

Written by Jim Underwood, CFA, Chief Portfolio Strategist

As we approach November 8th, I am repeatedly asked, “How will the outcome of the upcoming elections impact investment markets, and which is better for the stock market – Republican leaders or Democratic?” My honest, easy answer (or non-answer) is always – “it depends”. However, let’s see if any broad generalizations can be made based on historical observations.

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Securitas, derived from the latin word for security, is an Article Series by Welch Hornsby, meant to help raise your awareness of the importance of information security.

Smartphone/Tablet Theft 2nd Quarter 2016 Security

Written by Jon Atchison, Information Security Coordinator

While you may not see the stories on major news networks, smartphone theft is big business and you would be surprised to learn that in 2013, 
3.1 million smartphones were reported stolen in the United States. It may also come as a surprise that nationally, just under a third of all robberies involve a smartphone of some kind.

A stolen smartphone (or tablet) represents a win-win for the thief because they have your device and in many cases, they get the information inside that device. Identity theft (and fraud) often begins from within a stolen device. Remember that ID theft is merely the stealing of your information. ID fraud occurs when the would-be thief uses your information for financial gain (loans, lines of credit, using your credit card to purchase groceries or gas).

So, ask yourself, “What if my iPhone or iPad (or computer) was stolen? Would I know what to do? Could I track and erase the data on my device?” In answering these questions, the first suggestion would be to learn about your technology and any such capabilities. Knowledge of how you can protect, track and erase your device is an essential first step. Having this knowledge will give you confidence when creating a plan in case your device is lost or stolen. In this article, you will find two scenarios where having a plan is crucial.

  • What to do when a personal device (computer/tablet/smartphone) has been stolen.
  • What to do when someone has used my identity to make a purchase or secure a loan.
    • Stolen card numbers are a more likely event and represent an easier mark for the thief. Stealing enough information about you to secure a loan is a different problem altogether.

Another suggestion would be to prepare yourself for a potentially daunting exercise in perseverance and patience. Living through either scenario is not going to be fun – but executing a well-prepared plan will make the experience much more manageable.

Scenario #1 – Your tablet/phone was lost or stolen while on vacation (or from any location). We will use an Apple product as an example.

Don’t panic – I say that because I assume you have already placed a passcode on the device. This is the FIRST line in the defense of your identity/privacy. If your iPad/iPhone or other tablet has no barrier between it and the general public – everything is fair game to the lucky thief.

Make a Call – If you suspect theft, notify the local authorities and try to retrace your steps in an effort to identify where the device went missing. Also, call your investment advisor, banker, CPA, etc to notify them of the potential theft. Many phishing emails originate from a client’s stolen device.

Track your device – Apple gives you the ability to locate your devices (iPads, Macs, iPhones) via the I encourage you to learn more about how Apple and Android help protect you and the information on your devices.

Change your passwords – Strongly consider changing any password associated with email located on your device. Other password changes could involve banking/credit card apps and shopping apps as well. Definitely change the account password for your AppleID (or Google Play if applicable).

Notify your banks and credit card companies – If you had your bank account(s) and credit card data integrated into your phone through their apps, notify them immediately and request that an alert be placed on your account. They may offer other helpful suggestions as well.

Scenario #2 – What to do when someone has used my identity to make a purchase or secure a loan.

There are fantastic resources that I would like for you to consider when thinking about your response to personal identity theft. The first link below is a more concise approach titled, “What To Do Right Away.” You might want to print this out and have it ready just in case…

The second link is “Taking Charge: What To Do When Your Identity is Stolen” and will help you build a personal recovery plan.

I encourage you to spend some time in these documents and work through them to build a greater awareness of where you have the most exposure.

Identity thieves and fraudsters gain the most from victims who are not prepared. A victim who has a plan, knows their technology and who to call can mitigate much of the risk that comes from a stolen device. Being able to quickly respond to these events will save you time, money and hopefully some sanity.
A premium is often placed on investing in financial markets, our careers and healthy lifestyles. While these are worthy endeavors, we live in a world that requires more diligence in protecting and caring for our privacy and identity. The former usually takes time to realize a return, if any. I believe the latter will most certainly benefit you not only in the short run, but in the long run as well.

Written by Jon Atchison
Information Security Coordinator for Welch Hornsby, Inc.

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