Saturday, September 1, 2018

This Week's Message: Our Present Thesis

In last Thursday's blog post we pointed out how without the tech sector the S&P would have quite a ways yet to go to reach its January 26 all time high.

Drilling further down, we can see that without Apple and, to a lesser degree, Microsoft, even the tech sector itself would offer little to write home about:

So what do we know about the environment from 1/26 to the present? Well, we know that the macro setup has remained supportive of a growing economy and higher stock prices. We also know that newly imposed tariffs, and the threat of more to come, has done a real number (relative to what the setup otherwise dictated) on industrial, materials and, indirectly perhaps, on financial stocks. And we know that the U.S. and China have thus far largely spared tech companies -- Apple and Microsoft in particular.

The above leaves us with the following thesis:

Given the profoundly ugly economic history around protectionism we believe that odds continue to favor a resolution that all sides will hail as a victory.

Upon such resolution -- assuming that the macro setup is still bullish at the time -- we expect that the notably underappreciated, relatively undervalued and globally-centric industries referenced above (along with non-U.S. equities en masse) will see their stock prices advance as traders rotate in their direction, and away from the protection of treasuries and, to some degree, away from tariff-spared tech stocks. Which explains why we continue to favor cash and CDs over bonds, and why we think our present under-weighting (relative to financials, industrials and materials) to tech stocks remains prudent.

If, however, the Administration continues to push the needle on trade, we see no scenario where conditions do not ultimately -- before cyclical forces would've otherwise warranted -- morph into recession (with higher-flying tech stocks leading the decline into bear market territory). A situation that would have us moving to a defensive posture within client portfolios.

To, in the latter event, add huge insult to potentially huge injury, we can't think of a worse time than the present for a recession: The federal government has just cut taxes and is spending at a record pace, while monetary policymakers haven't remotely cleaned up the Federal Reserve's bulging balance sheet; amassed as they poured liquidity into the banking system in response to the last recession. Plus, if yet holding $4.2 trillion worth of treasuries and mortgage backed securities (that bulging balance sheet) isn't limiting enough, the Fed presently maintains a policy rate that is by historical standards remarkably low. I.e., In the event of recession in the relatively near future, fiscal and monetary policy responses would be substantially hampered, to say the least!

Summary: General conditions remain notably positive and, therefore, supportive of growth in equities (financials, industrials and materials in particular) going forward. We, however, see the present setup deteriorating in accelerated fashion if/when it becomes clear that the "trade war" is to be a protracted affair. In the event of recession in the relatively near future, neither the fiscal nor monetary authorities are in any shape to apply conventional means to support the economy; which is a messy scenario that can be easily delayed (and potentially alleviated) -- buying more time for positioning -- by calling a trade truce before conditions rollover.

Given the risks involved, we presently believe that odds indeed favor a trade truce before conditions rollover. That said, we remain open to all possibilities.

Have a nice week.

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