Argent Quarterly Investment Commentary – March 2018
“Out of clutter, find simplicity. From discord, find harmony. In the middle of difficulty lies opportunity.”
– Albert Einstein
In the first quarter, our old friend, stock market volatility, returned after a lengthy absence. To be honest, we hadn’t really missed the volatility – it was fun watching stocks progress on a steady upward slope for more than a year. On the other hand, we knew it couldn’t last. It was Will Rogers who famously said, “The only thing that one can predict about the stock market is that it will fluctuate.”
There are several causes for the recent volatility, with trade tensions – tariffs – being foremost among them. When President Trump tweeted, “Trade wars are good and easy to win,” he was basing his viewpoint on what we believe to be a unique interpretation of economic history. Basically, the whole idea behind tariffs is to raise prices for particular goods. This typically does help workers and companies involved in making those goods, but it hurts those who work in industries using the goods which now cost more to purchase. Thus, tariffs on steel and aluminum will create a few more U.S. jobs for those in the production of steel and aluminum, but the resulting higher prices for these metals will ultimately depress global demand for all kinds of things. Most studies we read show that for every worker who benefits from a tariff anywhere from 10 to 50 workers are hurt.
To be fair, we are really not in a trade war today – perhaps it would be better described as a trade skirmish. Good economies such as ours can easily survive skirmishes. The risk is how and when others, such as China, retaliate. If countries retaliate in a measured way, little harm is done. If retaliation, however, leads to an escalation of more tariffs on both sides, the economic impact, and the impact on global stock markets, will be more severe. We are reminded of the Martin Luther King, Jr. quote, “An eye for an eye leaves everyone blind.”
Despite it all, the economic backdrop remains relatively favorable, and a good bull case for stocks can be made. As a result of the year-end tax cut, corporate earnings appear to have had an outstanding first quarter, projected to show average year-over-year gains in the neighborhood of 17 percent. That, in turn, has reduced the projected average Price-Earnings Ratio to around 16 times; not cheap, but a reasonable level. Merger and acquisition activity is also relatively strong and monetary policy is still generally accommodative on a global basis. Finally, while Interest rates are moving up both domestically and abroad, they are still very low by any historical measure.
There is also a bear case for stocks, and risks of trade wars and tariffs are near the top. Trade wars make it harder to predict the trajectory of corporate earnings growth going forward. Stock markets, whose returns are derived from investors’ confidence in future corporate earnings, do not like uncertainty. There are additional risks to the market. The Fed has raised interest rates four times since 2015, and it would appear several more interest rate increases are on the horizon, perhaps as many as three more this year. Given a low unemployment rate, strong corporate earnings and a weak dollar, we could also experience more inflation, which could lead to even more Fed interest rate hikes, larger Federal deficits and a reduction in merger and acquisition activity.
Going forward, we are left with a market Albert Einstein might say has clutter and discord. Nonetheless, every calendar year, with just a few exceptions like 2017, the stock market has an annual drawdown (drop from its peak value to its low-point) averaging 14 percent. Every five years or so, the drawdown is as much as 20 or 30 percent. Thus, stock markets this year are merely back to doing what they have done in almost all years – fluctuate. As we suggested in our January newsletter, we believe 2018 will be a year with several peaks and valleys, although our expectation at that time was that the market would end the year higher, perhaps with low to mid-single digit returns. We will stay with that prediction, as we believe that the unique entrepreneurial spirit embedded in our economy will continue to work its wonders. While we may grumble about the government and see endless ways things could be better, gains over time will surely continue, although rarely in a smooth and uninterrupted manner.
(c) 2018, Argent Capital Management
Argent Capital Management, LLC is required by law to disclose all pertinent information on the firm’s operation in our Summary Disclosure Statement. Past performance is no guarantee of future results and is listed gross of fees as of March 31, 2108. Copies of all pertinent disclosure statements including performance are available upon request or available at www.argentcapital.com