I was reading Byron Wien’s September 2019 market commentary and I thought I’d share a few takeaways. But before I do, I’d like to suggest signing up for Byron’s monthly commentary. I read several market commentary newsletters each month, but I find Byron’s is the easiest to read because his writing style is very conversational and the content is straightforward. I’ve never met Byron or had any interaction with him, so I don’t want anyone to think I’m promoting him for personal gain. I just want to let people know about his work because even though he hasn’t come out and said it, I think he’ll be retiring in the next few years won’t be writing his newsletter anymore. His likely replacement, Joe Zidle, writes a monthly commentary, but it’s not as macro-focused as Byron’s.
The sooner China and the U.S. arrange a mutually beneficial trade agreement the better off the world financial markets will be.
Second to the U.S., China is the world’s largest economy. For decades China has been the world’s product manufacturing hub. They are able to manufacture products quickly and affordably. They have also managed to keep their currency (the renminbi) weak relative to other developed/developing nations. As a result, China is a net-exporter, which means they sell more of their manufactured goods than they do purchasing goods from other countries. One negative result of this is that it can (and has) created a trade imbalance with certain countries which, over time, can be damaging.
As a country, China is evolving and no longer wants to be viewed as producer of products, but instead as a product-innovator. President Xi Jinping has a 100-year plan for the country which includes infrastructure projects (rail, airports, roads), investing in technology (artificial intelligence), and uniting the eastern part of the world with the One Belt-One Road project. As Byron points out in his newsletter, because of China’s long-term view it is possible they are willing to endure the negative effects of a prolonged trade war with the U.S. because they may just see it as a small blip in their long-term plan.
Objectively speaking, a better trade agreement between the U.S. and China is necessary and I don’t have the expertise to determine what is the most effective and fair way to create that. What I do know is that the financial markets seem to think that tariffs are not the answer given that this is one area causing major unrest for investors at the moment.
The U.S. economy will be a key election issue in 2020
The U.S. economy has been in bull market for over a decade. I think the financial meltdown in 2008 scared a lot of individuals and companies to show a bit more prudence in how they invest and/or save money. While the gains in the S&P and the Dow have been spectacular, that doesn’t mean there hasn’t been volatility. In the 2018, there were over 20 1.0% swings in the market; it is unclear how 2019 will end up. There are many reasons for this but in short Byron’s suggests the main drivers are the ongoing trade war with China, monetary policy uncertainty, and political unrest. To a certain extent, I don’t disagree with this assessment.
Despite what is in the headlines, the ingredients for what makes a recession haven’t fully come to the fore. Unemployment is below 4%. Inflation has remained relatively tame and the borrowing costs for U.S. businesses are at record lows. The most recent concern was when the yield curve inverted which historically has signaled a recession is imminent. GDP has remained relatively stable around 2% even with the small decline in recent months, and the U.S. savings rate has steadily increased since 2008. It’s great that people are saving more, although there are some studies that suggest that if people save too much and spend less, it could hurt the economy during a recession.
For the 2020 election the economy will be a major factor in how people vote (it usually always is). I just hope that despite who the president is we can find a political and economic balance that is beneficial to the U.S. and the world.
Monetary policy – what else can the Fed do?
When the Federal Reserve recently attempted to raise interest rates it was based on the premise that the economy was improving and it was time to return to a state of normalcy. When rates are low the demand for and access to capital for consumers and businesses rises. More people buy homes or refinance debt and more businesses invest in capital projects. When this happens it is great for the economy – more spending; more hiring. However, as a result of more spending businesses steadily raise their prices which can lead to inflation (too much money chasing too few products). Naturally when this happens the Fed takes corrective action to keep this under control. But with interest rates already at record sustained lows, what measures can the Fed take to boost the economy if there is a recession in the next 18 months? In some countries around the world including Germany, Japan, Denmark, and Switzerland they have negative interest rates, which is where banks charge those who save money and pay those who borrow. I don’t think the U.S. economy is in such a condition to where negative interest rates are necessary or likely. In light of that that, Jerome Powell (Current Federal Reserve Chair) still has a lot of difficult decisions to make over the next several quarters. He’s facing political pressure from the White House and economic pressure from the business community who would like some degree of predictability so they can make better long-term business decisions.
These are interesting times, to say the least. I am cautiously optimistic that if there is a recession in the next 18 months it will (hopefully) not be as bad as the last one. But, maybe that’s what people said the last time around. Who knows.
If you have any thoughts about this post or on the economy in general I would love to exchange notes.
Cheers – KM.