The financial press has been consumed recently with speculation about the outcomes of both the Fed’s latest meeting and President Trump’s ongoing trade negotiations with the Chinese. As we warned in our last letter, there appears to be a stalemate in the trade negotiations, and it now appears that the Chinese may have decided to wait until after next year’s presidential elections in hopes that they will get a better deal should a Democrat win the White House.
President Trump didn’t like the outcome of his negotiating team’s last visit to Bejing and he immediately announced a 10% tariff on $300 billion of additional imports from China, sending the stock and bond markets reeling.
BUT ARE TARIFFS AS BAD AS WE FEARED?
However, the silver lining in the trade storm clouds is that U.S. companies are rapidly adapting to the tariffs and moving their purchases to manufacturers from other countries. As Tom Taylor, the CEO of Floor & Décor Holdings, commented on August 1 in his quarterly conference call:
We have a flexible global supply chain and an experienced merchandise organization, which has allowed us to accelerate plans that we began in 2018 to diversify our countries of origin to reduce our sourcing risk. As a result, there will be a meaningful shift in our countries of origin in 2019 and beyond. Specifically, by the end of 2019, we expect the percentage of our merchandise sourced from China to decline to the mid-30% range from 50% in 2018. We believe it will continue to decline in 2020 and beyond.
In other words, regardless of the outcome of the trade negotiations, Chinese imports will become progressively less important to the U.S. economy (and the stock market).
In addition, Floor & Décor executives project that tariffs will only add about 2 - 2 ½% to the retail price of their products. Based on materials representing less than half of the cost of a flooring installation, the total cost increase to consumers for a new floor will be minimal, causing little or no disruption to their business.
WHAT ABOUT THE FED?
Although last week’s .25% rate cut was welcomed, Powell’s comments in his news conference that followed confused the markets and practically neutralized any benefit we saw from the rate cut. But overall, the Fed appears to have changed the direction of their policy. In recent months they appear to be much more accommodative, reversing the relentless rate increases that we had seen prior to December 31.
Now we believe that the Fed will probably just lay low (as they usually do during years prior to Presidential elections) and avoid policy moves that would appear to be affecting the outcome of the Presidential election. The markets will welcome the absence of any interference.
As we stated in our last letter, an occasional storm should not disrupt a good investment plan. An investor should expect an occasional storm in the financial markets, and a good investment portfolio should be designed to withstand the occasional volatility the storms create. We attempt to play offense or defense, depending on the “weather reports” we read, but we try to be sure your portfolios are strong enough to withstand any surprises we may experience.
AVOID THE “POPULAR” STOCKS
For some time, we have felt that the biggest risks to an investment portfolio would come from a concentration in the more “popular” stocks of the day. Index funds and many mutual funds are loaded with many of the same stocks. The popularity of the stocks called the “FANGS” (Facebook, Amazon, Netflix and Google) has been a popular topic on investment websites. There are several other “cult stocks”, but the valuations of stocks that are driven by popularity often get out of proportion to rational value.
What we have seen many times over the years is that when a geopolitical event or financial disruption occurs, individual investors panic and sell their funds and stocks, particularly the most popular names. The hedge funds, knowing how this occurs, attempt to beat the small investors to the punch and program their computers to quickly dump the most popular stocks and index funds, in the process severely driving down the prices of these stocks. This has long been a concern and we have attempted to avoid owning too many of the “popular” stocks.
We were particularly intrigued when our consultant from Blackrock, one of the largest fund managers in the country, recently suggested that we look at a fund designed to minimize volatility. Of course, when someone recommends any new investment to us, the first thing we look at is the historical performance of the product. If the performance of the product is attractive, we then examine the methods being used to obtain those results, to decide whether we believe the methods that are being used will sustain those results in the markets we expect to encounter. Most of the time we find a “fatal flaw” that causes us to pass.
But in the case of “low volatility” or “minimum volatility” funds, we liked what we found, both in the results and in the methods that had been used to produce those results. The most promising aspect of these funds is that by avoiding the most volatile stocks in the market, they systematically invest in higher quality but lower profile stocks. The result is that they have achieved market-like results with much less volatility than the typical mutual fund.
With fundamental analysis becoming less and less reliable in selecting individual stocks, we believe we need to use more and more mutual funds to reduce the risk that an individual stock will cause undue harm to our portfolios. We believe the “low-vol” funds are a promising addition to our portfolios. You will see these funds used more and more as we transition to what we believe will be portfolios with less volatility while still providing good investment returns.
“A correction or crash is not a bad thing for long-term investors.
Of course, nobody enjoys watching the value of their brokerage account go down. I still look back on 2008 as a particularly traumatic period, and in full honesty, there were times when I considered throwing in the towel when it came to the stock market. Thankfully, I didn't. I understood one important concept that all long-term investors should know: that corrections and panics are the best opportunities.”
As we always say, please give us a call if you need a clearer explanation of our thinking. We always enjoy hearing from our clients and will do our best to help you understand everything we do.
Dave Crouch Kim Blackburn Kay O’Connell
Registered Principal Branch Operations Manager Financial Advisor
Any opinions are those of Will Rogers and not necessarily those of RJFS or Raymond James. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. There is no assurance any of the trends mentioned will continue or forecasts will occur. The information has been obtained from sources considered to be reliable, but Raymond James does not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. Investing involves risk and you may incur a profit or loss regardless of strategy selected. Raymond James is not affiliated with Blackrock.
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