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The Brave Report: Market Commentary for March 2018

For pdf version of this report click here: The Brave Report-March 2018

Who is really steering the ship? We often hear from great leaders that the key to their success is surrounding themselves with great people. However, the other important factor is actually listening to the great people they surround themselves with. Distancing themselves from people they disagree with or that are providing feedback most often leads to negative results.  Regardless of your opinion of President Trump, over the past month, it seems he has been distancing himself from many of his closest advisors. No president, or other leader for that matter, can be an expert on everything and in order to succeed must rely on the expertise of others to fill in the gaps. I get the feeling that this isn’t happening.

Throughout this bull run, we have been on, political and policy uncertainty has been the biggest headwind. My worry is that eventually the uncertainty will become too much and investors will be forced to just wait on the sidelines until the uncertainty dissipates.  I do not think we are there yet but at some point, I fear we hit an inflection point.

Market Overview

It looks like volatility is here to stay.  While we didn’t see the same level of swings we saw last month, we have definitely seen investors searching for market direction.  Over the past month, the NASDAQ was again the winner, climbing just under 1%.  The S&P500 and Dow Industrials finished the last month to the downside, losing around 0.5% and 2% respectively. This performance did not happen in a straight line as we saw a number of multi-day swings throughout the month and are currently seeing the market sell off a bit since peaking on March 12th.

On the fixed income side, we saw things stabilize a bit. After finally breaking thru the 2.9% level last month, the yield on the 10-year spent the month trading between 2.8 and 2.9%, only briefly jumping above 2.9% following the fed rate rise. It has since settled back into the 2.80s.  We did continue to see the yield curve flatten with shorter-term rates rising more quickly than their long-dated counterparts. The comments from the fed dampened some of the inflationary fears that were present last month.

Fed Meeting: As was almost universally expected, the Fed decided to raise the fed funds rate by a quarter of a percent at their meeting this week.  The actual rate increase is not what most investors were worried about. The projection of future rate hikes and the debut of the new Fed chair, Jerome Powell, were what most people were most unsure about and interested in. In terms of their projections for future rate hikes this year, they maintained the previous projection of 3 rate hikes. However, the vote results showed that they were one vote away from projecting 4 hikes.  My expectation is that we do end up seeing 4 rate hikes but by maintaining the previous projection they give themselves more optionality moving forward. Their goal is not to surprise people and this projection makes it clear that 4 hikes are not out of the question.

The other dynamic of this Fed meeting was it was the first announcement and press conference for Jerome Powell.  Most investors have been very interested in judging his hawkishness and also how he answers reporter’s questions. While he is viewed as pretty moderate, he is seen as more hawkish than the outgoing chair, Janet Yellen.  I was interested in seeing if he attempted to maintain status quo or if he tried to put his own stamp on the Fed.  Based on his initial press conference it seems that he is not trying to make any major changes to the current path.

I think this first press conference should put most investors at ease in terms of the direction Powell may push the Fed. I also think he succeeded in not surprising investors. The only comment that seems to have spooked investors had nothing to do with the job of the Fed. He showed concern over the economic impact of a potential trade war. While this is out of his scope as Fed Chair, this helped add to the major uncertainty in the markets right now. His demeanor is also much more direct and concise than we saw from Janet Yellen and I think it will take a few meetings for the public to get used to this, but I prefer it.

Trade War: The biggest economic uncertainty that has moved to the forefront is a potential trade war looming on the horizon.  A few weeks ago Trump outlined a plan to institute tariffs on aluminum and steel especially singling out China. While the final tariffs didn’t have the bite originally proposed it is feared that this is just the start of a more protectionist trade policy that could eventually lead to a trade war. As I write this, Trump is set to deliver a new set of tariffs on China to punish them for intellectual property theft.  While this new round of tariffs are just proposals, that doesn’t remove the potential for retaliation from other trade partners.  The actual economic impact of what has been proposed so far would be very minimal.  However, it sets the stage for a much more painful trade war that could have lasting impacts on the global economy.

These new tariffs have been widely criticized by both sides of the aisle and seemed to be the disagreement that led Trump’s chief economic advisor, Steve Cohen, to resign.  Cohen was seen by most as the “smart” one in the room when it came to shaping the economy within the administration. It is feared that he will continue to surround himself with more “yes” men which is not typically a good way to achieve the best outcome.

I tend to wonder if much of this tariff talk is simply a negotiating tactic.  By talking tough initially it allows the President to settle back on to something more moderate while still accomplishing his initial goal of more favorable trade relationships.  The problem is that easily could escalate as other trade partners push back or retaliate.  Over the next few weeks, we will get a better picture of what the final tariffs will be but it will be important to watch this closely.

Strategy Commentary

I am still maintaining my equity exposure but am much more cautious than I was a month ago. The new uncertainties around a potential trade war, especially with China, could potentially mute some of the expected growth that the recent tax cuts may add to our economy.  We have yet to see any of this spill over to actual company performance and we are a long way from a trade war materializing to something that impacts our longer-term growth forecasts. For now, the impact is just speculation.

Domestically I am maintaining my overweights to technology, financials and materials. Materials have continued to be an underperformer and I expect to rotate away from the sector in coming days. Financials should continue to get a boost from rising rates but there is a risk of the yield curve inverting at some point which could put some negative pressure on the sector. Tech has gotten hit pretty hard in the past few weeks but I am still optimistic about the growth potential in the sector. I expect this to be a short-term correction in the space.

I reduced some of my emerging markets exposure in the past month as the possibility of a trade war seems more likely.  Chinese stocks could see a bit of a correction as the situation sorts itself out. I still like emerging markets over the medium and long term but just think there is some additional uncertainty in the short term to warrant some reduced exposure.

I still have a negative outlook on the fixed income space. While rates have stabilized a bit since last month I believe they are just taking a pause before they move a bit higher.  I have increased my cash allocation as a replacement.