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Domestic equity and bond markets provided another positive month for July. International and emerging equity markets did not fare so well, and were down -1.27% and -1.22% respectively. While these returns are relatively normal monthly results, they belied what was to come as we entered August.
Recall that during July, the general data trends of weakening manufacturing growth world-wide continued. The trends of a strong U.S. consumer, housing market, and job market continued in contrast to the manufacturing side of the economy. Also weakening were measures of inflation domestically and internationally. Geopolitical headlines continued in Europe, Hong Kong, Japan, South Korea, Argentina, the U.S., and China. President Trump had expressed more frequently and openly his belief that the U.S. Federal Reserve should lower interest rates as the Fed approached its July 31 Federal Open Market Committee meeting. For its part, the Fed chose to focus on the slower than desired rate of inflation in the U.S., and began to signal that it just might lower rates roughly seven months after its last rate increase in December of 2018. Financial markets were in agreement, and the Fed delivered a 0.25% decrease to the Fed Funds rate. This was the first Fed Funds rate cut since October of 2007.
While financial markets liked the rate cut, they did not like Chairman Powell's characterization of the cut and declined on the news. Citing low inflation, and softer growth, the Chairman described the move as a "midcycle adjustment" or "insurance cut". In past rate cycles, the Fed would sometimes pause its path of increases and follow with a rate cut or two until the economy regained its momentum. The expansion would continue a while longer until a true recession required sustained rate cuts. These comments specifically spoke to those expecting multiple rate cuts now. Not likely, according to the Chairman.
The next day after the Fed meeting was August 1st. With July in the books, and the Fed meeting out of the way, markets looked forward to reading the data and continuing to adjust expectations for additional Fed easing. However, an unexpected piece of news surprised everyone. President Trump announced that he would implement a 10% tariff on the remaining $300 billion of Chinese goods not already subject to tariffs. Markets were under the impression that trade talks had been progressing, and escalation was not immediately in the cards. The response was negative, with the stocks of retail companies selling off particularly hard as the additional tariffs would mostly impact consumer electronics, apparel, and footwear.
China's response to these tariffs requires a bit of background on a complicated subject... currency markets. To most investors, currency markets are an esoteric subject, even though currency markets are large and very important to the global financial system. Currencies are impacted by inflation, economic growth, trade, interest rates, political instability, etc. If Country A places a 10% tariff on Country B's exports, Country B could respond by weakening its currency by 10% and offset the impact of Country A's tariffs. However, this would be a dramatic, and potentially destabilizing decision.
China has long been accused of purposefully devaluing its currency in an attempt to make its exports cheaper around the world and draw in manufacturing from other countries. As its manufacturing base grew, its Yuan became even stronger as other countries needed to buy Yuan to buy Chinese exports. But there are some nuances to understand here. China's Yuan, or Renminbi, was strong because China's economy was growing fast for an extended period of time, and the global economy was growing fast enough to buy its products. The Yuan should have appreciated faster than it did, but the Peoples' Bank of China (PBOC) would sell Yuan in the global currency market to keep the value from rising as much as market forces said it should.
Post the Great Recession, this has changed. There are several reasons. It isn't as cheap to manufacture in China as it once was. Chinese wages grew. Transportation costs rose. But most importantly, there was a recession everywhere, and China's now large manufacturing base could no longer sell as much stuff to its customer countries. Rather than the PBOC selling Yuan to keep the value artificially low, the PBOC has been buying Yuan to support the value. In response to new tariffs, the PBOC didn't provide as much support to the Yuan and it fell below the 7 Yuan per US Dollar mark. That 7 Yuan mark is viewed by the market as an important reference for stability. Global financial markets were not happy, and sold off again. President Trump responded by officially labeling China a currency manipulator, which triggered some inquiries by U.S. and global institutions that monitor currency and trade. The trade war now has the potential to escalate into a currency war.
Sometime during the first ten days or so of each month, our Asset Allocation Council convenes to evaluate how we invest in stocks or bonds, domestic or international markets, investment grade or high yield bonds, cash, alternatives, etc. The Asset Allocation Council already had its concerns about global growth from a slow-down in manufacturing, the tariffs, and geopolitical instability. The escalating trade and potential currency war tipped the scales of risk for the Council and changes to our stock, bond, and alternative asset class weightings were made. Our investment targets were already "neutral" meaning we were not leaning towards either stock, bonds, or alternatives for our investors. Everyone has a long-term investment policy that corresponds to their risk tolerance and return needs. Neutral simply means that an investor with a long term target of 50% stocks and 50% bonds would be at those weights rather than favoring one side or the other. These recent changes made our investment targets more defensive to address what we evaluated as a higher risk environment for investors. Now we are tilted away from riskier (stocks) assets. Below are the before and after weights for our Balanced Asset Allocation targets for investors utilizing alternatives assets. Similar changes were made to the allocation targets for our most conservative to our most aggressive investors.
We lowered our equity (stock) weighting by reducing our allocation to U.S. large cap stocks. We had already cut our weighting to international and emerging stock markets months ago. Our increase to bonds was achieved by adding to U.S. investment grade bonds. We added to cash. Our overall alternatives weight remained the same, but we changed the character of that weight. We reduced our exposure to commodities and increased exposure to real estate and long-short strategies. It is important to stress that these weighting changes are a result of what we judge as a heightened risk environment. These changes may prove profitable or not, but we feel more comfortable having our investors positioned this way at this time.
Just a few short days after our asset allocation changes, President Trump announced yet another change to his tariff policy. In response to feedback from the business community, some tariffs on consumer goods will be delayed until December 15th so as not to interfere with the Christmas inventory stocking season and the prices retailers and shoppers might pay. Stock markets went up on that news, but were down again the next day. At some point, uncertainty creates its own risk.
We will continue closely monitoring financial conditions, economic data, and markets for signs of additional stress. Our analysis is data driven, and not a reaction to recent volatility in the equity markets. Please contact your local Iberia Wealth Advisors team with questions.
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Executive Vice President, Director of Equity Strategies
Tracy joined the IBERIA Wealth Advisors team in September 2010 and has over 20 years of investment management experience. She has a broad background in fiduciary asset management which includes portfolio management for high net worth individuals and institutions, asset allocation policy making, investment management consulting, equity research, and equity and fixed income trading. Tracy manages client accounts across the IBERIA Wealth Advisors footprint and oversees the construction and management of IWA's three proprietary equity strategies, Dividend Focus, Growth Focus, and Total Return. She serves as a member of the IWA Asset Allocation and chairs the IWA Investment Policy Committees. Tracy is a frequent speaker on economic and investment topics within the community and authors many of IWA's investment publications. She has been included twice in the Birmingham Business Journal's Table of Experts Series. Tracy graduated from the University of Alabama with a Bachelor of Science degree in finance and is a CFA Charterholder. She is a member of the CFA Institute of Alabama and has a Series 65 license. She has served as an industry mentor for the CFA Student Research Teams from both The University of Alabama and Samford University. Tracy is a past member of the Episcopal Dioceses of Alabama Finance Department and the University of Alabama at Birmingham (UAB) Finance Department Advisory Board.
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Disclosures
Views are as of the date above and are subject to change based on market conditions and other factors. The views expressed are those of the author(s) and are subject to change at any time. These views are for informational purposes only and should not be relied upon as a recommendation to purchase any security or as a solicitation or investment advice from the Advisor.
The information contained in this presentation has been compiled from third party sources and is believed to be reliable, but its accuracy is not guaranteed and should not be relied upon in any way, whatsoever. This information does not constitute, and should not be construed as, investment advice or recommendations with respect to the securities or sectors listed. Diversification and asset allocation do not assure a profit nor protect against loss.
The actual return and value of an account fluctuate and, at any time, the account may be worth more or less than the amount invested. Past performance results are not indicative of future results.
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Presentation is prepared by: IBERIA Wealth Advisors
Copyright © 2019, by IBERIA Wealth Advisors; All rights reserved.
Investment Products: * Not FDIC Insured * Not a Bank Deposit
* Not Insured By Any Federal Government Agency * No Bank Guarantee * May Lose Value
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