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Comforting Lies vs. Unpleasant Truths

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“Comforting Lies vs. Unpleasant Truths” was the title of a recent JPMorgan presentation about the fixed income markets. Although headlines and tweets may provide comforting confirmation of pre-existing beliefs, discovering the unpleasant truths requires more work. The comforting lies discussed below may have an outsize influence on near-term sentiment, but unpleasant truths are more likely to prevail over the long term.

Economic considerations are the motivation for protectionist policy initiatives: Commentators focus on the economic implications of President Donald Trump’s trade threats, but political dimensions may drive White House trade initiatives. Trump’s voter base largely consists of people who are anti-trade and believe that globalization was the primary cause of manufacturing job losses. The frustration of voters “left behind” by technology and globalization was an important factor in Trump’s election, and mobilizing those voters is important to Trump in the months leading up to midterm elections.

Although the political dimension of Trump’s trade policies is easy to understand, there may be flaws in his thinking about the economic dimensions of protectionism. Trump’s myopic focus on the trade deficit as a measure of economic success ignores some unpleasant realities.  The lowest the trade deficit has been since 2000 was at the peak of the global financial crisis, so reducing the trade deficit isn’t necessarily a guarantee of economic success.

Trade tensions with China are mounting, contributing to rising market volatility as investors fear the outbreak of a trade war. The back and forth between the U.S. and China resembles the “Festivus” episode of the television show Seinfeld, in which each side “airs its grievances.” There are legitimate grievances with China regarding intellectual property and market access, however trade hawks such as Peter Navarro offer simplistic solutions without addressing the potential cost of a trade war for U.S. investors and consumers. Retaliation from China and other trade partners could harm many of the people that Trump is hoping to help. American farmers export a lot of soybeans to China, GM sells more cars in China than in the U.S., and China is the leading export market for Boeing.

In reality, however, Trump’s tweets are often an opening “bid” in negotiation, and he frequently softens his more extreme policy demands during the course of the negotiation. In thinking about today’s trade tensions, I’m reminded of Sen. George Aiken’s suggestion to President Lyndon Johnson during the Vietnam War, “declare the United States the winner and begin de-escalation.” The confrontation between the U.S. and its trading partners, particularly China, may ultimately to lead to negotiated compromises on a range of trade, tariff, access and intellectual property issues. Trump will then declare victory and move on to another topic.

Market timing is a winning strategy:  The resumption of market volatility is a wake-up call for investors who took last year’s relative calm for granted. Rapid swings in the market bring out the worst in investor behavior and provide heightened visibility to commentators who claim to be able to time the market. Despite the understandable urge to employ an all-or-nothing approach to being invested in equities, “time in the market” has been a far more effective strategy than trying to time the market. Market timing, however tempting, doesn’t work.

Considerable evidence supports the conclusion that market timing is a recipe for failure.  Morningstar has an annual study that shows the impact over a 20-year period of missing the 10 best days in the market. The results tell a consistent story. For the 20-year period through the end of 2016, missing the 10 best days in the market reduced annualized returns from 7.7% per year to 4% per year. Annualized returns would improve for investors able to avoid the 10 worst days in the market. Unfortunately, the best and worst days in the market are often clustered together, as was the case in early February.

Although a few investors have experienced temporary success and fame from calling a major turn in the market, it is nearly impossible to find investors with a track record of repeated success in calling major market moves. In many cases, high-profile success is followed by failure.  John Paulson, Bill Ackman, Edward Lampert and Meredith Whitney are among those who have experienced adversity in trying to find success in their “second act” after reputation-making investment successes.

Sage advice from Cliff Asness, co-founder of AQR Capital Management, resonates with me: If you’re going to commit the sin of market timing, “sin a little.”  Incremental moves may satisfy the urge to market-time and avoid the potential portfolio damage of all-or-nothing approaches.

Technology stocks are heading for a repeat of the dot-com meltdown of 2000: Technology stocks have lost some luster, with some high-profile stocks suffering significant reversals. Facebook is dealing with the fallout from the Cambridge Analytica scandal. Uber and Tesla are facing scrutiny over fatalities resulting from crashes of vehicles using autonomous driving capabilities, creating uncertainty about how quickly self-driving cars will become part of the mainstream. Google and social media companies may have to pay additional taxes on European revenue, if proposed digital taxes are enacted by the European Union. In a development worthy of the “upside down” of the Netflix series “Stranger Things,” Amazon CEO Jeff Bezos has replaced “Little Rocket Man” Kim Jong Un as Trump’s public enemy No. 1.

Many of today’s top-performing technology companies are “platform” companies in which companies plug into the platform to add incremental value or gain access to a network of customers. Companies such as Google, Apple, Microsoft and Facebook have far more sustainable business models than many of the darlings of the dot-com era. Although some technology companies have what appear to be excessively high valuations, many leading technology companies are valued at less lofty prices relative to their earnings and cash flow growth. Although there are understandable fears that a technology stock downturn will lead to a market meltdown, the differences between today and 1999 make it unlikely that the recent technology boom will end in a meltdown.

Intuitive answers are convenient, but often provide an erroneous investment path. The unpleasant (or sometimes pleasant) truths require more work but provide a more durable approach to investing. Technology stocks may not be this year’s winners, but comparisons to the mania of 1999 are probably off-target. Trump’s rhetoric on trade may prove to be scarier than his eventual actions. Beware the false prophets who claim to be able to sell equities before a bear market, then reinvest in equities in time to capture the next bull market. In the long run, there is no replacement for thorough analysis, healthy skepticism and a cool head when markets are turbulent.

Daniel S. Kern is chief investment officer of TFC Financial Management, an independent, fee-only financial advisory firm based in Boston.

Prior to joining TFC, Daniel was president and CIO of Advisor Partners. Previously, Daniel was managing director and portfolio manager for Charles Schwab Investment Management, managing asset allocation funds and serving as CFO of the Laudus Funds.

Daniel is a graduate of Brandeis University and earned his MBA in Finance from the University of California, Berkeley. He is a CFA Charterholder and a former president of the CFA Society of San Francisco. He also sits on the Board of Trustees for the Green Century Funds.


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