Comforting Lies vs. Unpleasant Truths

“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.