The U.S. market continued up in July and is back to record levels, erasing the losses of late 2018. With rising trade tensions as the catalyst and a backdrop of suspiciously low interest rates, August is looking to wipe out much of the recent gains with a roughly 800-point one-day drop in the Dow and interest rates plunging to levels last seen right before the last presidential election. We'll come back to the 800-point gorilla in the room after a review of last month.
In July, U.S. stocks did fine, while foreign stocks slipped. This, plus low positive returns in bonds, led to only slight gains in our more bond-heavy Conservative portfolio and slight losses in our more stock-heavy portfolio dragged down by foreign funds, more or less in line with the Vanguard STAR Fund, a global balanced portfolio, that we watch.
Foreign markets are having a pretty good year but are lagging U.S. markets and were down in July. Healthcare was the main weak area in the United States, as constant talk of sticking it to the healthcare industry by both parties may be weighing on this industry, which has had years of above-market growth from increased subsidized health insurance and fast-rising prices for drugs and services. Our strongest areas in stocks last month were in value and telecom holdings, the latter boosted by new higher-technology stakes (which we are concerned about going forward from these levels).
Which brings us to the August situation. On the surface, this mini-slide started when the president re-upped his trade war tariff threats. Investors have seen many ups and downs in this often Twitter-based trade war with China, and frankly, the actual economic impact broadly speaking has been minimal. But then, the economy was strong and could shrug off minor issues. Now, with the bond market saying (through low long-term rates that are even lower than low short-term rates) that a global recession is coming soon, investors are getting nervous. We don't need a trade war with the number two economy in the world right now.
Adding relatively low tariffs to trade with one country was never really much of an economic drag for us. While there were certainly disruptions in specific industries, mostly commodities and agriculture, the consumer and most companies haven't felt much of a pinch.
This is partially explained by the fact that U.S. corporations are enjoying a major tax cut that exceeds by a wide margin the cost of tariffs they have to pay. Granted, some of the companies enjoying the most in tax breaks are not the ones paying the most in tariffs, but as a whole stock market, the tax cuts exceed the drag on earnings from tariffs. This doesn't mean that a trade war, if it doesn't achieve much, is a good idea, just that it shouldn't have to cause a recession.
But if you look at the history of sizable stock market slides, rarely was the trigger such a momentous economic event to warrant trillions in market value damage. In the last couple of decades, we had a crash from the Thai currency collapsing and from a default on old Soviet debt. Greece debt issues, which haven't even really gone away, once caused a major stir.
When you have jittery investors who have just seen fast gains over the previous years, you have an environment for a slide. Plus, we don't know what one relatively minor event leads to, because as Warren Buffett said, you don't know who is swimming naked until the tide goes out. For the record, Warren Buffett is sitting on a record amount of cash, probably waiting for the tide to go out so he can get some bargains.
Therefore, the real danger of a trade war with China is if we win, so to say. Most of the stuff coming in from China is really our brands anyway—we've basically set up factories or otherwise outsourced manufacturing to an efficient, low-cost, and low-regulation factory town. When was the last time you purchased an actual Chinese brand as opposed to just something made in China?
When we have a trade gap with China, it is because Apple makes phones in China and ships them here for sale. If the factory was in Texas (not going to happen, Apple just moved their last computer production from the United States to China), there would be a much smaller trade gap with China and a much higher price for phones and computers.
Through this lens, clearly we are paying the tariff. If the tariff threat ever does go up to include iPhones, either Apple is going to pay and eat the cost to keep the consumer price where it is or it is going to pass the cost on to the consumer. It could actually benefit Apple, because their leading competitor in higher-end phones, Samsung, makes their top-of-the-line phone in China. Apple has more money to subsidize tariffs. Maybe they'll have to pause their stock buyback program for a while.
How China pays is where the real economic trouble could happen. U.S. companies may cut down on demand from China. Walmart or, increasingly, Amazon may need less made-in-China items. If Apple doesn't eat the tariff and the price goes up, consumers may wait to buy a phone. All of this means that the suppliers in China temporarily lay off workers and stop buying from other suppliers. It could cause a recession—in China. Since China is a very leveraged high-growth country, this could cause unforeseen problems. Tesla is building a $2 billion factory near Shanghai. Without demand by the Chinese for these pricy cars, Tesla could default on debt.
It is worth noting that the manufacturing cost of most finished goods is a very small part of the retail price, so a 10% or even 25% increase in costs means a $100 sneaker may cost $1 more to manufacture. This isn't going to lead to much disruption to our consumers or our companies.
The latest shock to the market was when the Chinese currency declined in value, which we claim is currency manipulation, though it is exactly what you would expect if we bought less stuff in China and converted fewer dollars to Chinese currency.
On the plus side, interest rates are going so low so fast as to cause some sort of boost to an already pretty strong economy. This could all go away almost as fast as it has appeared. It really depends if people and companies go out and borrow more. Which will return us to the high-asset-price leveraged country that somehow can't handle even 2.5% short-term rates and not much higher long-term rates—which is what caused the short bear market last year in the first place.
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The U.S. market continued up in July and is back to record levels, erasing the losses of late 2018. With rising trade tensions as the catalyst and a backdrop of suspiciously low interest rates, August is looking to wipe out much of the recent gains with a roughly 800-point one-day drop in the Dow and interest rates plunging to levels last seen right before the last presidential election. We'll come back to the 800-point gorilla in the room after a review of last month.
In July, U.S. stocks did fine, while foreign stocks slipped. This, plus low positive returns in bonds, led to only slight gains in our more bond-heavy Conservative portfolio and slight losses in our more stock-heavy portfolio dragged down by foreign funds, more or less in line with the Vanguard STAR Fund, a global balanced portfolio, that we watch.
Our Conservative portfolio gained 0.63%. Our Aggressive portfolio declined 0.20%. Benchmark Vanguard funds for July 2019 were as follows: Vanguard 500 Index Fund (VFINX), up 1.43%; Vanguard Total Bond Market Index Fund (VBMFX), up 0.23%; Vanguard Developed Markets Index Fund (VTMGX), down 2.09%; Vanguard Emerging Markets Stock Index (VEIEX), down 1.19%; Vanguard Star Fund (VGSTX), a total global balanced portfolio, up 0.52%.
Foreign markets are having a pretty good year but are lagging U.S. markets and were down in July. Healthcare was the main weak area in the United States, as constant talk of sticking it to the healthcare industry by both parties may be weighing on this industry, which has had years of above-market growth from increased subsidized health insurance and fast-rising prices for drugs and services. Our strongest areas in stocks last month were in value and telecom holdings, the latter boosted by new higher-technology stakes (which we are concerned about going forward from these levels).
Which brings us to the August situation. On the surface, this mini-slide started when the president re-upped his trade war tariff threats. Investors have seen many ups and downs in this often Twitter-based trade war with China, and frankly, the actual economic impact broadly speaking has been minimal. But then, the economy was strong and could shrug off minor issues. Now, with the bond market saying (through low long-term rates that are even lower than low short-term rates) that a global recession is coming soon, investors are getting nervous. We don't need a trade war with the number two economy in the world right now.
Adding relatively low tariffs to trade with one country was never really much of an economic drag for us. While there were certainly disruptions in specific industries, mostly commodities and agriculture, the consumer and most companies haven't felt much of a pinch.
This is partially explained by the fact that U.S. corporations are enjoying a major tax cut that exceeds by a wide margin the cost of tariffs they have to pay. Granted, some of the companies enjoying the most in tax breaks are not the ones paying the most in tariffs, but as a whole stock market, the tax cuts exceed the drag on earnings from tariffs. This doesn't mean that a trade war, if it doesn't achieve much, is a good idea, just that it shouldn't have to cause a recession.
But if you look at the history of sizable stock market slides, rarely was the trigger such a momentous economic event to warrant trillions in market value damage. In the last couple of decades, we had a crash from the Thai currency collapsing and from a default on old Soviet debt. Greece debt issues, which haven't even really gone away, once caused a major stir.
When you have jittery investors who have just seen fast gains over the previous years, you have an environment for a slide. Plus, we don't know what one relatively minor event leads to, because as Warren Buffett said, you don't know who is swimming naked until the tide goes out. For the record, Warren Buffett is sitting on a record amount of cash, probably waiting for the tide to go out so he can get some bargains.
Therefore, the real danger of a trade war with China is if we win, so to say. Most of the stuff coming in from China is really our brands anyway—we've basically set up factories or otherwise outsourced manufacturing to an efficient, low-cost, and low-regulation factory town. When was the last time you purchased an actual Chinese brand as opposed to just something made in China?
When we have a trade gap with China, it is because Apple makes phones in China and ships them here for sale. If the factory was in Texas (not going to happen, Apple just moved their last computer production from the United States to China), there would be a much smaller trade gap with China and a much higher price for phones and computers.
Through this lens, clearly we are paying the tariff. If the tariff threat ever does go up to include iPhones, either Apple is going to pay and eat the cost to keep the consumer price where it is or it is going to pass the cost on to the consumer. It could actually benefit Apple, because their leading competitor in higher-end phones, Samsung, makes their top-of-the-line phone in China. Apple has more money to subsidize tariffs. Maybe they'll have to pause their stock buyback program for a while.
How China pays is where the real economic trouble could happen. U.S. companies may cut down on demand from China. Walmart or, increasingly, Amazon may need less made-in-China items. If Apple doesn't eat the tariff and the price goes up, consumers may wait to buy a phone. All of this means that the suppliers in China temporarily lay off workers and stop buying from other suppliers. It could cause a recession—in China. Since China is a very leveraged high-growth country, this could cause unforeseen problems. Tesla is building a $2 billion factory near Shanghai. Without demand by the Chinese for these pricy cars, Tesla could default on debt.
It is worth noting that the manufacturing cost of most finished goods is a very small part of the retail price, so a 10% or even 25% increase in costs means a $100 sneaker may cost $1 more to manufacture. This isn't going to lead to much disruption to our consumers or our companies.
The latest shock to the market was when the Chinese currency declined in value, which we claim is currency manipulation, though it is exactly what you would expect if we bought less stuff in China and converted fewer dollars to Chinese currency.
On the plus side, interest rates are going so low so fast as to cause some sort of boost to an already pretty strong economy. This could all go away almost as fast as it has appeared. It really depends if people and companies go out and borrow more. Which will return us to the high-asset-price leveraged country that somehow can't handle even 2.5% short-term rates and not much higher long-term rates—which is what caused the short bear market last year in the first place.