Global shares were flat this week, with mixed political and economic developments prompting most investors to sit on their hands. The week started off with tough talk on trade from Trump during a speech at the United Nations General Assembly, which came shortly after China pulled out of a meeting with US delegates to negotiate trade concessions. Despite Trump’s remarks, investor sentiment was buoyed after a trade deal was made by America and South Korea, with the prospect of further deals with Japan and Britain in the near-future.
Scandals within the Trump administration has dampened investor sentiment, as Trump’s nominee for the US Supreme Court battles multiple allegations of sexual assault and reports arise that the deputy attorney general Rod Rosenstein had suggested exercising the 25th amendment, which allows the vice-president to remove a president deemed unfit for office. The negative reaction of the market may suggest that most investors are fans of Trump, since the scandals are hurting the chances of the Republicans retaining their house majority in the upcoming senate elections.
In local news, the Australian economy seems to be picking up steam, with the 2017-2018 financial year budget deficit shrinking to $10.1b, almost half of the $18.2b forecasts in the May budget. GDP growth, employment growth and tax receipts were all stronger than the original forecasts, however wage growth still remains stubbornly low. The strength of the economy was reiterated by Standard and Poors, who reaffirmed Australia’s AAA credit rating and raised their budget outlook for Australia from negative to stable.
Finance 101 – How Trade Wars Work
With all the fuss about trade wars, it’s worthwhile revisiting how trade wars are fought. The objective of a trade war is to make domestic industries more competitive by making the products of foreign industries relatively more expensive. This is usually done in one of four ways:
- Tariffs – where foreign goods are essentially taxed, making domestic goods more attractive
- Subsidies – where domestic companies are subsidised, allowing them to sell goods at artificially low prices
- Quotas – where the number of foreign goods is capped to prevent oversupply (e.g. limiting the number of foreign cars that can be imported into the economy, protecting the sales of domestic car producers)
- Currency – artificially lowering the price of the domestic currency, making it cheaper to export and more expensive to import
When a company engages in a trade war, they are adhering to the economic policy of protectionism. Although protectionism seems like a good idea, it almost always makes a country poorer than if it embraced free trade, since it benefits a small group at the expense of a large group. Tariffs, quotas and artificially low currencies increase the cost of living for everyone by making imports more expensive. Subsidies are a way of saving jobs in non-competitive industries at the expense of jobs in competitive industries (the money spent on subsidies could be spent on education, infrastructure, etc).
So what is Trump trying to do with this trade war? It would seem that he is happy to promote free trade as long as it is reciprocated. When he says that America has been “killed” in trade deals, he is referring to America opening up its economy for foreign goods and investments, whilst many other countries remain protectionist and prevent American companies from participating in their economy. Trump believes that giving China a taste of its own medicine will bring them to the negotiating table to open up their economy. The question is how much pain needs to be inflicted on the global economy before the Chinese get to the table.
Rates Keep Rising
The US Federal Reserve raised rates as expected this week, with internal documents showing that another hike will be seen in December with three more expected in 2019. The tightening from the Fed reflects its optimism in the strength of the American economy. Significantly, it no longer refers to its monetary policy as accommodative.
The swift tightening of US monetary policy is having a number of effects for Australians. The Australian Dollar continues to weaken, as investors sell Australian assets to earn a higher interest rate in America. Property prices are likely to feel more pressure since banks will see an increase in funding costs (our banks are essentially a conduit for foreign debt, as discussed in the latest Stanford Brown podcast). And perhaps most importantly for investors in shares, higher American interest rates and a stronger USD will continue to pile the pain on emerging markets, meaning further volatility could be on the way!
Howards Marks Memo
Aside from TW3, there are few investment publications worth reading. With that being said, when Howard Marks releases one of his memos to his clients at Oaktree Capital, we usually drop everything and read it. In the words of Warren Buffett “When I see memos from Howard Marks in my mail, they’re the first thing I open and read”.
This month’s memo focuses on the complacency investors have shown in recent years in regards to risk taking. Here are our favourite takeaways:
- Howard Marks took risk off the table in 2006 when he saw that there was a dearth of caution, discipline, scepticism and risk aversion in markets. This meant he avoided the GFC, even though he didn’t know exactly what would cause it.
- A real estate professor at Harvard Business School – “real estate has ten-year cycles, but luckily bankers have five-year memories”
- “Nothing in the investment world is a good idea or a bad idea per se. It all depends on when it’s being done, and at what price and terms, and whether the person doing it has enough skill to take advantage of the mistakes of others, or so little skill that he or she is the one committing the mistakes.”
- “There’s a race to the bottom going on, reflecting a widespread reduction in the level of prudence on the part of investors and capital providers. No one can prove at this point that those who participate will be punished, or that their long-run performance won’t exceed that of the naysayers. But that is the usual pattern.”
- “Investors should favour strategies, managers and approaches that emphasize limiting losses in declines above ensuring full participation in gains. You simply can’t have it both ways. “
We share his cautious view on the world and asset prices. Now is not the time to turbo-charge the portfolio.
What’s On In Sydney?
With spring in full swing, October is shaping up to be a month to remember with bridges, Bondi, Bublé and bánh mì on offer!
You can find out about these great events and others in this month’s instalment of What’s On In Sydney!
Who am I?
Congratulations to Aaron and Carla for spotting a young Warren Buffett last week!
But who is the fine knight catching up on the classifieds? Bonus points if you can name the movie!
Pic Of The Week
Video of the Week – Oddly Satisfying
Have a great weekend!
Jonathan Hoyle, CEO & Nicholas Stotz, Investment Analyst