The Dividend Cafe - Making Bad Policy Matter Again

Episode Date: March 9, 2018

This week, David L. Bahnsen recaps the crazy week in markets caused by the Trump administration's tariff announcement. Links mentioned in this episode: www.DividendCafe.com www.AdviceandInsights.com

Welcome to the Dividend Cafe, financial food for thought. Hello and welcome to this week's Dividend Cafe podcast. This is David Bonson, the managing partner and chief investment officer of the Bonson Group, and as such, the bearer of bad news when things like protective tariffs get announced by a Republican president. So I'm going to focus a lot of our attention in the Dividend Cafe this week on the primary mover of markets this week. And kind of a big question mark in markets is probably a better way to put it, because actually markets really haven't moved a lot this week. is probably a better way to put it because actually markets really haven't moved a lot this week.

Last week they moved over a thousand points to the downside, most of that being after the president announced his intention to implement sweeping tariffs on all imported steel and aluminum. And so I've titled this week's Dividend Cafe, Making Bad Policy Matter Again, and certainly the markets have kind of responded, but I'm going to explain a little as to why maybe the markets are just not quite totally sure what's going on next here, and maybe you're in the same boat. So let's get into it. It should be no surprise that what's dominating markets this week has been trade policy, the outlook for economic growth in light of potential global trade disruptions, and the changing composition of economic leadership in the Trump administration. These are all pretty big things. The bulk of our talk here today will address these topics and their related cousins.

Hoping you're going to find it comprehensive, actionable, and comprehensible. Those are three pretty big words. You will pay no tariff to listen to this Dividend Cafe podcast. It's difficult to find the words to describe the policy blunder that a sweeping 25% tariff on imported steel represents another 10% on aluminum. I did publish an article at our marketepicurian.com website that I think delves far deeper into the whole subject. And we did a longer podcast at Advice and Insights, our Advice and Insights podcast dedicated to an elaborate

treatment of the subject. By way of markets, you know, they opened way down on Monday, exacerbating the 1,200 point loss of last week in the Dow, but then they rallied back on Monday to kind of be even on the day. They're mostly sort of flat on Tuesday. Wednesday, they dropped over 300 points, largely rebounding though by end of the day. And that was in response to the resignation of National Economic Council Director Gary Cohn, the longtime president of Goldman Sachs, who resigned this week, largely as a result of this tariff direction the president's taking. We'll see where things go from here. I have more to say on Gary Cohn's departure. But as of podcast recording time here on Thursday, we're kind of roughly flat.

And that's sort of been the day. But let me just give you two kind of summary takeaways from an investment standpoint of the way we're thinking about this particular either action or potential action. Because again, there is sort of a bouncing around going on in terms of what the president is actually going to do. Number one, the equity valuation premium that is warranted by growing and synchronized economic expansion is vulnerable. Corporate tax reform and deregulation have been huge and justifiable catalysts to market optimism. A sustained move towards protectionism that embraces tariffs and suppresses trade will hurt equity valuations, period. I have to make clear, it is not headline risk or event risk we're talking about. A big market rally would not mean all is back to normal.

For if we proceed with a protectionist policy and personnel paradigm, that alliteration is an accident, the slowing of growth takes place over time. That alliteration is on accident. The slowing of growth takes place over time. The efforts of foreign trading partners to curtail their purchases from us takes time. Now this is what we expect. A slow but real compression of what growth could otherwise be and therefore a compression of equity valuation. Number two, we see this overall category of risk being problematic for the U.S. dollar. Trade wars create less dollars coming into the U.S., which suppresses savings and investment. For a variety of reasons, we could see the relative beneficiaries being Japan and certain emerging markets. Crucial caveat, this does not

mean Japan and or emerging markets will benefit from a trade war. No one wins from a trade war by definition, but relatively speaking, if nothing else, the currency impact would likely bode well for those markets. Let me break it down for you. Why are markets puttering around right now on this issue? Simply put, markets know the stated bad news of last week, tariff intentions, and have absolutely no idea the president will really go through with it, what this will end up being, how intent the administration is on additional levels of protectionism. The market can't react with any conviction or magnitude at this point because on one hand there's the potential for a really destructive play out of this and on the other hand there is daily messaging

that feels like a walk back. Market actors simply cannot respond because where all of this is really headed is so uncertain. Will the European Union be content to see new tariffs put on them without retaliation? The U.S. sends an awful lot of shirts and jeans, peanut butter, motorcycles, boats, orange juice, bourbon, corn, many other consumer and agricultural products into Europe. They've explicitly stated their intent, European Union has, for tit-for-tat tariffs should this steel and aluminum threat go through. Grown-up supervision. The resignation of National Economic Council Director Gary Cohn, the former number two man at Goldman Sachs, and a steady, competent voice in the administration sent shockwaves through the market. after trying to rally a bit during the day,

markets always overreact to things like this, but that's not to say this is not a real story. It is. But perhaps for bigger and certainly different reasons than people realize. First of all, it likely means the direction of this trade, tariff, protectionist stuff is going to get worse, not better in the weeks ahead. Losing a persuasive and respected voice in the cause of free markets and free trade is not going to bode well for the cause of, well, free markets and free trade.

I've said plenty about the concern for investors the present steel and aluminum tariff represents. But with a voice like Cohn's gone, will the direction of U.S. policy in trade and tariffs get even worse? That is the market's fear. That is my fear. The replacement to Cohn at NEC, which is National Economic Council, it matters a lot, both in terms of the position itself, but also what it indicates to markets about what lies ahead for the administration's policy towards economic growth. At press time, clarity is not available on what direction the president is going to take. The knock-on effects not covered. Listen, proponents of what President Trump is proposing downplay the idea that there

will be backlash. Oh, the cost is overblown. Other countries need us more than we need them, they say. We think that's wrong. There will be backlash. But then many critics of President Trump's tariff policy state that the risk in knock-on effect or follow-on effect is retaliation from other countries. Well, I think that's true, but it's a tad incomplete. From my perspective, it is what the U.S. will be emboldened to do in response to the various retaliatory efforts of other countries. That will really let the genie out of the bottle. From the ramifications to NAFTA negotiations, to issues with China on intellectual property, to trade agreements with the UK post-Brexit,

a lot of complications can come in the third and fourth dominoes that go beyond just the initial retaliatory domino. Americans feeling Europeans pain. beyond just the initial retaliatory domain excuse me domino americans feeling europeans pain so what happens if president trump carries through on his threat to throw tariffs on european automakers is this a further leverage point the u.s has on europe and or vice versa well german car makers Well, German carmakers alone actually built 854,000 cars in the United States last year. The European car business is now a huge U.S. manufacturing story. Messing with that would be worse for U.S. jobs than it would be for European car companies. By the way, 62% of those cars are exported out of the country. So benefits the U.S. in terms of the actual trade deficit, if that were of the country. So benefits the US in terms of the actual

trade deficit if that were really the priority. The complexities of the global supply chain have categorically reframed the old understanding of how goods are made around the world. I'm gonna go ahead and leave it there. There is, I'm gonna conclude with one other point, but there is another section on the price of steel and how that ends up impacting American consumers, as well as a little comment I want to make and an interesting chart and tally of the composition of the Federal Reserve, what we know about the personnel presently in place there. But let me close with this thought.

It's not related to a chart. The chart of the week actually has to do with the United States 10-year bond yield, the 10-year treasury, and the U.S. versus yen exchange rate. U.S. dollar, Japanese yen. Very interesting chart and explanation. I would direct you to a dividendcafe.com. But let me close with the point that the carnage extends to the nonsense too. We know that equities and bonds are well off their highs in the last five weeks, and we've abundantly discussed the reasoning and outlook for that in both stocks and bonds. But for those following certain other manias, it's really not been a pleasant month at all. That cryptocurrency mania is over 50% down from its recent highs. Half of the volume

of the medical marijuana space has deteriorated. And the inverse volatility product suite was taken out behind the shed and shot. These are all niche products, but they've become speculative little bubbles and manias in their own right. And I gave ample opportunity to witness the folly of investor behavior. I get ample opportunity to see investors make silly decisions, either euphorically or fearfully. Investor behavioral laws apply to conventional assets, but boy, they apply in spades to non-conventional assets in the middle of a mania. So please check out DividendCafe.com. We're going to let it go.

Went a little long here, but really special. Advice and Insights podcast also available this week. Longer version of the economics of trade. I think one of the most interesting things we've done. And then next week, a very special Advice and Insights podcast as well. In the meantime, Dividend Cafe, thank you for listening. Go visit DividendCafe.com. Sign up to receive everything.

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