The Dividend Cafe - The Financial Implications of Winning or Losing the Trade War

Episode Date: October 16, 2019

Topics discussed: The market loved the word Friday that the trade war talks did not blow up, and that they, in fact, have created the possibility of a reasonably positive “phase one” deal. The issues around the trade war and their impact on the economy, the market, and the political atmosphere, are all so significant, they warranted a SPECIAL podcast discussion with our investment committee. So listen or view below as you wish, and reach out with any questions! This is a very comprehensive discussion of the whole matter, and you deserve to have the misinformation made right. Links mentioned in this episode: DividendCafe.com TheBahnsenGroup.com

Welcome to the Dividend Cafe, financial food for thought. I serve as our Chief Investment Officer, Managing Partner, and I have to my right, Robert Graham. To his right, Julian Frazzo. To across from him, Brian Saitel. And to his right, Dea Pernas. How did I do? Pretty good. I think you got it. Just getting the left-right is hard these days.

Maybe there's a political metaphor in there. It's hard to figure out what's on your left and right. So the reason for our podcast and discussion today is specific to the U.S.-China trade war. It's been a topic that has pretty much dominated a significant amount of capital markets discussion, analysis, and application since February of 2018. of 2018, and then particularly over the last couple of months, there's been a number of different periods in which the trade borders helped move markets dramatically lower or dramatically higher. You've had a lot of volatility. It doesn't feel to investors, it's interesting, it doesn't feel to most investors like they've lost a lot of money because the market's up pretty sizably on the year. It doesn't feel like they've lost a lot of money because the market's up pretty sizably on the year. It doesn't feel like they've made a whole lot of money because of how markets did last year.

And so depending on kind of what timeline someone chooses to look at, the fact of the matter is both things are sort of true. It's been a really good year in the market, and yet if you bring it back just a little bit further, we're actually kind of just flat for a long time. It's coming up on two years that the market's really sort of flat, meaning the S&P 500, not necessarily for all investors, like those who have implemented rebalancing asset allocation with bonds and alternatives and things like that. Total return on investors has been just fine. But I think I set all this up this way to make clear that it's the trade war

that has primarily, I think, been the source of kind of directionless markets who have been range-bound for some time. And so now let's just really bring it into the micro of maybe the last four or five weeks. Everyone's known this summit has been coming up with China, kind of a preliminary summit. It wasn't with President Xi himself, President Trump, but some of the senior level people that have been handling a lot of the negotiations came together and there's been a lot of talk like it was going to totally crash or it was going to be really, really sizable. And I think that what you got in the market response is a perfectly fitting summary for what took place.

You have markets down a few hundred points at the beginning of the week, and you have markets up a few hundred points at the end of the week. If you take the 100 points we were up on Thursday and the over 300 we were up on Friday, it more than offset what the downside had been earlier in the week. And now we're sitting here recording about halfway through the market day on Monday morning. We've had a whole weekend to digest, more news reports to do with, plenty of ample opportunity for smart people and incredibly not smart people to analyze things. And I've got to talk about some of that today.

And now the markets were, the futures, when I went to bed last night, we're up about 90. And when I went, got up this morning, they were down about 90. And then the market right now is up of 20 or 30 points. So, uh, you know, well, I mean, I'm actually have a comment I'm going to make about that in a little bit. Okay. So I'm going to start with, with Robert and then we got, I have a lot of questions I want

to ask and we're going to have our discussion and let our listeners, especially our clients, partake in our discussion. Was the story of what took place Friday a big story? I don't think so. To use a metaphor, I feel like I was watching a boxing match and the two fighters are kind of clinching. It doesn't mean the fight's over. It's just a time for everyone to take a little bit of a breath is the way I looked at it. And, you know, you saw the activity last week, positive. I mean, some forward progress, I guess. And then today's kind of a sleepy market day.

So being flattish makes a little sense to me, frankly. Let me jump in there and make clear. When you say sleepy market day, for those who don't know, the stock market's open today, but the bond market is closed and banks are closed. And you go, what's that have to do with the stock market? It has a lot to do with the stock market. You have no ability to affect capital, you know, money transfers. And those that are involved in the rates market that are in multi-asset class management often have to kind of sit the day out entirely.

A lot of times in the past, our annual New York trip has fallen on this day. And I've always seen it as a very slow day. I can always tell by the restaurant crowds in New York City that the stock market's open, but the bond market's not, and the restaurants are like half full. So there is sort of just a sense in which today is kind of a fake day, which maybe adds to the tippity of what we're seeing in the markets. Yeah. the tepidity of what we're seeing in the markets. Yeah. And I mean, the things that we kind of expected would be first to break, you know, China and Trump,

if you will, you know, the agriculture, it's kind of a win-win for both sides in this case. You know, China's feeling the pain. They have, you know, the swine fever issue over there. And then Trump needs to really sure up support in the agricultural heartland right now. So that was kind of an easy one, but let's not forget,

nothing's actually inked at this point. So it's just kind of muddled through. This is good headline news, but I don't think it means anything as of yet, personally. Okay. So do you think the market was wrong to go up 400 points Thursday and Friday? No, it's a reprieve from kind of the bluster. It's a positive announcement in some regards. So I think that's perfectly appropriate. Okay. Julian, what do you think? I think to me, that's much bigger deal what happened on Friday. Not so much the phase one deal, which I think doesn't mean that much. But I think what's most important is a few weeks ago, we were wondering, you know, how far Trump was willing to go with this.

And, you know, are we going to like a bigger war? Is he ready to hurt the economy more? And you had this deadline that was coming, 15th of October, for new tariffs. And clearly, you know, he had to find a way out of that, you know, find an excuse to bail out of this. And he found that excuse during this meeting and having this, you know, phase one negotiation. And as of today, we don't have really much, you know, there's no press release. There's nothing that you can really look at. You know, there's no agreement. There's just, you know, a meeting where, you know, there's no press release. There's nothing that you can really look at. You know, there's no agreement.

There's just, you know, a meeting where, you know, I guess Trump has really changed the rhetoric. And I think what's key to me is that now, I guess, he realized that he's hurting the economy, that he's not going to get reelected if he hurts the economy more than that. And that's why he's just completely reversing his, I guess, approach on trade war. And I think that means, I think we're going to be volatility ups and downs, but I guess we have a new direction from Trump, and that's the big positive news for me. I think that was the takeaway, too, from Friday. I think it was big news, but I think it was not necessarily because anything actually got done.

It was sort of a handshake deal, but it's more of shifting of gears for the negotiations of being kind of, you know, counterproductive to productive or, you know, something getting more, you know, escalating more or deescalating. And I think that's why the market was up. It's hopeful. And it just sounds like things are moving in the right direction. And, you know, you got to realize, I mean, exports from China to the U.S. are down 22% over the month. So it's a pretty big deal.S. are down 22% over the month. So it's a pretty big deal. And they were down 16% the month before.

So they're feeling the pain. I think they're feeling the pain more than likely the U.S. is. But either way, this is a turning point for some productivity in negotiations. Gail, what do you think? Yeah, yeah. There's not a lot to add there, I think. Yeah, I think as far as news go, it might be big news. But as far as the actual stamping out an agreement between these two nations, I think it's a little blip.

I think there's a lot more to come in terms of tariffs, jockeying, a lot more tension in the future. But it's far better news than an escalation. So I understand markets going up, markets reacting positively to that news. I think that a lot of what is missed in the media, and I have to say a lot of it is missed on purpose because I don't really believe that all of them don't get this. I just don't. I think that in the attempt, some of it is political where they want to minimize what could be viewed as a positive thing for Trump.

Some of it is just dramatic. They want to make something bigger that isn't that big of a deal. Whether it's political motives or commercial motives, I don't really care. It's just been really bad coverage. It's either been underdramatic or overdramatic at every opportunity. And I would assume each time with an agenda. And so to that point, and I asked Robert in the follow-up, like, okay, so it sounds like everyone doesn't think this announcement itself is that big of a deal, but there's some bigger things to come out of it. It's 400 points Thursday, Friday, a big deal. And someone could say, look, if this wasn't a big deal, why did the market go up?

At one point, the market was up 500 points on Friday. And I thought that the sell-off last 30 minutes was purely related to people just saying, hey, this is probably a 500-point story, but I'm not going into the weekend. I don't know what Trump's going to say about this over the weekend and so forth. This is one thing that bugs me so much about the president, that honestly I think that Julian's 100% right, by the way, about what this story does tell us as to where he is now. It doesn't tell us exactly where we're going to get.

But what could change this thing with the president that now looks like he really wants to get a deal done and he's willing to settle for a deal that's probably not going to be near as hard as he would have said it was going to be a year ago. I think that he would take $10 billion less of soybean purchases by China if it meant them tweeting nice things about him. And he would demand more commitments

of Chinese purchases if they were to go kind of minimize the deal or whatnot. In other words, it's kind of like becoming more ego-driven instead of substantive. Now, there shouldn't be anything surprising about it. And I don't even mean that personal to Trump, although he might be at another level of that. But there's always politics and political aspirations that are going to play into these things. But the idea that the market would have gone up 400 points and people have to immediately try to pick, like, oh, boy, the market's way ahead of its skis on this. This story is not that big of a story. But the market was down 300 points Tuesday. So it's like, how far back do you have to go to have a little historical context?

We're asking people to do 48 hours of research. I'm not asking people to go back the full 18 months, although I don't think that should be that hard. Certainly over the course of a week that started Monday and ended Friday, the market didn't underreact or overreact at all. It was just kind of barely even moved. Do you see what I'm saying, Brian? Yeah, I do. I mean, I think it was interesting, the difference in the yield curve, too, which I think is very forward-looking.

You know, the three-month, 10-year Treasury yield curve was inverted for a long time. It was decreasing in steepness, I guess, since 18 months ago when the trade talk negotiation kind of tariffs sort of started. And then as of this week, it finally went positive. Well, right now, I pulled it up a few minutes ago, anticipating, I guess, that you were going to bring this up. But we're six basis points positively inverted on the three-month 10-year,

which is the most it's been positively sloped in over a month. Yeah, and so I think that's real. So the positive, the change in stance with negotiations being more productive now, moving in the right direction, albeit we don't have a deal signed or anything, but at least there's two sides kind of willing to come to the table and try to get one done. I think they've both felt enough pain. Some of it might be more ego-driven or political-driven on the Trump side with an election coming up, and the other side is they've got their own side to deal with. But I think we're moving the right direction well i think i think that the way markets work

julian as a discounting mechanism um you're right to bring up that it would be hard although not impossible but it'd be hard to look at the events of the week and what appears to be headed towards a phase one deal i think the whole thing of people going oh wait wait a second this isn't written it's like did anyone think a written deal was coming friday i don't even know they had translators and the and like uh administrative people at the meeting i mean it was always a negotiation they never talked about a written deal coming but no we have a footprint of a deal there's some things in there that surprised me that were better than expected but here's my question. You mentioned that it appears now

Trump's really determined to get a deal. I think that the December tariffs that have not yet been addressed are also going to come off. And on a dollar basis, our friends at Strategas Research kind of boil this down for us. If we say, oh, they're just kind of not going forward with October escalation, it doesn't sound like that big of a deal. But if we say that tariffs that had a 46% additional escalation are not going up, 0% move from where we were versus 46%, that's a huge deal. And that's what has been salvaged. And that the dollar amounts thus far amount to $12.5 billion of impacted GDP, that's a big deal. Yeah, if that happens, that's a big deal. But I don't think that's priced in at the moment.

Now, this interim announcement, just the one tranche, shaves off $12.5 billion of planned increases for next year. That's the next big tariff, mid-December. And between now and then, we'll have this November meeting I think they're supposed to meet the leaders on the 16th or 17th and hopefully that's when they can agree to you know, not implement these tariffs

in December, that might come later but as you say, I mean, if these tariffs don't happen and now you still have, if you look today the implied cuts they still have 75% chance of a cut in October, and it goes to 80%, 85% by the end of the year. So we're due for a third cut this year.

Then let's see what earnings look like starting tomorrow. And if tariff, you know, because Trump is clearly, I think the really big difference is just Trump, I realize he's not going to win that war, and he needs to get reelected first. So I guess he's completely changing his rhetoric, Trump is clearly, I think the really big difference is just Trump, I realize, is not going to win that war. And he needs to get reelected first. So I guess he's completely changing his rhetoric. And that's the big news. And now, you know, it's...

But, Dan, is the fact that there's positive news in the trade front and that the futures market are still saying the Fed's going to cut, does this reinforce the point I've been making for a long time that the Fed's actions never had anything to do with the trade war. So as far as that being big news and as far as how that links to the Fed decisions, I'm going to have to go with your opinion on what kind of pressures this puts on the Fed as far as Fed kind of cutting or whatnot. I think at the end of the day, it comes down to their data dependency. And they said that they were going to cut, and we think they're going to cut another 25 bps before year end, regardless of what happens with tariffs mid-December. If this deal on Friday had included a press release, had included a press conference, had included Trump and Xi hugging, CapEx in the U.S. has still collapsed. The Fed is not cutting because of or not cutting and whatnot

on the postulations of this trade war. It's the impact in the corporate economy, and the leading versus lagging confusion is immense here. You have a tremendously sluggish business economy as measured by manufacturing, industrial production, capital expenditures. So if the Fed is data dependent, they say they are, you're agreeing with them. They were going to cut anyways, right, Brett? Yeah, they will.

And again, it's because of the data. It's services sector with 47.5 or something like that below 50. So that signals contraction. And they've got the rest of the world to look at as well. So that global landscape of negative rates and slow growth across pretty much all economies. I think it's cause and effect. You know, the trade war, the tariff negotiation back and forth is a deflationary mechanism for things. And I think that's maybe caused some of those numbers to pull back a little bit, which in turn causes Fed to maybe want to lower rates a little bit. But I think it's all those things together. Yeah, it's not the actual event from those discussions. It's how it bleeds into that data. Robert, let's switch gears to the idea of tail risk.

And it's something that we want clients to understand that so much of what we have to do when we're engaged in capital markets is around very low probability, but high impact events. And when they're negative, we generally call them tail risk. And I wonder if one of the most unappreciated aspects of this story, people are saying how much agriculture they are buying or not buying, and is it October, December, and whatnot. But I wonder if the removal of some currency tail risk is the biggest part of the story, that it appears China's agreed to kind of set the level of interventions they're doing in their currency at a certain place, and that therefore that takes away the huge tail risk event from early August, which was U.S.

retaliation in currency intervention, that being off the table. What say the... I read something from one of our great research providers this morning talking about the currency issue specifically. And the fact that the Chinese currency had already depreciated pretty significantly past that seven level via market forces, it kind of alleviated a lot of that risk already. Now, a lot of the moves that would happen in the future with regards to the US not intervening, that's a good thing, because we talked in an earlier edition about how that would be somewhat unprecedented for us to intervene there. And I'm glad that that's pretty much off the table as a result of those market forces and

some type of trade deal going forward. So it's a huge deal. I don't think people are talking enough about that going forward. But I don't think much is going to happen again because of those market forces that already started moving their currency in that direction. So what's a bigger deal to market? So maybe there isn't an answer, but I think it's good for us to take a stab at it. It is $12.5 billion of planned tariffs that are already canceled, and that number will hit $24 billion if the December escalation goes away as well. So I always like to frame this in Dividend Cafe on the relative to the impact from corporate tax reform. Because I point out that there was, let's say, $100 billion of fiscal stimulus that came in from it. Here's what the impact of trade war has been. So if you start talking about 12 to 25%

of that level being back in play in the economy, I think it gives you kind of a context for how sizable it is. But you have to measure that against something that the market can't see because it didn't happen, which is the notion of an escalating currency war with China. I'm going to share my view, so I'm not hiding the ball, but I want you to disagree with me if you disagree or just comment around it. I think that the biggest story of what could have gone wrong being gone on the currency side, that's why I think that is the biggest story, that there is a significant elimination of tail risk.

The upside of the story right now is very minimal, but the downside to the story has largely been, a lot of it has been eliminated. Do you think I'm on to something there, Julian? Yeah, I agree. I don't know if I would put that on there, but currency, I think it's the whole downside of being in this negative loop of more tariffs, more retaliation. And I think it feels to me- But are we out of that negative loop of more tariffs, more retaliation. And I think it feels to me- But are we out of that negative loop if something comes back in phase two, if there is, in other words, we've paused,

but is that negative loop gone or is it paused? Yeah, we've seen the wheel many times going back. I would bet that this time is different and that's because of the political agenda. And so that Trump cannot afford to be back in the negative loop that whatever happens with phase 2, whatever happens with December 15th he'll find a way to spin it

as a victory and he'll find a way to not hike tariffs because he needs positive feedback it's not going to help the economy probably but it's going to help sentiment and that's how indirectly you're going to help the economy probably, but it's going to help sentiment. And that's how indirectly you're going to help the economy.

People feel a bit less worried about the world. So even if, let's say he gets reelected, you still think he tries to spin everything positively? Well, you mean after he's reelected? I guess it'll be different. You're talking about leading up to it? You're talking about more leading up? I'm thinking about leading it up to it. So we have one year of, I think,

you know, one year of trying to avoid any volatility, ceasefire, and then we'll see. Yeah, well, it's something like 100% of the time since 1984, the incumbent wins, the stock market's up 90 days before the election.

Well, I think that it's... I wrote a paper that goes all the way back to the Depression and only can find one argument, and it's actually a false positive, because you had the market up and the incumbent lose, and that was in a very

unpopular Korean War where Truman had only been elected by about three votes to begin with, the famous upset over Dewey. And then Eisenhower was an incredibly popular Republican general, beat Truman. That was the only precedent I found where you had a, and it isn't about 90 days versus one year, because each election I did measure in a different time frame.

It was, was it a positive stock market experience versus not? And essentially the stock market has been an almost perfect predictor for 100 years. But see, Trump's falling in that gray area because you're going to have very likely a really positive total return from his election through the new election date, but it's very possible that you have a muted extended period in the more recent time. So if you end up at Dow 27,000 next year, around where we are now, the fact of the matter is that the total return from where it was in November of 16 is pretty good. Annualized. But it will be coming off of two years of flatness, and that's difficult. And by the way, what happened with Obama too when Hillary was running

is Obama had eight positive years of stock market return, and he had a really high annualized return out of the bottom dregs of the financial crisis. annualized return out of the bottom dregs of the financial crisis. His return is dramatically lowered if you count it from November when he was elected, because what it dropped from the election day to March of 2009 when it bottomed was so much that when that gets factored in, it takes away a few years of return. And that's what you're supposed to measure. You don't measure from inauguration day, like stock markets all of a sudden realized, oh, this guy's president on inauguration day. You start at election day.

So my point being that Trump's got this really good stock market return, but it may not feel like it if there's a year or two of mutedness. And if you recall, the market peaked in August of 14. The dollar rose dramatically. Oil markets collapsed. And it was actually, all the way up through past Brexit and whatnot,

16 ended up rallying a bit. A lot of the rally came after the election. But from mid-14 to mid-16, it was pretty flat. Yeah, totally flat. But it's better that than going into into election with recession and you can't win then see in other words in

other words it's a knowable outcome versus an outcome that's just positive enough to be unknown at least it's neutral yeah on her team I guess yeah but I think I think that there's another factor too and now we're gonna delve into politics and I want to bring it back to trade and economics people love it when we talk currency and and trade economics it's one of the most i think just kind of enjoyable entertainment things in the whole podcast universe and politics frankly bores people right oh yeah well another factor what if this trade war had careened out of control markets dropping economy worsening,

a lot of the worst case outcomes, not going into the November election next year, but going into the impeachment fight. So I really believe that the consensus is correct here, that the House will end up voting to impeach him and that the votes will not be there in the Senate. But I got to say, with the pushback I've seen over the last week to his decision in Syria with the Kurds and whatnot, where Republicans that I've never seen criticize him in three years have now been very vocal in criticism. If the wheels were, it's not happening. I'm not saying this. And I'm certainly not saying I want it. I don't want any listeners to get the wrong idea. But I think it's worth discussing from our vantage point, from a market standpoint.

listeners to get the wrong idea. But I think it's worth discussing from our vantage point, from a market standpoint. If there was a feeling that the wheels were coming off the bus, and the market was collapsing, and the trade war was going nowhere, and it was giving talking points to Democrat candidates like it did at the last debate, when he said, I want to see Trump get a deal. I think it was Mayor Pete who kind of was trolling him a little about it. I think you could see some senators become more likely to sway vote, too. Do you agree, Robert? I do. I think he's very weakened at this point as a result of specifically the international news around the Kurdish withdrawal.

I think that was probably a big mistake. And then he tried to walk it back with the tariff deals, things like that. I don't know that it would necessarily get the Republican senators over the line to actually enforce the impeachment. Not 20 of them, but four or five. But it's still, you know, optically a big deal. And I think he's just trying to, you know, walk his way out of a corner here with this trade deal. And I think markets see that a little bit. Well, I agree.

And I think that the point you brought up, Julian, that it looks like he now is going to be a little bit protected from his worst instincts is the most logical outcome. But again, even that, I guess you have to kind of, you know, you can't be conclusive because there's some unpredictability with the whole thing. So what do you guys think is the investment outcome? Like what would we be doing right now different than we were thinking a week ago? Anything at all? Is there any actionable difference in equity sectors, in small versus large cap, and value growth, and international? I'll ask you, Brian, and we're getting ready to have some pretty substantial meetings with two emerging markets managers in New York next week. Is emerging markets more attractive right now than a week ago?

They get a trade deal going, yes, it is. I mean, that's been a big headwind for all international investing, particularly emerging markets. Because of currency or because of trade or both? Both. Yeah, I think both. So I would say this to your question, would we be changing allocations based on what happened on Friday? No, probably not.

But it definitely gives some validation to some positioning that we already have, which is in the emerging world and more of a bias over value to growth, those types of things. I think those are going to be benefactors from getting some positive negotiations done between the two countries. Well, I would agree. Daya, do you think that this is something that Brian brought up, the sentiment? I think that there has been a negative sentiment in emerging markets. I'll tell you what has not suffered through it is fundamentals. They're low-valued. The way we approach emerging markets in particular, let's leave China out of it in their big export economy. But just looking at South America, looking at other parts of Southeast Asia,

it seems to me that the overall environment has got to add a point to the PE ratio of emerging markets, which is worth 5% to 8%. What do you think? Yeah, I just think the emerging markets, if you want to lump those countries in that asset class, I think there are huge benefits to the free flow capital and free trade. And if there's a higher likelihood we are moving more towards that, there are going to be beneficiaries of that, just like everybody else, them to more of an extent, because they're so dependent on that capital versus maybe a developed nation. So I think that might be worth a little unpacking. Are you saying depending on the capital in the sense of their economic activity

or are you referring to the drag of dollar-denominated debt, the currency impact? I am referring to as far as how that capital affects economic activity. to the, as far as how that capital affects economic activity. The more foreign direct investment, the more the wealth of that country increases if you measure that wealth through the amount of goods and services that are available to those citizens. So yeah, and obviously those companies that we invest in, those earnings will grow and those fundamentals will be stronger.

Hence, I think it should warrant a higher P. Yeah. So, Julian, is there anything in the U.S. equity side that you think is kind of impacted? And again, please be careful, no individual names, but bottom up, what do you think? Yeah, I was going to say, I don't think valuations are really impacted, but the prices at which we can buy some of these companies really tend to move a lot, can be volatile. And I always screen for new opportunities, new names that we could add to the portfolio.

And at the moment, it's hard to find anything in consumer, the defensive sector like utilities or consumer staples, they're pretty highly valued. But if you look at industrials or energy, there's some bargains out there. So then the question is, you know, do we want or what would we sell to buy them? But I think clearly there's certainty and the trade war, you know, creates some opportunities to buy very good companies

that are cyclical but not as cyclical as the market believes at a good price. Yeah. Well, in terms of the small cap versus large cap discussion, I don't know if you guys got to read that strategy report out of Strategas this morning. I think there's some that I think maybe over-apply the issue about dollar, that they tend to think that a stronger dollar is inherently better for small cap and a weaker dollar therefore would have less impact to it i'm not sure i agree with that i

think that to the extent you just are making a general comment that there's less multinationals in the small cap universe i get that but you know right now there's so many other factors at play i'd be i'd be a little skeptical of of going down one track and evaluating even with the trade war this is a big enough topic that we're having one uh pod special podcast devoted to it but it's hard right now to say hey the big announcement came we have a changed view on what could happen on tail risk with the trade war so we're altering our asset allocation when you still have the Fed. You still have questions about earnings season, which we talked about last week. Is that a bigger story right now? I think it is.

Kind of the feeling I get in the markets is that there's maybe going to be a more rotation into more value-based companies. And it's been happening. It's been happening. And I think it will continue and perhaps accelerate. I think people are just getting a little sick of the uncertainty and they just, they don't want to make money. They want some positive cash flow, some profitability.

Whether you talk about certain tech companies feuding with political candidates or unicorns with crazy valuations, things like that. I think people are just getting tired of it. I mean, those parts of the economy had a good run in terms of price return over the last couple of years. But I think that rotation just getting tired of it. I mean, those parts of the economy had a good run in terms of price return over the last couple years. But I think that rotation is going to continue into value going forward. And the small cap stuff, I would agree.

It's really people saying they have less multinational exposure. But, you know, strong dollar, weak dollar for them. They just need a little bit of TLC in the U.S. Yeah. You know the delta right now, Julian, is between the P.E. of the growth, Russell growth, big cap, and value, big cap, is the two standard deviations apart from its average. Largest delta in history. Reflection how cheap value is or reflection how expensive growth is or both? I guess a bit of both. It's all relative to,

I think it's first relative to the, you know, where the bond market and the treasury is out. The fact that money is cheap and then that pushes, you know, valuation higher. So people, you know, ready to pay very high multiples for growth.

And they will only know in a few years if they're right or not. But I think that's why it's more comfortable owning value. So if growth is so overpriced and value is so underpriced, why is the trade not obvious to go long value and short growth? Well, I don't know if I'd go that far as far as betting against the growth sector necessarily. But I also think there's a yield play. I mean, rates are going lower.

A lot of negative yielding debt around the world, $15 trillion. People need income. And technically, you get more income owning just the S&P 500 than you do a 10-year treasury bond right now. And so I think those value stocks that pay out dividends and cash flow and things are attractive for those reasons, too. So I think that rotation is underway. But I don't think it's over. I think it's probably second inning type of thing. I think it's just starting.

way but i don't think it's over i think it's probably second inning type of thing i think it's just starting yeah i think i think my rhetorical question about why that isn't necessarily the best play is because that one of the things is the the momentum of it that it could it could go worse it could stay a long time and frankly it's been this way for a long number of years so if it was such a it's the inability to see that when valuations get skewed from historical mean, it never is a timing signal. It just simply means that there is, you know,

something that may be mispriced relative to historical levels and it will correct as valuations mean revert. But that doesn't mean, you know, if it's in six months or two years. Does the trade war settling things, and let's say you get another quarter point from the Fed, does it really, really pick up

the burden of earnings season, as we talked about last week, to tell us what happens in the next three months in the market? I think that just going back to the supply side, I think that if you see business confidence reacting very favorably to what happened on Friday and the ceasefire in general, then I think you could see, as far as guidance goes, as a result of a lot of these earnings calls, CEOs being a little bit more optimistic, which should definitely help things. Well, I will jump in. There's no way. There's no way business confidence can jump up meaningfully from what we got Friday. Because it's not enough. Business treasurers making decisions for multi-billion dollar CapEx projects need more than that. They need ink on paper. Okay. Yeah, right.

Obviously, this is predicated on them having some faith in the agreement. I mean, not just the phase one agreement. I'm saying I think that they need the phase two agreement before you can see CapEx pick up. Well, you would even need the existing tariff removed, ideally, because you still have a lot of tariffs. Yeah, and that's ultimately what they're after. A long-term deal is what you need for business confidence.

That's what it is. I think the leg of the economic school that we need to continue watching is consumer confidence more than anything else and i think earning season is really important for that because if we see you know profit margins start to compress a little bit that's the time when companies perhaps start raising price prices down the road right because they want to get back to a more sustainable level if the tariffs the december ones don't come in that's going to help that possible. So I think earnings more than ever are really important to watch in the margin side. Well, but that's a different statement than what you started off making about consumer confidence being a big, big thing to watch here. I would push back on it. Of course, I'm permanently in

school of thought, thinks consumer confidence is the most worthless economic metric ever. But do you think that the consumer confidence has had a contrary behavior to the trade war thus far? No, I don't think so. Well, I think in terms of consumer confidence- It seems to me, let me put my cards on the table and then feel free to disagree. I think the consumer is always the last to know when they shouldn't be spending money. So they'd be confident about something as a false signal often. I would agree. And so I would agree with you in that regard. But I think if prices increase,

that will hit that consumer confidence indicator more so than it has before. Because we haven't, as we talked about in previous podcasts, we haven't seen price increases necessarily in effect for the consumer going forward. So it's more consumer behavior that if there's actual increases in what they got to pay for an iPhone. Now the dollars they spend on the credit card probably won't change. It's just more stuff. Right, right, right.

Yeah. Okay. Well, I get that. And so what will happen out of that? Will, to Daya's question, will guidance from third quarter results have any discussion of a phase one deal? any discussion of a phase one deal or will it more than likely still be hey we want to get back to capex but we need more resolution what do you think join well I think they will you know like they always do beat on q3 and then be very cautious guiding for q4 and that we're not out of the woods. So, you know, it's, I guess,

probably because the market is always going into this earning season with, you know, being quite skeptical and conservative. We might have, you know, a better season than we were, that was priced in. So it might go up on average and they're probably all going to do a bit better than expected.

But then the guidance should be quite conservative because the uncertainty is still there. So let's frame it this way. I'm going to ask you the question one way. I'm going to ask Brian another way. What would have been a bigger impact to markets had there been no phase one preliminary deal Friday in trade, and yet our earnings results as they start to come in the next few weeks were dramatically outperforming those negative expectations. Yeah. Or if there was the trade deal there was, but then we get disappointments in earnings. Maybe they're not disappointment, but they're in line with expectations instead of beating

expectations. Well, I guess if you call it like a real trade deal where it's off the table for the next 20 years, I would say that's a big, big impact. And then who cares about the next quarter results because now you can forecast. What if they went on a plane and went home? Like the Premier said, nah, nothing's going on here. Well then, back to fundamentals and back to earnings

and really, I guess, whatever happened, this negotiation is not gonna impact Q3, Q4. It's going to impact next year. Sure. So if we take the flip other side of it, what if you have improvement from phase one, but not like the full 20-year deal and all that? But what if you get really good progress trade front, another Fed rate cut? Let's say two. You get two.

And earnings numbers are just not good. For the first time, I think we're expecting a 3% decline. And the last two times we were expecting a 2% decline. We got a 2% increase. What if a 3% decline actually is a 5% decline? No, that would be a big deal. Bigger than the positive big deal of trade and Fed and positive backdrop? Yeah, I think the devil would be in the details of the trade deal. So it's hard to say

definitively on that. So it would depend on exactly what was accomplished with the trade for me to be able to tell you exactly which one would overshadow the other. But I would say if you get... So earnings, we're already expecting earnings to be lower this quarter, 3%, 4%, something like that. Earnings have widely beat expectations this entire expansion pretty much every time. And so having lower guidance is not the end of the world. Technically, this will be like the 15th quarter of the last 20 quarters where we've had sort of negative or muted guidance and the market has gone up. And so there's nothing wrong there. But yeah, I mean, I think if you had a dramatic downshift in the fundamentals, which really would come out in the form of earnings, that would be a game changer.

That would be a game changer more than the China deal. So, Dave, is that kind of our conclusion, that for those who are paying attention to quarter-by-quarter moves in the market, that the earnings season is really maybe the bigger story right now than the trade front? Yeah, it's hard to determine how that would play out. I assume that if CEOs can kind of blame the earnings miss on issues with the trade deal, and a trade deal was stamped out and the market has a lot to look forward to, I think that would outweigh a miss like that, in my opinion, given how much the market places an emphasis on forward guidance. But it's not something I could say with a high level of conviction.

I don't know. I guess it depends on how these companies are missing and the story behind it. I think that it is important to be able to reinforce for clients right now the difficulty of the period we're in because we do these podcasts weekly, sometimes a couple times a week. And we're sitting here talking about what moved the markets last week, even breaking up one week into two periods of that first half of the week for a second half of the week. And now we're extending it to a little more rational of a timeline, meaning a whole fourth quarter. But honestly, I think that the different growth stuff that we do and believe in so much here is so important right now because we're sitting here talking about stuff that is real

and is absolutely intervening in the behavior of capital markets around the trade war or quarterly earnings expectations or the next FOMC meeting. But the fact of the matter is that if one of those things got removed as an impediment to markets, there would be something else there and that is just not going to change as far as my eyes can see right now. When you're starting off at 17.5 times S&P 500, you just don't have the greatest argument for index investing ever, which is that it's underpriced relative to historical valuations. So even during a recession, I can be very bullish about stocks

because you just simply have an argument. You believe in capitalism, so you believe corporate profitability is going to come back. You don't know if it'll be three months or a year. But you know that that's what markets do, meaning companies' ability to get back to bottom line. And so in a lot of ways, it's just hard to be overly optimistic where you want to have a heavy overweight to equities. If the Fed is going to do QE4 and give two more rate cuts and trade war goes away and Elizabeth Warren's not going to be president, I still can't get super excited about a stock market almost at 20 times. And if all those things happen, the market would be at 20 times. Yeah, it would. I would get excited about it based on the Tina kind of idea where there is tina turner tina turner

tina is in uh the acronym there is no alternative on a relative basis i would get excited about it but i agree a fundamental basis looking where p's are historically it's difficult but uh is tina still going to be working if you had full trade war removal uh elizabeth warren's not going to be president and the fed's cutting and you get some global synchronicity and accommodative monetary policy does that would that invite emerging markets as an alternative i don't think it'd bring europe back in play because i'm very convinced that there's secular structural problems but i wonder if even tina would be somewhat diminished because in theory some of those positive macro events would open up Japan a little bit, would open up EM a little bit. Right. of just stocks in general, the stocks that we own in general. And emerging market equities would be one of them.

Relative to broad asset classes like bonds and alternatives and cash. But speaking of that rotation, I think you would get outperformance in some of those sectors. So if all those things came to fruition, lowering rates, trade deal gets done, Warren's not president, those things happen. I think stocks in general would go up and maybe those valuations on the index might get towards 20. But I think you'd have things that are currently trading valuations in the single digits or high or low double digits, emerging markets or some of these value sectors. We're talking about energy, industrials, things like that. I think the percentage move up on those would be larger than the overall market.

So I think you'd get out performance with that. So there's still pockets of the market I think that I could get excited about more than the overall just broad index. Good call. Let me go around the circle this way, and then I'll close this out. Robert, why don't you give a concluding thought on what you think about where we are with the trade stuff, and then maybe a macroeconomic conclusion. Yeah, with regards to the trade stuff, I think it's a ceasefire more than anything. We'll see what actually comes to fruition in, I think, November is when they're due to actually sign or finalize this round. I think looking at earnings in the shorter term is, in my opinion, more important than what happens over the next couple weeks. There'll be probably tweets, things like that.

On a macro level, I would certainly echo, in the meantime, the Tina thesis. I think for right now, the rotation to value will continue well i'm excited to finally start with q3 reporting um tomorrow actually um but i guess more than q3 and q4 guidance i'm really hoping to get the beginning of 2020 guidance for companies and unlike they're unlikely to do that until that on Q4, which will be in January, February. So we'll see how much visibility they have on 2020, but that's really what matters because I get at the moment S&P estimates assuming like a 10% on your growth for 2020,

which is far from done. So if that doesn't happen, it's hard to see how the market can go up next year. Yeah. Yeah, I would say the takeaway from last week, Friday, with this sort of mini deal or phase one deal was not so much the details, which there weren't really all that many. There's some agricultural good purchases and some commitments on IP and currency and such, but it's just the shifting of gears for being more at odds with one another to getting something more productive done. And I think that's positive for markets.

I think it's positive for the economy. And I think it's positive for, ultimately, eventually, it will be positive for fundamentals, but it will take some time. So from an economic standpoint, I'm fairly positive on things at this time. Yeah, I agree. I think those things are positive. What happened on Friday is a hell of a lot better than an escalation. I'm also looking forward to Q3, numbers two. I'm looking

forward to hearing some of the sentiment and the guidance. And as far as the ceasefire goes, I agree with Julian that Trump has every incentive in the world to maintain a ceasefire. Although it also depends on what the Chinese are doing. I mean, no matter what his incentives are, he's not going to lose face if some Chinese official says X and he's got to respond, and then we're back in a similar situation. So, yeah, I mean, I think there will be a ceasefire, but also I want to maintain some degree of defensiveness,

you know, the idea that multiple outcomes are possible. That's where I want my concluding thoughts to go is kind of piggybacking off of your final thought there about defensiveness. I've really not done well in any level, presuming that President Trump would behave the way that one would expect or where you think the leverage is lined up. I most certainly agree with the logic of everything that we've said today. And yet there are so many third and fourth order effects that could come out of everything going on that I have to have a kind of cap on my level of confidence. You know, I could see a scenario, honestly, where the whole thing kind of gets away politically, and then he just doesn't care what the political outcome would be

out of the China deal. I don't think that we should be operating as if both sides view it like, oh, we have the other side where we want them, and so therefore both sides will just do nothing. I maintain a contrarian position that China has more leverage than the U.S. does. A lot of people don't agree with me, and a lot of people just don't like what I'm saying, and that's okay. But I stated on the basis of the fact that it's not even about the political cycle, though that's a big part of it relative to ours. It's based on the fact that their population expects something different. Our population expects the market going higher, unemployment staying low, GDP growing. In Rust Belt states, they want to be able to say there's new manufacturing jobs, all those things. I think that there's a significant portion, once you get outside of Beijing proper and Shanghai proper,

there's a significant portion of the population that's willing to endure economic pain out of national pride. And the Chinese have done a good job. I think it's mostly propagandist, but they've done a good job selling them that they're being attacked reputationally and they have to defend their national honor. And so at some point of negotiations get tricky right now. We are negotiating on basis of mutually assured economic destruction and that's moving the ball forward. But if something falls apart, I think it would be easier for China to say, OK, well, whatever, let us let us have it. Then then the U.S., knowing that there's so much other vulnerability out there. So I believe the news Friday is positive.

I believe currency tail risk has largely been diminished. And I expect President Trump to go all the way through, get the deal done. But I will refuse to take away our mantra that the expectation right now is volatility, volatility, volatility. I think you will have up 400 point. Now, futures being up 100 and then down 100, okay, that's a little overnight volatility, but I mean more than that. I mean 500 point up weeks and 500 point down weeks for the next several months. I think that's what we're probably ahead for. And I would like to be reinvesting dividends throughout that period. Amen.

I think it's an accumulation of capital that is one of the only ways you actually get some form of free money in the world of investing. So I think anyone else? We'll see. We'll see you here. Okay. I will close us out with that. Thanks, everyone, for listening to this Investment Committee special podcast on the U.S.-China trade war.

If there are any meaningful developments on things, we'll come back with another. The next Investment Committee podcast we're going to do will be a kind of comprehensive summary that Daya and Brian and I are going to present when we get back from New York City. I leave in a couple of days. Daya and Brian and I are going to present when we get back from New York City. I leave in a couple of days. They join me a couple of days thereafter. And we have nearly, I think, a dozen and a half meetings in the city with various hedge funds, portfolio managers, relationships of ours. Not only conducting our due diligence on strategies that we're actively invested in ourselves, we're actively invested in ourselves, but also just sort of doing idea sharing and having these types of discussions that you're witnessing, our committee has on this podcast. We're having these

with all these multiple people to help formulate our worldview, challenge some of our presuppositions and determine if there are, in fact, areas where different risks would be suitable, less risk would be suitable, more risk. These are really fruitful conversations. We're going to bring you a podcast to kind of handicap all those things and summarize those things here in a couple weeks. Reach out anytime. Please write us a review. Please subscribe to this Dividend Cafe podcast and whatever your chosen player is.

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