Wednesday, July 11, 2018

Whether you like it or not, tariffs are the right way to go - let's talk economics and not politics.

From the Desk of Joe Rollins

We just ended the first six months of 2018 and while the markets have been quite volatile and the flood of news (real and fake) have been overwhelming, it has been a satisfactory time for the growth of your assets. I have so much to talk about in this blog that I guess I will need to give you the cliff notes rather than the full book. I want to discuss the flood of bad information we are seeing regarding tariffs, and separate the reality of the economics of tariffs from the politics of someone wanting our current President to look bad. In addition, I will bring you up to date on a recent national award that our financial firm received. This is the third national award that we have received over the last three years – none of which we applied for, asked for, or paid for. It is always very rewarding to be recognized in your profession, especially when you are not seeking recognition. In addition, I will bring you up to date on a Netflix series that you might be interested in (especially if you are my age) that brought back many bad memories.

Before I begin discussing all of these interesting topics, I must give you the financial headlines and the market performance for the first six months of the year. The Standard and Poor’s Index of 500 Stocks was up 0.6% for the month of June, ahead 2.6% for the six months ended June 30, 2018 and up a sterling 14.4% for the one-year period then ended. The NASDAQ Composite was the real winner for the month: up 1% for June, up 9.4% year-to-date and up 23.6% for the one-year period ended June 30, 2018. The Dow Jones Industrial Average was down 0.5% for the month of June, down 0.7% year-to-date and up 16.3% for the one-year period ended June 30, 2018. Just for comparison of stocks as compared to bonds, the Barclays Aggregate Bond Index was exactly zero for the month of June, -1.7% for the six months ended June 30, 2018 and -0.6% for the one-year period then ended.

For the last several years, I have explained that it is unlikely that bonds would be a profitable investment in this economic environment and the numbers have proven that fact. Yet, every day I read about allocations of portfolios to bond indexes and shake my head in bewilderment. I am not exactly sure why you would be willing to invest in an asset that is almost guaranteed to go down. I think one of the major problems in the financial advice sector is that too many advisors operate with the old playbook where you allocate portfolios based upon someone’s age without much thinking or discussion. I would like to think that we are much more proactive and use actual economic performance rather than traditional playbooks that oftentimes are outdated or inappropriate for someone in your financial situation. One of the great benefits of allocating a portfolio specifically for that investor is that we can tailor that portfolio based upon knowledge of all your assets and liabilities. I have come to believe that way too many advisers use formulas that do not perform well in this economic environment. I guess maybe that is the reason we continue to receive national awards and grow assets.

Joe, Dakota, Ava, Josh and Carter in Rome - Three Coins in the Trevi Fountain

Ava holding up the Leaning Tower of Pisa

Dakota, Ava and Joe on a gondola in Venice

I read so many economic newsletters, papers and follow so-called “experts” in forecasting the stock market that sometimes my eyes glaze over while trying to actually understand where these experts get their financial information. The most recent example of this overreach in trying to explain a simple concept is the issue of tariffs. It seems that so many of the commentaries today are actually foaming at the mouth regarding tariffs, and it makes me wonder whether they really understand what they are discussing. There is absolutely no question that everyone would be better off without a tariff war. I am not exactly sure why these commentators are asserting that we have one today, but maybe I can explain the economics so that you can cut through the haze and see that the President is actually on the right course as compared to the headlines.

Simplifying tariffs is relatively simple. The European Union imposes a 10% tariff on all cars imported from the United States. I just came back from a two-week tour in Italy. You see absolutely no cars in Europe by names that you would identify as built in the U.S. I can honestly say I saw less than 10 cars with U.S. based names on them, and even then, I do not know that they were not built in Europe. Contrast that with walking down any street in America. The vast majority of the cars you will note have been built in other countries. Mercedes, Toyota, BMW, Honda, Kia and other cars actually constitute the vast majority of cars driven in the United States. I am not trying to say that some of these cars are not built in the United States, but I rather suspect the vast majority are imported rather than being manufactured here. So, this is a prime example of how tariffs are unfair and do not constitute the economic destruction like the financial blogs are projecting.

The United States levies a 2.5% tariff on cars imported into the U.S. and the European Union imposes a 10% tariff on cars imported into Europe. Yes, there is a higher tariff on light trucks coming out of Japan, but for the sake of keeping this illustration simple, we will only talk about cars. How can any financial analyst agree that the tariffs between the United States and Europe are on an equal basis? Why wouldn’t the U.S. deserve exactly the same tariffs into Europe as they levy into the United States?

The President recently proposed that there would be a 20% tariff on all cars imported into the United States, and Europe came back with an announcement that they would consider equal the tariffs into the European Union. Think through this statement for a second. The United States exports almost no cars into Europe while the European Union exports the majority of their cars manufactured in Europe to the United States. Just exactly who do you think would be hurt more by this equalization of tariffs?

As an investor for 40 years, it really fascinates me how the stock market reacts to these quotes by the President. You have to understand that the President of the United States made famous “the art of the deal”. He proposes a 20% tariff on Europe in order to encourage the Europeans to reduce their tariffs to the United States. Absolutely nothing has happened economically but the market reacts in bewildering swings both up and down. At the end of day, if the President could accomplish a tariff that would be zero both to the U.S. and to Europe for importing cars, he has performed a great service to us all. Why, for any reason, that the market would go down with that good news, continues to be a conundrum that perhaps I am just not smart enough to understand.

So, when you are talking about tariffs, no one wants a tariff war. What our President wants and what this country deserves is equal treatment of tariffs. Of course, we would prefer that European countries come to the United States to manufacture, employ our people and pay taxes, but more than that, we want equal tariffs in both directions so that all companies can compete regardless of where they are located.

Reid and Caroline, children of Partners Robby Schultz and Danielle Van Lear, are enjoying the summer!

Paw Patrol at The Fox

Big Canoe

There has been much said about the proposed tariffs in China. Once again, I remind you that China imports roughly $500 billion worth of goods into the United States. The U.S. exports to China roughly $130 billion of goods per year. It is pretty simple to see who has the most to lose in a tariff war with China. But more importantly, at some point, we have to hold China accountable for their clear intent to steal technology from the United States. They openly require companies to manufacture in China, but in doing so, they require them to turn over their intellectual property for free. I think the President is absolutely correct in calling their hand on this, as so many presidents before have elected to ignore.

But let’s talk about the economics of the transaction as compared to the politics. Let’s assume that it would be possible for China to restrict 100% of the goods shipped from the United States into China. So, in this hypothetical situation, we would lose exports of $130 billion in an economy that this year will be in excess of $22 trillion. You can do the math (if you can figure out all the zeros) but the effect on the GDP would be less than 0.6%. And that is assuming that China can do without the goods and would not buy them anyway without the higher tariffs. Even though it is what you read almost every day in the financial news, to assert that this loss of exports would have any economic effect on the U.S. is absurd. The theft of the intellectual property of U.S. based companies is much more worrisome than the sale of $130 billion of goods.

There is no question that you can find specific examples of companies that would be hurt by tariffs. But once again, while it brings great pain to a specific company, the economic effect to a legendary company such as Harley Davidson is practically nothing for the long-term growth in the U.S. economy. However, the loss of $500 billion in sales to the United States from China would have a severe economic effect on China, and that is the reason why a deal will be reached. There will be high profile reports going back and forth, but at the end of the day, China needs us a whole lot more than we need them.

We received news on Friday that the economic news continues to improve on a monthly basis. For the last several months, it has been like Christmas with the flood of new economic evidence that the economy is on firm ground. On Friday, it was announced that for the month of June, the U.S. added over 220,000 jobs. Many of the headlines read that the ratio of unemployment increased for the month, but if you saw that headline without reading the details then you missed a major point. Yes, it is true that the unemployment report indicated that the unemployment rate was 3.8% last month and 4% this month. However, the underlying news indicated that over 601,000 new people entered into the labor force during the month.

A lot of these newly employed were college graduates just beginning to look for jobs, but it more likely included a lot of people who had not been looking but wanted to get into the tight market for workers that we are witnessing today. I have written many times that the secret of economic growth is having more people work. For the last year or so, we have been adding more employees to an already strong workforce. The fact that we had over 600,000 new people looking for jobs who will eventually be hired supports the economy even more. As I have often mentioned, each new employee supports his or her family, corner drug store, and creates economic trickle down from each new job. The future economic growth is centered on having each employee work and each new job supporting so many more Americans. The news on Friday regarding the employment report could not have been more encouraging to the U.S. economy.

Next month, I will write a lengthy dissertation on the inverted bond yield which seems to be the one economic factor that is quoted by virtually everyone as a negative. Just to give you a highlight on that issue: don’t believe everything you read without understanding the why. At the current time, the bond yield is not inverted even though it is moving in that direction; however, it could be years before the actual inversion occurs. I will assert that the economic effect of the world is now constraining the upward moving of the long-term bond yields and the economic effect that is only positive for stocks. You will have to wait until next month to enjoy that interesting read – I know you can hardly wait.

Not that is has anything to do with economics, but I thought I would discuss a documentary you might enjoy. I graduated from college at a time when the Vietnam War was actually declining in importance. I was called up six times for the draft but was never taken. While never drafted into the military, I lived through the enormous upheaval that we had in this country with protests of the war. I was in college from 1967-1971 and saw the protests up close and personal. I lived through the assassinations of Martin Luther King and Robert Kennedy within three months of each other and I remember the riots that occurred as a result of those horrific events in the United States.

I came across a series on Netflix by Ken Burns called The Vietnam War. I guess it was originally a PBS series that is available on Netflix where you can watch one episode after the other. Even though it is over 15 hours long, I could not stop watching. If you do not feel complete outrage after watching this series or tear up at the end, you really just do not understand what you are watching.

If you didn’t realize that our government lied to us for all of these years, sending men to die in a war that could not possibly ever be won, then you do not understand the history. I think most people reading this blog might not even remember that time frame or the hypocrisy that was our government during these years. If you are interested in knowing the inside history of these volatile years, I would highly recommend that you devote a few days to watching this series from beginning to end. The last couple segments are the most interesting since they bring the story up to date, but you really have to see the pain and suffering of the initial episodes to understand the conclusion the series has come to in recent years.

Also, this month, we received a national recognition that made us proud. We were voted one of the top 300 RIA (Registered Investment Advisor) firms in the United States. I dare say, there are at least 300 RIA firms in Atlanta alone, so this means quite a lot to us. This also follows the two additional awards that we received over the last few years. For further details, please refer to the blog posting from last week.

I am often asked what distinguishes an RIA from a broker or adviser, such as banks and major brokerage houses. The difference is that we are required to be your fiduciary and they are not. We cannot sell you products in which we would benefit while they do. Given that they are in direct conflict of interest with your interest, by definition, it always amazes me that people use banks and large brokerage houses for investing. Since their financial interests are clearly not yours and while they are not your fiduciary, why one would ever invest with anyone other than an RIA makes zero sense to me.

In any case, we are certainly proud to have received three national recognitions for a company that I started 38 years ago, with the sole intention of simply paying my bills for the next 12 months. I believe the national recognition comes from really hard work from my partners and staff as well as the satisfaction of our clients. When your clients make money, your assets under management expand and your reputation improves. Again, we are very honored to have received these great recognitions over the last few years.

As we enter into the second half of the year, the economic landscape could not be brighter. Corporate earnings will be up significantly because of the higher economy and lower taxes. I cannot see interest rates increasing dramatically given that international bonds are significantly lower than the already high rates in the United States. And the economy just continues to get stronger with GDP likely to be up over 3% in the second quarter of 2018; I still feel very confident that we will reach our double-digit growth projection for 2018. Therefore, we have the trifecta of economic conditions that lead to higher stock prices: increasing earnings at an accelerating rate, interest rates that are low and not materially changing over time, and an economy that continues to grow at all levels.

Once again, we invite you to come visit us during our slower summer months, while we have time to catch up, discuss your goals and whatever financial concerns you may have.

As always, the foregoing includes my opinions, assumptions and forecasts. It is perfectly possible that I am wrong.

Best Regards,
Joe Rollins

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