Perspectives on Service, the China Deal, Brexit, Iran and Interest Rates

 

First of all, let’s take a moment on this Memorial Day weekend to honor those who protect our nation and make our lives and liberty possible, especially those who have made the ultimate sacrifice for us. We owe them a debt we can never repay, but we can let their example of service inspire us to serve in some important way. All of us have that opportunity.

Contemplation of the service of these brave people can provide us with perspective that is useful, even as we consider markets, economics and international politics. I find myself much less obsessed with every twitch of the market or every new story about China trade issues or Brexit when I consider how lucky I am to be an American and to have had the opportunity to serve in our armed forces. I was not called on to sacrifice very much, other than a few years of my time and some creature comforts, and I got far more out of my active duty time in the Marines than I put in. Every way I look at this, I know I am blessed, and that others have given far more.

What’s up with China?

Our CIO John Bussel wrote “The China Syndrome” a couple weeks ago, discussing the trade issues and problems. If you have not read it, I recommend it; it is short and right on point. I won’t go over the same ground here, but instead briefly discuss another aspect of the global conflict with China, one that reminds me of some of my experience in service during the tail end of the Cold War.

Amidst all the hand-wringing about a trade war, there is precious little coverage of aggressive Chinese military activities, including the building of artificial islands in the South China Sea [1], islands which have become military facilities and the basis for claiming most of the South China Sea for China, essentially claiming waters from several neighbors and international waters as well. They have already started defending them, as countries like the US, India, Japan and The Philippines regularly sail ships through these waters to assert the rights of all ships to sail through international waters.

It reminds me of the way these things were done during the so-called Cold War. The general public seemed unaware of conflicts; they certainly were not getting news coverage. But at sea, in the air, and in many remote (and not so remote) places on the ground, there were aggressive actions putting lives at risk and potentially leading to serious conflict. So, it is here, low level attacks and some limited fighting, as China pushes as hard as it can without triggering something big and damaging to their interests.

I mention this because trade, for China, is part of an integrated long-term strategy. Anyone who hopes to understand how these issues unfold needs to keep that in mind. China is not a free country in which various interests contest openly for temporary power, where new leaders replace current ones every few years, and where the well-being of people and businesses weigh heavily in decision-making. They fully expect their top-down authoritarian government to strategically outlast opposition from democracies, which typically find maintaining a long-term disciplined strategy more difficult. We can expect this to be a very long struggle. I also think, just maybe, we can expect to make some progress and avoid disaster, muddling through as we have so many times before. [2]

Brexit, interest rates, etc.?

And what about stocks? They seem to hang on every word coming out of trade negotiations, but are they really? True, they have been declining for a few weeks now, and issues related to Chinese telecom giant Huawei create very complicated issues for all kinds of technology companies, and for governments everywhere. Trade issues mix with serious national security concerns, in light of China’s strategic plans and the tactics they employ. And what about 5G?

I am inclined to believe that markets are wiser than many suspect and they understand the difficult long term issues here. They also understand the posturing and bluster that are often part of negotiations and take them with more than a grain of salt. It is also interesting to observe that markets might be more afraid of the Fed than they are of China and a trade war–we saw how sharply they declined in December when the Fed followed through with another rise in the Fed Funds rate. We can never be sure of exactly what causes what in the markets, but the Fed certainly appears to carry a lot of weight.

After seemingly scaring the pants off the markets in December, the Fed has become extremely conciliatory, apparently reversing the hawkish stance they had been taking. Stocks rebounded nicely in Q1, as we saw, and we are also seeing interest rates declining, here and abroad.

The ten-year treasury note fell to 2.30% [3] to end the week, the lowest level since 2017. So, we have essentially just seen interest rates fluctuate for a couple of years; we earned the coupons as equities rose nicely. There were people recommending getting out of bonds, seeming to forget the critical risk control they provide to the portfolio. People were reminded of that in December, when stocks tumbled. The bonds may not have yielded a lot, but they are part of riding out the rough patches, so you are fully invested for the recovery which often follows.

Bring it home

Yes, we have other turmoil abroad as well, from Brexit and Theresa May’s resignation in the UK to Iran’s threats and overall weakness in European economies. We saw some weak US numbers recently. But we are not seeing anything likely to derail our muddle through scenario just yet.

A little slowing in growth in the US is not a disaster, especially not with record low unemployment and growth in wages as well as in GDP and profits. Net of all the ups and downs this year, the S&P 500 is up almost 14% [4], an excellent year so far.

So be of good cheer and remember our fallen brothers and sisters this weekend.

Best,

Roger Hewins

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1 Heydarian, Richard Javad. “The Conflict to Come in the South China Sea | Article.” Asia Times, Asia Times, 22 May 2019, www.asiatimes.com/2019/05/article/the-conflict-to-come-in-the-south-china-sea/.

2 To be clear, I am not in any way suggesting we become more authoritarian in order to better counter these challenges. I am just trying to see and acknowledge reality as it is. We should be grateful every day for living in such a successful republic. For all its many shortcomings, our republic is a priceless gift from our predecessors, and we should cherish it and pass it on to the next generations.

3 Kruger, Daniel. “Treasury Yields Fall to Lowest Level Since 2017 Amid Worries on Growth, Trade.” The Wall Street Journal, Dow Jones & Company, 23 May 2019, www.wsj.com/articles/treasury-yields-fall-to-lowest-level-since- 2017-amid-worries-on-growth-trade-11558622545.

4 Source: Morningstar Direct, data as of May 24, 2019.

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