Move Forward, But with Caution



Probably one of the worst consequences in all of this rhetoric over trade in the past year is that the markets have become dominated by daily stories over the trade war and who tweeted what. What has been lost is the focus on individual businesses. This is both a good and a bad thing of course, as it has created opportunities in some very good businesses that we’ve been able to take advantage of. The downside though is that it can take a psychological toll to watch your statements in the red, even if you know that you own some good businesses that will eventually make you money.


There are some things which currently concern me about the current market environment. This is not to say that these are definitely going to lead to a recession, but they are concerning enough that they give me pause when trying to buy too aggressively at the moment. They are as follows, in no particular order:


Trade War

Despite the fact that the US and China seem to be moving in the right direction this week, we all know that this sentiment can turn on a dime. What hasn’t changed this week is that the US has levied tariffs on over $500 Billion of Chinese goods and that the Chinese have responded with tariffs of their own. Without getting into specifics, this is a big problem for the global economy and is leading to slower growth, and perhaps more importantly, lower business confidence, which is more important for future investment.


The idea that we can seamlessly move manufacturing back to North America or to other countries in Asia is really oversimplifying things. That will happen, but it will take a lot of time, investment and work to achieve. It is unlikely that the US will see any meaningful return of manufacturing jobs as a result of these tariffs. Wages for American workers are simply way too expensive in many manufacturing industries to compete with some Asian countries, including many countries other than China. In the meantime, there are going to be a lot of growing pains and ultimately higher costs to North American consumers if the trade war is not resolved.


In the short term, China’s currency has been devalued a bit and they’ve also introduced more stimulus into the economy to try and offset the effects of the tariffs. These measures will probably not work in the long term as they lead to higher government deficits and lower productivity in the economy. Similarly the US has introduced subsidies for their farmers who have been hurt by tariffs. You can’t subsidize your economy into prosperity (see my next point). If these temporary measures prove to be permanent, we are all going to be poorer for them.


Government Debt

While this isn’t as much of a problem in Canada, both China and the US have a massive government debt problem. They have both spent the last ten years running massive government deficits in a long period of economic expansion. This is very dangerous because when there is inevitably a recession, there will be less ammunition left to fight the downturn with increased government spending, which is what both countries did in 2008. This leaves us with the possibility that the next recession will be worse than it needs to be.

One thing is certain, the current level of deficits in the US are unsustainable and barring rapid economic growth (which looks increasingly unlikely) they are going to lead to problems down the road which will be bad for the global economy.


This is all without discussing the government debts of many European nations, which are on a whole other level of awful. This is a big problem with no obvious solution.


Bonds Providing Negative Yields

This is kind of related to the previous concern over government debt, and ironically could prove to be a solution to it (if the government can issue debt that pays them, is debt really a problem?). The reason why negative yielding debt makes me worry is that it doesn’t make any sense, and I don’t think anybody has a good understanding of what the long term consequence will be. Why would anyone loan money with the prospect that they’ll get repaid less than what they lent in the beginning. It’s not rational.


Unless of course you think every other investment is going to be that much worse…

This isn’t limited to governments. There is a bank in Denmark which is offering a negative rate mortgage. The interest rate on the mortgage is -0.5%. The bank still charges fees which they will earn a profit off of, but essentially you will have no mortgage costs over the term of the mortgage and you will actually have to repay less than what you borrowed. This is crazy!


I have no idea where this will end up, and that’s the problem. I don’t think anyone has any idea where this will end up. However, I can envision some potentially really negative consequences of this, including runaway inflation and painful but necessary interest rate hikes by central banks which will be very bad for the economy and for the markets. Of course we can’t say for sure that will happen, but we also can’t rule it out. In a world where borrowing money is better than free, then money loses all of its value. If that happens then inflation shouldn’t be far behind.


What Do We Do About This?

I have more things I’m worried about in the global economy but I don’t want to completely ruin your day. What would probably be more useful to you is to tell you what to do about all of these potential problems.


Well as many of you who read these blogs regularly, the best thing we can do is to stick to what we’re already doing, which is buying great businesses, with enduring competitive advantages, at fair prices. If we do this, we will continue to do well, in spite of what the wacky world economy will throw at us.


This also goes for your financial planning. If you are at or near retirement, then this may not be the best time to be investing all of your money into a small cap oil and gas business. While it may work out in the long term, you might not make it long enough to benefit from it. As the famous economist John Maynard Keynes once said “in the long term we are all dead”.


The more prudent course of action for most investors is to make sure they have a proper financial plan in place which properly itemizes their goals and sets out concrete and realistic steps to achieve those goals. If you have a financial plan in place, the plan should dictate how aggressive your investments should be. While it’s important for investors with a long term time horizon to maintain a healthy share of their portfolio in businesses like the ones I’ve described above, short term spending needs are also important, and they will likely require an investment other than stocks.If you have questions about this, you should talk to your financial planner.


This does not mean that investors should sell all of their stocks and hide in GICs or bonds. This would be a very bad investment decision in the long term. The best long term investment will remain high quality businesses (including some small cap oil and gas companies). For this reason it is very important that investors still maintain a healthy share of stocks in their portfolio. Still we need to be prudent. The best way I can sum up my advice is in the words of one of the world’s best investors, Howard Marks. We should “Move forward, but with caution.”


- Craig White, BA, LL.B., CIM


Craig White is an Investment Advisor at the award winning firm Endeavour Wealth Management with Industrial Alliance Securities Inc. Together with his partners he provides comprehensive wealth management planning for business owners, professionals and individual families.


This information has been prepared by Craig White an Investment Advisor for Industrial Alliance Securities Inc. (iA Securities) and does not necessarily reflect the opinion of iA Securities. The information contained in this newsletter comes from sources we believe reliable, but we cannot guarantee its accuracy or reliability. The opinions expressed are based on an analysis and interpretation dating from the date of publication and are subject to change without notice. Furthermore, they do not constitute an offer or solicitation to buy or sell any of the securities mentioned. The information contained herein may not apply to all types of investors. The Investment Advisor can open accounts only in the provinces in which they are registered.

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