The Independent Market Observer

Market Ups and Downs: What's Going On?

Posted by Brad McMillan, CFA®, CFP®

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This entry was posted on Mar 6, 2018 12:45:58 PM

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marketWell, that was quick. After a sharp but short pullback in late January/early February, the market started to rally again. But it was derailed by the announcement—by the U.S. president—of an impending trade war. Then, after an even shorter and less sharp pullback, it seems to have started to rally again (although it is slightly down as I write this). What’s going on?

Will the tariffs happen?

First up, let’s consider the steel and aluminum tariffs. If imposed, they will likely be the first round in a trade war. Other countries and the European Union are already very publicly mulling how to respond in a way that does the most economic and political damage possible to the U.S. Harley-Davidson motorcycles (aimed at Paul Ryan) and Kentucky bourbon (aimed at Mitch McConnell) are two of the potential retaliatory targets on the political side. This kind of tit-for-tat can very easily get out of control and lead to much more economically serious trade restraints. The potential damage remains very real—if sanctions happen.

But will they happen? The Republicans in Congress, and many in the administration, are dead set against the tariffs. Free trade has been a foundation of the Republican Party for decades, and almost all of the senior leaders are committed to it. For Trump to issue tariffs, it would mean going directly against what the party has historically stood for.

This political resistance at least raises the possibility that the tariffs might not happen. Also raising that possibility is the very real—and almost universally appreciated—damage they could do, both immediately and over time. Finally, the president’s tendency to raise controversial issues as negotiating points, only to settle for a more moderate position, suggests that what eventually happens might be very different than what was originally proposed.

Assessing the market reaction

The market reaction, then, initially recognized the very real damage that could be done but also recognized that it might well not happen. Over the past couple of days, Republican politicians have moved into opposition, and the conviction that the tariffs wouldn’t happen appears to have hardened. The market is rallying on the conclusion that the status quo will continue.

As an investor, that makes sense and is pretty much in line with what I concluded last week. Not overreacting at the time was, and remains, the right thing to do. What is also still the case today, though, is that the prospect of damage—if the tariffs do go into effect—is very real. We still need to keep a close eye on this. Two days of recovery doesn’t mean the risk has gone away.

A positive takeaway

There is, however, a more positive takeaway from the past couple of weeks: the underlying upward trend of the market remains extremely strong. In this time, we have weathered a new and more hawkish Fed chairman, the first correction in two years, and the very real possibility of a trade war (as announced by the U.S. president). The important thing is not what has happened but, instead, what hasn’t. The S&P 500 is still within just over 5 percent of its all-time high and has kept moving up from the setbacks. Clearly, it will take more than this to derail the upward trend.

Fundamentals remain positive

That derailment could certainly happen, of course—imposing the tariffs for real could be the first step. But barring that, the fundamentals remain positive. As such, I suspect the risks of a serious market pullback continue to be contained and will remain so until something more fundamental changes. We will continue to watch for just that.

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