Battling History

The Dow Jones Industrial average has fallen 10% from its January peak of 26,616 and volatility has returned in force. The Dow has experienced 28 days with moves of more than 1%: 14 up, 14 down.  In February, the market fell more than 4% twice.

The VIX, a measure of volatility, has increased 114% this year, peaking at 50.3 in February. By comparison, it reached 80 in October 2008. The VIX, also known as the fear index, spikes when investors get nervous and frightened.

The down drafts and volatility spikes have been attributed to Trump’s proposed trade tariffs.  He currently wants to apply $100 billion in tariffs on Chinese imports.  He originally wanted global tariffs on steel and aluminum but has backed off on this and has carved out certain countries like Canada and Mexico.  Mr. Trump has said, “Trade wars are good, and easy to win.”  In a recent interview with the radio show Bernie and Sid he added: “We’ve already lost the trade war. We don’t have a trade war, we’ve lost the trade war.”  He continues, “I’m not saying there won’t be a little pain, but the market has gone up 40 percent, 42 percent so we might lose a little bit of it. But we’re going to have a much stronger country when we’re finished.”

The Dow Jones is up 25% since the Presidential Election and 239% from the March 2009 low so giving some profit back isn’t all that bad, is it?  If the market were falling because of poor fundamentals or lackluster earnings, then a little profit taking wouldn’t be a concern.  However, this isn’t the case as investors are focused on the specter of a trade war coupled with rising rates.  These two items may be too much for the market to bear.

Fortunately, or unfortunately, we have some case history with tariffs.  During the height of the depression and a few months removed from the stock market crash on October 29, 1929, the Smoot-Hawley Tariff Act was passed in June 1930.  This act applied tariffs to 20,000 imported goods.[1]

On April 15, 1929 President Herbert Hoover said, “Such a tariff not only protects the farmer in our domestic market, but also stimulates him to diversify his crop.”[2]

“In May 1930, one thousand and twenty-eight economists signed an open letter urging the president to veto the legislation – and published it in the New York Times.”[3]   The economists added that “many countries would pay us back in kind.”[4]

World economies suffered, and banks collapsed.  The Fed Reserve raised interest rates in 1928 and 1929.  The Fed was decentralized in the 20s and didn’t become a voting body until 1935. Two years after Smoot-Hawley passed, U.S. imports dropped 40%.[5]  Two dozen countries retaliated, and our imports and exports fell by two-thirds between 1929 and 1932.[6]

The Reciprocal Trade Act of 1934 gave FDR the ability to negotiate bilateral trade agreements allowing him to reduce tariffs.  This act, along with World War II, has been credited with improving our economy, restoring global trade and ending the depression.[7]

The current rhetoric is being described as a negotiating tactic designed to bring fair and free trade to China and the United States.  I hope this is the case because trade wars can escalate quickly.  Forrest fires always start with a little spark and if left unchecked, can spread to thousands of acres.

If we do engage in a prolonged trade war you won’t have to worry about the Fed raising rates because they’ll fall like they did during the Great Depression. During the Great Depression stocks, interest rates and inflation fell while T-Bills and long-term bonds rose.

Here’s how these items performed from 1929 to 1932.

The S&P 500 fell 84.8%.

Inflation fell 25.4%.

Long-term bonds rose 19.6%.

T-Bills rose 9.2%.

I’m a believer in the invisible hand and I’m hopeful China and the United States can avoid a trade war.  Hope is not a strategy so prepare yourself for more market turbulence as these two economic super-powers battle each other through social media.  The best way to inoculate yourself from the market’s turmoil is to follow your financial plan and diversify your assets.

“History doesn’t repeat itself, but it often rhymes,” ~ Mark Twain

 

Bill Parrott is the President and CEO of Parrott Wealth Management an independent, fee-only, fiduciary financial planning and investment management firm in Austin, TX.  For more information please visit www.parrottwealth.com.

4/10/18

Note:  Past performance is not a guarantee of future returns.  Your returns may differ than those posted in this blog and investments aren’t guaranteed.

 

[1] https://en.wikipedia.org/wiki/Smoot–Hawley_Tariff_Act

[2] The Forgotten Man by Amity Shlaes, 2007

[3] Ibid

[4] Ibid

[5] Ibid

[6] The Editors of the Encyclopedia of Britannica, 4/8/2018.

[7] https://en.wikipedia.org/wiki/Reciprocal_Tariff_Act

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