Acknowledge the hurt
There is no denying the obvious. March came in like a lamb and went out like a ferocious lion, which hurts. The point of being a Rational Investor is not to let your emotions drive your decisions – positive or negative. The challenge will be to channel poet, Rudyard Kipling, to “…keep your wits about you while all others are losing theirs.”
Be thoughtful
It starts with critical thinking. What is the severity of the threat? How does a Rational Investor separate the signal from the noise? What is the tactical short-term impact? What is the strategic long-term impact? Market timing has historically had a lousy track record.
Tariffs are not the single issue
In our view, the tariff headlines are mostly noise. The actual outcome will likely be less severe than currently feared, with an expected focus on China. And after the latest “outrageous ask” there will be rounds of dealmaking resulting in lesser tariffs. This is not the end, rather the end of the beginning. After all, what lasting memories still exist of the 2018-19 “Trump Tariffs?” In a market that was concentrated in premium prices, this is a harsh reminder that perfection is a risky, fleeting perception.
The strategic issue
While we do not think this issue is a recession (though tariffs will contribute to slow GDP growth this year), we believe it’s stagflation – the combination of slow growth and persistent inflation. This is likely to begin with GDP growth of less than 2% and inflation of more than 3%, which would contribute to a drag on the real rate of return (the after-inflation adjusted result). So, where does it go from there? That remains to be determined, but our take is that in January of 2022 the economy shifted into a new secular interest rate cycle with the prospect of rates rising over years to come.
There is a better strategy to cope with stagflation
For equities, the component parts are as follows:
- Do not replicate the market; differentiate your portfolio from it.
- Focus on high quality (especially the balance sheet).
- Focus on reasonable price (premium valuations are at risk).
- Be proactive about risk management.
- Persistent growth matters.
- Position yourself to make progress in the headwind. Do not be complacent about coasting on a [the old] tailwind. (The mega tailwind was the 40-year secular cycle of disinflation and declining interest rates, which, in our opinion, ended three years ago).
- Be wary of rose-colored glasses and assume that earnings estimates have had an optimistic bias.
- Preserve your purchasing power.
For bonds, focus on short maturities, good credits, and the capacity to average up on your portfolio yield as rates move up. Avoid intermediate and long maturities as they tend not to defend.
There are several factors contributing to the risks of higher interest rates. The first is de-globalization (Trump tariffs are type of codification of de-globalization), others include wage pressures related to low levels of labor participation, but the biggest factor is the impact of the massive scale of our growing national debt.
Be opportunistic
The tariff headlines will likely, albeit slowly, fade with a period of “deal making.” So, look to be opportunistic amid this difficult reaction. Focus on defending against the larger, longer-term risks because Rational Investors play the long game.
