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A Note on Market Volatility

PMA Investment Committee
Published on April 5, 2018

After many months of calm, volatility in the market has returned, as it always does, this time provoked by trade tensions. This is now the fifth note we have sent to clients in response to an upsurge in market volatility since August of 2015. Back then, it was uncertainty in the Chinese economy; in January of 2016 we had the worst five-day start in U.S. stock market history; in June of 2016 the voters of Great Britain spooked the world with their vote on Brexit; and in November of 2016, American voters elected Donald Trump. Five notes in a little less than three years. There will always be drivers of uncertainty in the market, even as they come at us in different guises – China, Brexit, Greece, tech companies, Trump on trade, etc.

In our November 2016 note after the U.S. election, we wrote:

There is, to say the least, a degree of uncertainty as to how Trump will govern, in particular with respect to his international trade policy, which uncertainty financial markets abhor and which may cause a period of increased volatility particularly if the fundamentals of the international trade regime are threatened.

These words back in November of 2016 may appear understated in the context of recent events, but in fact they were prophetic – President Trump’s recent trade policy creates uncertainty which markets hate, and threatening to upend years of established international trade agreements by tweet is a sure way to exacerbate these tensions.

Is there anything that an investor should do right now?

The PMA investment committee met on March 28 to discuss the market’s reaction to the recent trade action and to decide what, if anything, to do. We do not believe that President Trump really wants to crater the markets, cause a recession, or bring the world economy to its knees. That would be bad for him politically. But after exempting Canada and other allies from the tariffs, Trump took square aim at China, fulfilling one of his key campaign promises and pleasing a key constituency in the “rust belt” states that unexpectedly awarded him their critical electoral votes. He and the Chinese may now be locked in a game of high-stakes poker.

We do not know how this will play out. If the Chinese eventually back down, and ease their rules on joint ventures and the sharing of our technology, Trump will declare victory, tensions will ease, and the volatility may subside, at least until the next unexpected events cause short term investors to flee equity markets. The optimistic view of this is that all this tension will bring parties together and they will work out their differences, similar to the model with South Korea. The pessimistic view is that the trade war will escalate, neither side will compromise, and volatility will continue.

For now, we decided to use any excess cash in our clients’ portfolios to rebalance back into bonds and not put any additional money in stocks, unless a portfolio is well below its target allocation in equities. We will continue to monitor the markets and your portfolios. Let’s not forget that the markets are still up about 30% since the election of 2016, and that until this trade war broke, concerns were about an economy that was doing too well, raising fears of inflation and asset bubbles. For better or for worse, the great wealth generation machine that are modern financial markets come with a price, and that price is frequent bouts of volatility, fueled by the animal spirits and unpredictable nature of human beings, and reinforced by unpredictable politicians, armed with misguided ideas and high-stakes negotiating techniques.

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