Humpty Dumpty Had a Great Fall
In the last couple of weeks, even the most passive investors have been shaken by the volatility of financial markets. The constantly shifting headlines surrounding the US administration’s trade policy have sparked a frenzy of trading which has pushed asset values around worth trillions of dollars.
In just a matter of four weeks, the S&P 500 has gone from trading down 6% to 10% from its all-time high, to down almost 19%, to now down just under 13%. Similarly, the much less volatile bond market has had its fair share of eyebrow raising moments, with the yield of the US 10-year note going from a 4.23% yield to 4.37%, then down to 4.0%, and now back up to 4.45%. Such yield swings equate to as much as 6% or more swings in the value of bonds, a very large move for the “safest” asset class. Riskier fixed income assets, such as high yield debt, have naturally fared even worse, with yields increasing as much as 1%, implying an 8%+ price decline.
The Draconian tariffs announced by the Trump administration on April 2nd launched a selling pressure that was only reversed by the April 9th announcement of a partial 90-day pause. The equity market’s resulting rebound was even more volatile and less orderly than the selling it reversed.
Warren Buffett has taught us that in the near term the stock market is a voting machine, whereas in the long run it is a weighing machine. The challenge for investors today is to gauge whether the daily vicissitudes of the market accurately reflect the longer-term outlook for the US and global economy. Are global tariffs here to stay; are we back at the ex-post ante of “free markets”; will it get worse before it gets better; are we certain to have a recession manufactured by trade policy?
If April 2nd represented Humpty Dumpty falling off the wall (was he pushed?), then does April 9th represent all the king’s horses and all the king’s men putting him back together again? We believe that something fundamental changed on April 2nd that even a 90-day tariff pause (or longer, or even made permanent) cannot undo. There are no mulligans in investor sentiment, in our opinion. We do not believe the equity market’s lofty valuation of late February can be re-achieved in this cycle. Investors fully weighted in equities at that time, will no longer be as sanguine about the outlook going forward – they will look to sell on strength. Foreign holders of US debt are more likely to sell, rather than keep buying, especially if they have fewer dollars coming in from shrinking exports to the US.
We do believe that some of the near-term market volatility may abate, but brace for a prolonged period of sideways movement and a possible resumption of volatile markets, even under the most optimistic scenarios regarding trade negotiations. Our outlook for bonds remains relatively unchanged, even though its drivers may have shifted a bit. While we expected persistent, above target inflation from loose monetary policy to keep the US 10-year note yield at or above 4.5%, it is now higher prices from tariffs and potentially less foreign appetite for our bonds that may achieve the same result. The Fed’s willingness to support bonds means anything much above 4.5%-5% may be short lived.
For those that believe that the days of US world economic dominance are behind it, with the US dollar as the preferred currency of global reserves on the way to history books, we do not choose to be this pessimistic. Despite the advent of digital currencies, or currency baskets such as the SDR (the Special Drawing Right currency basket developed by the International Monetary Fund), we do not foresee a world where trade among third party nations occurs in a myriad of currencies, when the global commodity and transportation (sea and air freight) is quoted in US dollars. Rather, we believe longer term the US will still be one of the best risk-adjusted markets in which to invest based on scale, homogeneity, rule of law, and relative GDP growth potential.
After all, the final verses of Humpty Dumpty are:
Humpty Dumpty counted to ten
Humpty Dumpty built up again
All the king’s horses and all the king’s men
Are happy that Humpty is together again
Please feel free to reach out to us with any questions or comments.
Dimitri Triantafyllides, CFA
Chief Investment Officer
dtriantafyllides@forestcapital.net704-533-9876 (office)
This report is for your information only and is not an offer to sell or a recommendation to buy the securities or instruments named or described in this report. Additional information is available upon request. The information in this report has been obtained or derived from sources believed by Forest Capital Operating Company, LLC (Forest Capital) to be reliable, but Forest Capital does not represent that this information is accurate or complete. Any opinions or estimates contained in this report are current as of the date of the report and are subject to change without notice.