If you study finance and statistics, there is the inevitable introduction of the prisoner’s dilemma. In case you are not familiar with this, it is the imaginary situation of a person caught committing a crime with his group of friends. All are separated and interrogated by the police. Each individual faces a choice of not telling on his friends, and if that happens, they all could potentially be released. If they do tell, they save themselves the longer sentence and get a milder one. If they don’t tell and others do tell, then they face a potentially very long prison stay. It is a teaching of odds and potential outcomes. Let’s move to the next area, which I am confident you are also aware of, that being the negotiating tactic of good cop and bad cop. It is the age old technique of having one sales person be very friendly to a potential buyer, and then the manager taking the opposite tact and holding a very hard line. It is used to negotiate a better deal and is a strategy many use in a wide variety of situations. More on this later.
As your diligent investment advisor, it is important to pay attention to all kinds of things related to finance. One such area is how the end of the world crowd is viewing events these days. Most of the chatter in this realm revolves around the bond market. You know, the one with 16 trillion dollars of negative yielding instruments which litter the world. The argument by this group revolves around buying more bonds. Keep in mind, many of these individuals come with a white shoe, Wall Street pedigree like Goldman Sachs, along with high profile hedge fund experience. They have a trading mentality, with a background in bonds. The trading class has one very important advantage that most individuals and firms don’t have, which is access to plenty of credit. The clearing firms or prime brokers allow them to place trades where they can use up to one hundred times their initial capital. Not three times leverage, not five times leverage, not ten times leverage, not twenty times, one hundred times. On ten thousand dollars, you can make a trade of up to 1 million dollars of value. Now, these ‘chosen ones’ don’t trade with a few thousand smackers, it’s for a lot more money, think hundreds of millions. As such, if they are correct, they score big. If they are wrong, well, they have probably done nicely in the past so they can handle a loss. They believe buying bonds is the proper positioning because interest rates are headed lower, not higher. Global central banks are forced to lower in order to stave off a global recession, and this includes our Federal Reserve, led by Jay Powell. So this is the end of the world trade, buy anything related to lower interest rates across the globe. As part of the thesis, the ideal instrument would be Eurodollar futures, where there is plenty of leverage available. Now let’s turn to what transpired last week.
Equity markets had a good few sessions, and were digesting Fed Chairman’s Jackson Hole Wyoming remarks about ‘acting appropriately in order to sustain the expansion.’ At this point, the self proclaimed ‘Chosen One’ chimed in. Early in the week, the Donald announced he would like to buy Greenland, and they took a pass, ‘thank you’ fearless leader. Next he turned to members of a religion, that being anyone of the Jewish faith. They were told to vote Republican because of the Democrats posture towards Israel and pro BDS policies (boycott, divest, sanction). However, on Friday, the telling blow for market participants was the attack on Jay Powell. President Trump views him as an enemy, just like the President of China, Xi Jinping. Not stopping there, Mr. Trump then ‘ordered’ American companies to start looking at alternatives to China and bringing their companies home. It didn’t take long for the financial world to notice, and low and behold the Dow wound up being down a cool 625 for the day. On the surface of it, you might wonder if Donald had suffered a bit of heat stroke, which would be understandable given the hot weather the country is enduring. Let’s go back to where we left off at good cop, bad cop.
You see, negotiations with China are scheduled for September regarding ongoing trade matters. Mr. Trump decided over the weekend another five percent increase in addition to the already scheduled 25% tariff on Chinese imports is now warranted. Meanwhile, his economic team continues to crow about how well things are going with China. Hmmm, bad cop, good cop, good cop, bad cop, seems familiar, right? The Art of the Deal? Maybe. Maybe not. Conversely, if the Donald sees how the market reacts to his negative comments regarding China, why wouldn’t he just talk up how well things are going on a continual basis, if all that matters is having the stock market rise? Let’s also consider the reaction of market participants. Given where global interest rates are and the emerging theme of an ongoing global slowdown, if not recession, these frequent selloffs show the sell first, ask questions later approach which has pervaded markets ever since 2008. We have seen it repeatedly, risk is avoided, and bond yields reflect it. Economic conditions in the United States don’t warrant such rich valuations in fixed income markets. So what is an investor to do?
If you have a well diversified portfolio, with good management teams and strong businesses which operate efficiently and consistently grow, there is a high probability that over a long period of time, your asset value will increase. The Chosen One is not making it easy on us, which will probably be the case for as long as he is the President. As far as I am concerned, Mr. Bono’s comments are on the money. In the meantime, I hope you enjoy the last week of summer and the long weekend.
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Yale Bock, Y H & C Investments, its clients, and the family of Yale Bock have positions in the securities mentioned in the blog, Investing in securities involves risk and the potential loss of ones principal. Past performance is no guarantee of future results. All investment decisions should be considered with respect to ones risk tolerance, return objectives, liquidity needs, tax considerations, and one’s overall financial situation. The fact that Yale Bock has earned the right to use the Chartered Financial Analyst in no way means or guarantee performance better than market indexes.