Dear BrickStreet Folks:

 

Back in April we sent a commentary along with Nancy’s illustration of our sporty Dow Jones car swerving at 100 miles per hour. Our comment then was, …“if the vehicle is travelling 100 miles per hour on a two lane road and begins fishtailing, the car is more likely than not to end up in the ditch.”

 

We hit the ditch on Wednesday dropping 803 points and followed up with another banged up fender on Thursday dropping 545 points.

 

1,300 points in two days defines hitting a ditch.

 

Now that “when “ we hit the ditch is answered, we get to ask several more questions.

 

1.       How do we get out of the ditch?

a.       Remember this is a ditch not a cliff. There are lots of ways that we get the markets back on track. Back in the days of Ben Bernanke’s Federal Reserve Bank he made it clear… If the market goes down, he would buy Treasuries and increase the money supply. Almost immediately. It got to be so predictable that each time the market sold off between 2009 and 2013 traders were “buying the dip” without hesitation or reservation. Brother Ben would put a floor under the equity markets with more liquidity at each hint of a serious selloff.   Those days are gone. The Fed’s appetite for buying more US debt and mortgages is no longer an available tool for the Central Bank to use.

b.      Educate and recalibrate. For the last six months we have seen some of the technology names… Netflix, Amazon, Google, Microsoft, Facebook and Apple soar to new highs, with no fundamental news to validate their higher valuations. They just seem to be the place to put money. By most metrics, the prices of the shares well outpaced the value of the underlying businesses. Meanwhile, there were a lot of companies getting overlooked and selling at discounts to these few standouts. So as the tops come off of the “go to” companies that rallied over the last year, investing in non tech names will give more broad support to the markets. Professional investors have a keen interest in finding the next wave of non tech heavy industries and move shares of those companies higher.

c.       Let the Fed do their thing. The Federal Reserve is the most powerful single entity that can affect public markets. Part of the current situation is being blamed on the Fed, and their quick pace of raising interest rates since December 2016. Ok… that‘s debatable, but The Fed has no interest or gains no benefit from the public markets crashing. So as they make adjustments to interest rates, markets may adjust accordingly. But the Fed made a commitment to create a “wealth effect” in 2009 which certainly worked for the public markets, and now they are saddled with unwinding that position without causing panic selling or even sharp selling like we witnessed this week. Without being critical, it’s safe to say that The Fed has never been very good at timing interest rate changes that flow well with the daily cycles of US economic activity. But they do come around, and so giving The Fed time to get it right without panic is an excellent mindset to getting us out of the ditch.

2.       What does Tax Reform have to do with the markets?

a.       Sort answer…. A lot. For the first time in over ten years Congress is telling the business community, “We got your back.” As we have written before, this is enormous. The tax code and regulations surrounding the relationship between employers and employees has held business hostage for a long while. Businesses that have heavy labor and physical materials costs have been struggling to survive, while “brain heavy” firms have done a lot better over the past cycle. The tax code speaks directly to those companies that use hard goods and hands on labor to make a profit. Investing in these firms will be very profitable over the next three to five years due to tax and regulation reform.

b.      Incentive to invest. There are many industries in the US that fit the description of hands on. Now that Tax Reform has introduced an opportunity to invest in “things” instead of “apps”… we will see an acceleration of productivity and innovation over the next five years that will allow investors to ride along with those companies that take advantage of a favorable, tangible oriented business environment.

 

3.       Tangible versus Intangible.

a.       This is fundamental. In today’s US economy do we need more mobile phone app designers or more electricians? More economists or more welders? More trombone players or more plumbers? The point here is that a vacuum of skilled labor… and I am saying plumbing is a skilled labor… maybe it’s not engineering, but when your upstairs neighbor’s toilet overflows, we will all agree it’s necessary skilled labor. Lots of publically traded companies rely on skilled labor. Hospitals, auto manufacturers, homebuilders, trash haulers, transportation and distribution companies… all rely on people that can do a physical task. Facebook and Netflix don’t hire a lot of those folks. And this is where the public market money is going to over the next cycle. Our nation is way behind in physical investment, from roads to schools, airports, sewer systems to electrical grid. The return on these investments is much slower than the return on a phone app so the likelihood of a flash rush into these types of companies is not high. But it is predictable that well managed companies with labor and materials heavy businesses will be growing in the next business cycle.

4.       The Global Markets.

a.       The major indices in Germany, Hong Kong, Japan, South Korea and China all topped in February of this year. The thought of trade discussions, whether it was the Pacific deal, NAFTA, or tariffs on Chinese goods all sent lightning strikes through those markets when the world realized that the US had grown teeth when it comes to trade. France and the UK topped in May, for many of the same reasons. The US market took a pause this summer and then flew into new highs last month contrary to all of the northern hemisphere indices. It seemed that we were immune to correction. We know that as the world is more and more interconnected, even as big as our markets are, it is most likely that global investment will rebalance over time.

b.      Global policy is being viewed in a very different light these days. At the end of the day, policy is power. How that policy affects mature public markets is the multi trillion dollar question. We are confident that US policy will continue to be disruptive and also misunderstood and misrepresented in the near future. This will make investors in foreign markets much more defensive and may well give support to our Treasury markets going forward. The US is by far the safest place to invest money, and you, the American taxpayer are the most loyal of all taxpayers on the planet. So US Treasury debt is as solid as it gets for foreign capital to rest.

 

I know this is long winded… and Nancy retired this summer, so no cartoon (Dang!) but the 1300 point sell off this week was long overdue and in our opinion, and has reset the marker for what we see as a fundamental change in market leadership. We wrote about it in 2016. The rules have changed. Congressional policy, The Federal Reserve Bank, capital spending, workforce development, and basic investment is making a U turn. Fully expect the fenders to scrape the ditch wall several more times before this is over. New leadership will come from those companies who have a quick response and access to markets who employ an educated, skilled work force that can deliver with scale and efficiency.

 

Thank you for your continued confidence as we provide advice to build and maintain wealth.