Trying To Explain Market Activity

There are some days when we struggle to explain the market activity. Today is not one of them.

Markets are not fans of tariffs. They are taxes, which are loathed, and they throw sand into the gears of an efficient world trading system. Companies have spent the past few years developing North America-wide sourcing and selling networks, facilitated by NAFTA. That trade treaty is due to be replaced by the highly similar USMCA, though it has not yet received Congressional approval. In the course of an evening, the US/China trade battle gained a second front.

Many of you know that I am a fan of older movies and that I find explanatory lessons in some of them. Today I was reminded of a speech given by real-life economist Ben Stein in the film “Ferris Bueller’s Day Off”:

“In 1930, the Republican-controlled House of Representatives, in an effort to alleviate the effects of the… Anyone? Anyone?… the Great Depression, passed the… Anyone? Anyone? The tariff bill? The Hawley-Smoot Tariff Act? Which, anyone? Raised or lowered?… raised tariffs, in an effort to collect more revenue for the federal government. Did it work? Anyone? Anyone know the effects? It did not work, and the United States sank deeper into the Great Depression. Today we have a similar debate over this.”

The Smoot-Hawley tariff cited by Dr. Stein was notorious for imposing added costs to an already fragile economy. It is now obvious that the policy was misguided, as it was imposed to solve problems not directly related to trade. One can certainly argue that the Chinese tariffs are specifically related to trade imbalances that have grown over prior years, but last night’s Mexican tariffs are being imposed to combat something completely different – immigration, not trade.

Last night, shortly before the President’s announcement, I did a radio interview where I stated that the current market paradigm is better explained by “sell the rips” rather than “buy the dips”. The show’s timing was certainly auspicious, but my analysis was based upon the observation that moving averages were turning lower, and it is generally more profitable to be on the sell side of markets with declining highs and lows.

However, the hedge is different in this environment. When buying the dips, it is often prudent to hedge one’s downside risk. When selling rallies (or “rips”), the opposite is true. It becomes prudent to hedge the upside, and it behooves investors to do so in this stock market environment. If the President can start trade battles more or less at will, thus it is also within his purview to end them quickly. For much of this year’s first quarter, equity investors bought shares after a string of unsourced rumors of positive developments on the trade front. If there is an actual deal, the market can reverse its losses in a hurry. Sellers who are following downward momentum need to be cognizant of that.