Tariffs: A shock to the economic system
Every week, we look for a meaningful and relevant economic or market topic to drive our articles. This week, the choices include a reported agreement between the U.S. and China to hold off on raising tariffs in the near term and a perceived change in the Fed’s attitude on raising interest rates in 2019. These current events have an interesting connection: They both tie into recent market behavior as the result of our increasingly “big data”-driven world—which is linked economically whether we like it or not.
Tariffs: A shock to the economic system
I am going to start with tariffs since it is the implementation of selected tariffs by the U.S. that disappointed markets earlier this year. These tariffs were a significant shock because tariffs, in general, have been declining since the 1930s and have changed very little for nearly 40 years.
Changes to a well-established international trading market, whether needed or not, are generally very disruptive. The disruptions over the past year can be easily seen in many of the world’s stock and commodity (NYSEARCA:DBC) markets.
Besides being an important political and economic tool, tariffs are important to investors because the imposition of tariffs and the uncertainty over future tariffs has a slowing effect on global economic activity. Anything that slows economic activity tends to negatively impact corporate earnings, employment, and eventually stock and home prices.
A slowing of the global economy and a lowering of economic growth forecasts has occurred in recent months since tariff increases became a reality. There is a potential for further slowing should tariffs increase further.
This actual and potential economic slowing has also contributed to the perception that there may be a change coming in the Fed’s planned interest-rate trajectory.
The Fed’s influence on investors
To understand this trajectory, it is useful to know that the Fed and major central banks around the world have supported the economy by maintaining deliberately and abnormally low interest rates for much of the past 10 years.
Coming into 2018—with the economy constructively strong and at full employment, and inflation approaching targets—the Fed was expected to raise interest rates fairly steadily throughout 2018 and 2019. The goal was to raise interest rates back to a level more commensurate with an economy with inflation at or above 2% and statistically at full employment. This is in line with the Fed’s “dual mandate”: to “foster economic conditions that achieve both stable prices and maximum sustainable employment,” according to the Federal Reserve Bank of Chicago.
While the Fed is concerned about other issues, such as economic growth and the relative value of the U.S. dollar(NYSEARCA:UUP), its primary focus is on its dual mandate. The way the Fed most often influences both employment and inflation is through their control of the level of short-term interest rates.
This is important to investors. Investors’ primary investment choice is generally between stocks and bonds. Stock investors prefer low and stable interest rates because low rates spur economic growth, which benefits companies and their investors. Rising interest rates tend to slow the economy, and higher yields compete with the returns from stocks for investors’ capital. Therefore, rising rates are often bad for stocks.
The role of “big data”
This is where I am going to tie in “big data.” According to an article published by Northeastern University, the total data in the world will grow tenfold from 2013 to 2020.
This, I think, will prove to be more revolutionary than evolutionary in the years ahead. Up to the late 1980s, we had limited amounts of data by present standards, and much of that was collected manually. In the decades since, we have collected vast amounts of data electronically in real time, but we have not yet mastered what all of that data means or how best to use it.
In the decades to come, we will not only have vast amounts of data but the ability to use that data to better anticipate events in health care, weather, economics, and many other aspects of life. This means the real-time state of regional and national economies will be more transparent to central banks and investors.
Such transparency also provides central banks the ability to potentially anticipate events in the economy rather than respond to them. If the Fed is going to change the speed at which they raise rates and possibly the level they raise them to, this may be an indication of that new and increased ability to anticipate provided through big data. And while the Fed is still expected to increase short-term rates this month, it is the anticipated increases through next year are coming into doubt.
A dynamically risk-managed approach for now … and the future
In the future, the ramifications of changes in economic policies will be better understood due to the growth of data and our abilities to understand that data. Also, changes in interest rates will likely become more anticipatory than reactive.
“Big data” may result in benefits for political, economic, and interest-rate policy, but what will likely not change are the emotional reactions of investors to news of all types. November was a good example of this. In just 21 trading days, investors took the S&P 500(NYSEARCA:SPY) Index on a journey up 4.89%, then down 6.44%, and then back up 4.85%. All of that distance was traveled in response to the news, yet, for the month as a whole, the Index was up a modest 1.79%.
It is for that reason that I believe in the use of dynamically risk-managed, rules-based, data-driven investment strategies that are designed to seek opportunities to profit and manage risk.
These types of investment strategies have guided investors through recessions, expansions, stock market crashes, economy-crushing interest rates, changes in global political leaders, and even the introduction of a new global currency (the euro). Though the future may be different from the past, many of its challenges will likely be similar—and dynamically risk-managed investment strategies offer the tools to deal with them.
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