What is Your Plan When the Markets Punch You in the Mouth?
What to do with rising interest rates, robust corporate profits, massive tax cuts and a self-inflicted trade war
Mike Tyson was a fierce boxer with a savage killer instinct, known more for his antics and brawling than for his eloquent words. That is an understatement. Prior to a fight with Tyson, challenger Tyrell Biggs told reporters he had a plan for winning the fight. When asked about this, the Los Angeles Times reported Tyson's famous response:
"Everyone has plans until they get hit for the first time."
Although this is an old fighting adage, it can be applied to multiple situations in life. This may not be truer than where we are now with the stock market. For the investors who actually have a plan, there is not a playbook for rising interest rates, robust corporate profits, massive tax cuts and a self-inflicted trade war. How are current conditions going to punch your investment portfolio in the mouth?
RISING INTEREST RATES
Yes, you can lose money in bond funds and probably have at times over the last year. Many investors use bonds as a safe haven for their portfolio. Unbeknownst to most, bond funds have an inverse relationship to interest rates. As interest rates rise, the price of bonds declines. With Fed Chair Jerome Powell increasing the Fed Funds rate, mortgage rates inching up and a late-stage economic cycle, a surprise decline in even the most conservative bond-heavy portfolios is not out of the question.
The likelihood of an all-out trade war between the United States and ta is up for debate, but markets do not like uncertainty. A trade war is an economic brawl between at least two countries. Each nation tries to protect its own economy by raising import taxes, called tariffs. The impact can reduce growth, slow the sale of goods across borders and increase prices for consumers which results in lower profits for companies. This can ultimately cause a slow down in the economy with higher unemployment while sending the stock market plummeting.
In an interview with CNBC earlier this year, billionaire investor Warren Buffet was asked about a trade war, and warned: "...it's counter to the interests of us. It's counter to the interests of China. It's counter to the interests of every country in the world. The world thrives on trade.”
In the midst of a robust economy with American’s 401(k)s invested in stocks and confidence high, even the best investment plan may not be enough when the world’s largest economy is lacing up to fight with the world’s second largest economy.
America has experienced multiple tax cuts throughout history. Although economists do not agree, many say tax cuts stimulate the economy which helps increase the stock market. Most recently, Ronald Reagan slashed taxes in 1981, and George W. Bush signed two major cuts into law in both 2001 and 2003. These tax cuts came during or on the heels of a struggling economy and stock market decline.
In December 2017, the Tax Cuts and Jobs Act was passed into law – a time in which America had the lowest unemployment in years, a robust economy and a stock market on a record bull market run. These are the good ol' days and tax cuts have provided an economic exuberance not seen since the tech bubble burst nearly two decades ago. The most important distinction of this tax cut is the slashing of corporate tax rates boosting the profits of corporations and their stock prices. If nothing else, history has taught us the economy is cyclical. As Americans pour money into the stock market during the good times, the markets have an evil way of correcting not only prices, but the risk tolerance of investors.
CHANGE OF PLANS
Many Americans maintain an investment strategy of ignorant bliss. Others have a portfolio plan which is outdated, insufficient, or is plainly a bad plan. The stakes are simply too high not to care or be prepared.
In a 1957 Readers Digest article, Allen Saunders is attributed with saying “Life is what happens to you while you’re busy making other plans.”
In the same vein, your portfolio returns and financial goals are what happens when you are living life. Most Americans are spending more time annually planning a family vacation then planning an investment strategy and financial goals. History has taught us, that the markets are going to punch us in a face. Those investors with a plan will have a head start, but better be ready to adjust the plan during adverse economic conditions. Life happens; the markets are volatile; and investing is not linear.