by Connor Darrell CFA, Assistant Vice President – Head of Investments

Geopolitical Update: China & Iran Represent Risks
We have raised our “International Risks” rating to a 7 from a 5 following recent developments in the Middle East and escalating tensions between the United States and China. We continue to stress that geopolitical events tend to have a smaller impact on markets than fundamental economic factors such as GDP, corporate earnings, and consumer confidence, but believe that recent news flow warrants investors’ close attention.

Earlier this month, the Trump administration ordered the deployment of significant military assets to the Persian Gulf, citing intelligence that suggested a rising probability of Iranian attacks on U.S. interests in the region. The Iranian economy is under significant pressure as a result of U.S. sanctions, and there appears to be growing concern within the Iranian government that Donald Trump will be re-elected in 2020. We have already seen multiple instances over the past few weeks where Saudi oil assets were sabotaged, and the general consensus in the intelligence community is that these attacks were carried out by Yemeni rebels on behalf of Iran. U.S.-Iranian relations are at their weakest level in years, with Secretary of State Mike Pompeo and Iranian Foreign Minister Mohammad Javad Zarif never having directly spoken to one another. The lack of a direct channel of communications between the two chief diplomats underscores a growing concern that any potential confrontation may be blown out of proportion and escalate quickly. Any meaningful escalation of tensions in the region would have the potential to de-stabilize oil prices (20% of the world’s oil travels through the Strait of Hormuz on its way to end markets) and further strain the United States’ relationship with China.

The trade negotiations between the U.S. and China have been thoroughly explored in virtually all media outlets, as well as in previous iterations of The Weekly Commentary, but there is another dimension to the discussions which extends beyond trade deficits and trade surpluses; the race to 5G. It has become increasingly apparent that the United States government views the race to establishing and dominating the world’s first 5G (fifth generation) cellular network technology grid as a matter of national security. First adopters of 5G technology are expected to sustain a meaningful long-term competitive advantage, and China is heavily focused on pushing to challenge the United States as the dominant force in the evolution of the world wide web. China’s approach to controlling information on the internet is vastly different from the openness championed by traditional American values, and in many ways, the race to 5G represents a philosophical battleground over the flow of information; one that has continued to escalate in recent weeks.

Shortly after the most recent round of trade discussions fell through, President Trump announced a ban on Chinese smartphone manufacturer Huawei. The ban blocks U.S. companies from doing business with Huawei, and essentially prevents it from accessing key inputs to its manufacturing process (which are produced by American companies). We see this decision as a clear and meaningful step to explicitly hamper China’s advancement in 5G technology and keep U.S. companies on a level playing field (Chinese companies receive direct support from the Communist-led government).  From an investor perspective, a meaningful disruption to the supply chain of technology equipment or additional bans would have the potential to cause volatility in equity markets as companies’ revenue streams are impacted. Even if a trade deal is reached within the next several months, the complexities of the technological rivalry between the two countries is likely to persist and will represent potential challenges for global companies which may be caught in the crosshairs of further policy action. Furthermore, a prolonged period where tariffs are imposed on Chinese goods would likely have a negative impact on economic growth. Recent research published by the New York Fed estimated that the newest round of tariffs could cost the average American household $831 per year. The focus on China and trade has the potential to draw the market’s focus further away from fundamentals and toward the unpredictability of the president’s Twitter feed. Such an environment will be very difficult to navigate for market timers and short-term traders.  In our view, the best defense for this type of uncertainty is broad diversification and discipline. We will continue to utilize The Weekly Commentary to share our thoughts on new developments as they unfold.

How to Deal with Volatility
Over the past 18 months or so, a variety of surfacing risks have taken their shot at derailing the bull market. Chief among them have been the deteriorating U.S./China trade relations, weakening (but not stalling) global economic growth, and of course the ever-present abundance of geopolitical tensions around the world. The market’s reaction to the setback in U.S./China trade negotiations last week led to a rough day of trading on Monday, and many investors were left wondering whether the markets would crater as they did back in 2018. But the fact of the matter is that for equity investors, volatility is to be expected. However, the very presence of volatility is the primary reason that equity returns tend to be higher than other asset classes over the long-term (we can think of returns in this context as our compensation for enduring the higher levels of risk and the stress that can come along with it). So how can we as investors better manage the emotional roller coaster that can accompany this volatility? We offer some thoughts on the subject below:

Understand your situation and your goals:
As with most aspects of personal finance, it is important to reflect upon your current stage of life. For example, if your distance from retirement can be measured in decades, it is reasonable (and likely prudent) to take no action, and perhaps even look at market weakness as a buying opportunity. On the other hand, investors who are near retirement or perhaps just recently retired are likely to look at market volatility in a drastically different light. For these investors, it is important to also consider the size of your nest egg and your specific income needs relative to your portfolio. A conversation with your financial advisor (and perhaps an update to your financial plan) can go a long way in helping you determine what the best course of action might be if you are becoming concerned with the volatility in your portfolio

Maintain a Bucket of Liquid Cash Reserves
When building a financial plan, we typically recommend maintaining at least 6-12 months’ worth of spending needs (this number might be lower for accumulators) in low-risk, interest-bearing assets, and refer to these assets as a liquid reserve. These reserves can serve as a source of income during periods of market weakness and can prevent you from needing to draw down your other assets after they have decreased in value. Given the still low rates offered by most checking and savings accounts, money market funds, CDs, and short-term high-quality bonds, these tend to be the best options for investors today. However, it is important to remember that these types of assets expose you to the potential opportunity costs associated with not holding investments with higher expected rates of return over the long haul.

Remind Yourself of the Long-Term Wealth Generating Power of Markets
Perhaps the most important thing for long-term investors (which most of us are) to remember when volatility strikes is that the financial markets have a remarkable track record of generating and compounding wealth throughout history. Our Vice President and Financial Advisor Joe Goldfeder, CFP® recently recorded a great video on this very subject. In it, Joe shares some powerful statistics about long-term investing and the resilience of markets, and also discusses some of the above concepts in a little more detail. CLICK HERE TO WATCH