Service Day 2017
A slide that Brian Andrew, chief investment officer of Johnson Financial Group, likes to use at client presentations about the global economy and investing vividly illustrates how politics can get in the way of clear‐eyed decision making.
When asked whether economic conditions are good, 79% of Republicans say “yes,” compared with only 33% of Democrats, according to data compiled by CornerStone Macro.
“We're all living in the same 2% (economic) growth, 3.5% unemployment, 3% wage‐growth world, and yet we have such a completely different view of it based on our politics,” Andrew says.
This split is more pronounced today than ever, but it can mean investors make decisions affecting their portfolio for the wrong reasons. Setting U.S. Treasury securities aside, most investments are in companies, not the government. Fiscal policy – the government's tax and spending strategies – does matter, but over long periods of time, not over a 24‐hour news cycle.
“There are ways to measure specific effects,” says Andrew, who oversees $12 billion in assets under management at the Wisconsin‐based firm. “We've got to live in that real world and not just let the noise freeze us up and keep us from doing something.”
Change Doesn't Happen Overnight
One reason not to obsess over politics, and specifically the upcoming U.S. presidential election, is that it's still relatively early in the election cycle. Candidates who rise in popularity early often don't win their party's nomination.
That didn't stop one investor from telling Andrew, recently, that he was skittish about investing in healthcare stocks because of leading Democratic presidential candidate Elizabeth Warren's plan to create a Medicare for All healthcare plan that would eliminate private insurance.
“First of all, she's not the president. Secondly, in order for her to get that passed, she's going to need to get some help from Congress. And thirdly, there are 70 million people who are approaching age 60 or more,” Andrew says. “There's no question that the amount of money spent in this country on healthcare will continue to rise, and that's a tailwind for healthcare investments. [Warren's] policy is much less important to me than that tailwind.”
Missed Opportunities
Paying attention to politics also can blind investors to truths in the global economy. A few weeks ago, Andrew was giving a speech to a group of investors, and he suggested they think globally when considering technology stocks. Those who think Facebook, Amazon, and Netflix are too expensive should look at Tencent, Alibaba, and Baidu – Chinese tech companies that can add diversity, and growth, to a portfolio.
A gentleman in the audience raised his hand and said, “Our president is fighting China – why would I want to help companies in China and put them in my portfolio?”
It's a response grounded in politics that ignores the fact that China has three billion people, many of whom are tech savvy consumers.
What About the Trade War?
A slowdown in the global economy resulting from the U.S. trade war with China is a real result of President Donald Trump's trade stance, but Andrew says it isn't some “nebulous thing to fear.” It's quantifiable. Instead of saying, “I need to get out of the market because we're raising tariffs,” use the information at hand to figure out the tangible result to earnings.
“We know if we put 25% tariffs on $540 billion worth of goods, that probably causes the economy to slow by 0.07%, give or take two‐ or three‐tenths of a percent,” he says. “I'm not happy about 3% growth going to 2%, but it's not the end of the world. And I can understand which companies are more or less affected by that and then make investment decisions that way.”
Profiting from Volatility
The markets, of course, react constantly to shifting political winds. Consider the U.S. bond market, where the 10-year Treasury yield has bounced half a percent up and down several times in just the last six weeks.
“Almost all of that is tied to the noise that comes from the trade conversation,” Andrew says.
Investors should instead focus on what the “fair value” of the 10‐year note should be and think about whether that will change whether we get a trade deal or not. Neither result is likely to have a big effect, since any deal that's struck won't be great and if no deal is struck, nothing has changed, Andrew says.
“Our view would be to watch that volatility around what you believe to be fair value and take advantage of that,” he says.
Johnson Financial sees fair value for the 10‐year at about 1.75% to 2% (it's trading at about 1.79% today), in part because interest rates in Europe are so low. The German 10‐year bond is in negative territory, trading nearly 0.4% below 1%.
“We've been pretty bullish on the bond market for a long time, and we've been chastised a lot for that because there's this desire to see rates move significantly higher,” Andrew says. “We just don't see that in the cards.”
If Treasury prices fall and rates bounce back to 2%, Andrew says his firm would be a buyer, “because I think we could probably see the lows again.“ (Treasury rates move in the opposite direction of prices.)
The same dynamics are true in the stock market. There have been some fairly significant moves in recent months on short‐lived news events. “That disruption in the market is something that investors can take advantage of,” Andrew says.
For individual investors who rebalance their portfolios according to the calendar, for example, at the end of every quarter, or every year, “this is a good time to take a more proactive approach,” Andrew says, “and to pay a little bit more attention to how to take advantage of that volatility.“