Chairman’s Letter Q3 2019

A look at the risks facing the financial market at this time.




October 1, 2019

As the relentless barrage of news about Trump, the trade war, the election, impeachment, and interest rate policy captivate national and investor attention it’s easy to feel like the investing landscape is fraught with risk. What are the biggest risks and what's worth focusing on? 

‘Risk’ is an omnipresent factor in investing, but certain risks are more impactful on long-term business results than others. For example, if Trump says, “Lower corporate taxes are coming next year!” that’s impactful and important. If Trump says, “The trade war is over and I’m sorry!’ that’s a big deal. If Nancy Pelosi tries to impeach Trump that’s just a headline.

RBC’s Head of U.S. Equity Strategy, Lori Calvasina, recently commissioned a survey to see what’s keeping investors up at night ahead of the 2020 election. Of the thirty-four issues polled, here are the top twelve things investors are worried about: 

Trade War/Tariffs (19%) 

2020 Election/Democrats/Elizabeth Warren (11%) 

Trump/Trump Tweets (11%) 

Monetary Policy/Rates (10%) 

Geopolitical Risk/War (10%) 

Earnings Risk (5%) 

Style Shift (4%) 

Brexit/Europe (4%) 

Consumer Rolling Over (4%) 

Expensive Tech Valuations (3%) 

Debt (General) (3%) 

Global Growth Slowdown (3%)

We can break down this list of worries and subjectively assign each worry to one of two buckets: worries that may impact corporate profits over the next two years and those that likely won’t. In doing this we see that 56% of investor worries are related to earnings issues and 44% are related to things that don’t really affect profits. So, one could argue that investors are wasting a bit less than half their time on things that don’t matter.  

Let’s look at the top worries in each bucket to see the real risk of each and their likely impact on stock prices. 

Investor worries that may impact corporate profits over the next 2 years: 

Trade War (19%) and Earnings Risk (5%). These are rightly the biggest worries for investors (of both public and private businesses) and for voters. As we have argued before if Trump wants to stick around, he had better settle up with not only the Chinese but also the Europeans. Business owners and employees vote with their pocketbooks in mind and recessions pretty much end political lives. Trump would be wise to remember that there are more jobs in small business than in farming and that they are feeling the weight of uncertainty. 

Our sense is that Trump is increasingly looking for a trade deal but the Chinese, who also want a deal, are so frustrated they may prefer to stick it to the president and see his ship hit the shoals. Their calculus is muddied only by who the next president would be should a no-deal cause the U.S. to tip into a recession. Whether Warren or Biden was to become president a republican Senate is still probable, and this will likely result in a better deal than fiddling with the mercurial Trump. Look for this to become a more frequent point of discussion and a headwind for stocks as investors fret over recession worries.  

Monetary Policy and Interest Rate Risk (10%). These worries are really an extension of the two risks mentioned above. The bottom line is that interest rates are going lower because Trump is screwing things up with trade and that’s what’s causing falling business confidence. Frankly, rates are already low, and businesses and consumers are already feeding at the low-rate punch bowl. As Bill Clinton's campaign strategist James Carville famously said, “It’s the economy, stupid”. Trump would be wise to put his focus where it’s needed, on the economy. 


Investor worries that likely won’t impact profits over the next 2 years: 

Elizabeth Warren (11%) and Trump (11%). Recently, polls have shown that Elizabeth Warren is gaining on Joe Biden. This is now the second biggest concern of investors after the trade war (19%). Trump (tied for the second biggest concern) is fighting multiple fires with the most impactful one being the slowing economy. Impeachment is a political sideshow compared to what voters will do to him if the economy slides into a recession.  

In fact, we would argue that if the risk of recession grows due to trade concerns the republican Senate will abandon Trump and throw him out to protect their own jobs. The odds certainly favour Trump working in his best interest and getting a trade deal, but that requires Chinese cooperation. To us, the real risk is that Trump has pushed the Chinese so hard that they will walk away from a potential trade deal. They’ll let the U.S. suffer, watch Trump sink his own ship on Twitter and wait for him to get pushed out.

What happens if the election comes down to Warren vs Trump? Or Warren vs. Biden? How will markets trade running up to the 2020 election and how will they react if Warren wins? And more importantly, why did Warren win? Because that will influence how stock markets trade for the next 12 months. 

Our best guess is that the markets will worry first and foremost about the risk of recession over the next 18 months, and the biggest threat to recession is a continuation of trade disruption. Biden is seen as more moderate and business-friendly, so if things go poorly on the trade front look for Biden to maintain his lead. If Warren prevails, look toward more regulation (costs) but not the end of the American dream.  

We think the real risk is that the Chinese play the long game and stick it to Trump. This would cause stocks to fall as a no-trade deal would sap investor confidence due to profit concerns, and likely affect consumer confidence as tariff and political chaos rose. That’s why we advocate for caution now and are taking a conservative stance in your portfolios. It takes two to tango and Donald may have stepped on too many toes.