Despite a good reporting season for US companies in general and great results for the portfolio companies as well, the US stock market has recently moved into a negative trend (although today the market goes up…), partly because of fears of a US-China trade war. It began few days ago with Trump’s statement on the imposition of Chinese import duties worth $50 billion, which he claims is a violation of US intellectual property. The Chinese reacted immediately and announced the imposition of customs duties on 128 US-manufactured products worth about $3 billion.
In Europe, Trump’s plan has been denounced, and German Chancellor Angela Merkel has even said that Germany views the US president’s actions as illegal. The deterioration of relations between the US, China, and Europe is not encouraging news for the markets, which are already fragile in light of the rise in US bond yields. Many experts believe that if and when the 10-year US bond crosses the psychological level of yield to maturity of 3%, many additional investors may abandon stocks and further hurt their prices.
A heavy cloud is also evident from the banking sector in Europe, which continues to be under heavy selling pressure due to an increase in fears that a financial crisis will develop there. The concern is that a reduction in the central bank’s bond purchase program could make it difficult for struggling countries and many banks to operate properly in the coming years. According to the central bank, more than 5 percent of bank loans are junk loans in some level of default, which is a risk that should not be ignored if you’re invested in European stocks (for comparison, in US banks these junk loans are just over 1% of total loans).
Are you afraid of what these things will do to the stock market?
If so, I would be happy to hear you explain how exactly this trade war or the financial problems of the European banks will adversely affect the financial results of the companies in the portfolio. Actually, it won’t…
Contrary, the portfolio companies will continue to flourish and present strong results. This still does not mean we will not see temporary declines in the price of their stocks. This is something that happens from time to time in the stock market when investors afraid and act irrationally. However, this means that the fair value of the shares in the portfolio will continue to be higher than their current price, so they will have to go up in the future and bring us the desired profits.
Consider for example Cars.com, which announced yesterday a plan to buy back up to $200 million of its shares over the next two years. This is about 10% of the company’s outstanding shares, which means that they too understand that the shares are trading at a deep discount.
Bottom line: Sometimes there are times when the best thing to do is nothing. At the moment, this is just such a period. As stated before, I still recommend holding between 15%-20% of your funds in cash (or in Short-term treasuries if you’re a US Dollar investor) and the rest in stocks. This is a suitable allocation for the conditions of the current market. Sooner or later new investment opportunities will rise and I’ll be glad to buy them to the portfolio.