Is It Time To Time The Market?

by: Laurence Kotlikoff

Summary

A central tenant of economics is that trying to time the market doesn't pay.

Absent inside information, the market price knows what you know and has already priced in what you know.

But there are other reasons for each of us to personally time the market. In the current context, the most important is an increase in risk.

Being exposed to higher risk is akin to suddenly having higher risk aversion. It leads us to optimally reduce our exposure to risky investments, including the stock market.

The trade war and political upheavals have increased the VIX measure of risk by 50 percent over the year. This means we should all reduce our exposure to stocks.

About 15 months ago I wrote a column for the Seattle Times, the Dallas News and some other papers entitled, "Now Might Be the Time To Sell Your Stocks." I focused, in part, on the risk of a trade war. Unfortunately, my advice came a year too early. The market continued to rise thanks, in part, to the passage of the tax reform.

Having royally screwed up in my first-ever market forecast, I've foresworn prognostication. But avoiding calling the market is not the same as pointing out that the VIX -- the standard measure of market risk -- has been far higher this year than last year, roughly 50 percent, and that standard portfolio theory tells us to reduce our holdings of risky assets when their risk rises.

Let me expand on the state of risk. As I write, I'm in Canada having just addressed a large gathering of business execs. Their reaction to Trump's imposition of tariffs on steel and aluminum is one of shock, anger and outrage. One participant after the other pointed out that Canada had fought with us in successive wars and was our closest ally. They were deeply insulted that Canada would effectively be treated as a national security risk, i.e., as a country that wouldn't supply steel, aluminum and other key metals in a crisis. (They also pointed out that Canada imports more steel from the U.S. than the U.S. imports from Canada.) To a person they said that NAFTA is dead.

Hearing such strong emotions from normally docile Canadians led me to wonder if the market is fully pricing the risk of Trump's insults, which he's directed at all four of our largest trading partners -- Mexico, Canada, the EU and China. So far these countries are simply matching, albeit in highly strategic ways (targeted at businesses in red states), actual or threatened tariffs on the U.S. But anyone with half a brain can see through Trump's strategy, namely launch a preemptive, vicious attack and expect your opponent to fold in full or in part at which point you limit your assault.

Trump has long history of commercial relations in which he makes a deal, has a vendor perform, then refuses to pay until the vendor, under threat of a spurious and costly lawsuit, agrees to a lower price. This is theft, plain and simple, and our heretofore allies now know they are dealing with a thief.

But our trade "opponents" can also play this game. If, in retaliation for their countervailing tariffs, Trump raises the ante with yet more tariffs (e.g., on German cars), Mexico, Canada, the EU and China can double or triple down. In the extreme they can levy exorbitant tariffs of all U.S. products and form a free-trade zone among themselves. Their collective economy is more than twice the size of ours. Consequently, Trump is leading us into an economic war that we will surely lose. And, ironically, if wholesale economic war does break out, our access to critical military imports will be jeopardized.

Trump's threats and insults are also producing major political changes that make an all-out trade war more likely. Mexico's left-leaning presidential candidate, Andres Manuel Lopez Obrador, now holds a double digit lead in the polls. The Mexican election is less than a month away. Obrador has caught fire in part by pledging to "put Trump in his place" and stating that "Mexico and its people will not be the pinata of any foreign government."

Trump and Bannon have helped elect (to what extent is unclear) two populist parties in Italy, which threaten yet a further enormous shattering of the European Union. That may be Trump's real goal -- the EU's demise. Recall his statement that the European Union was created to “beat the United States when it comes to making money.” If destroying the EU is Trump's objective, his new German "ambassador" is on the job. The "ambassador" just publicly pledge to "empower" right wing, euro-skeptic political groups throughout the Union.

As for France and Germany, relations between its leaders and Trump appear to be "terrible." This is the one-word description of the most recent phone call between President Macron and President Trump. To shore up EU unity, a full-scale trade war with the U.S., conducted by President Macron and Chancellor Merkel, may be just what the doctor ordered. It may also be what these fed up leaders are planning to deliver.

Then there is China, which Trump is about to hit with 25 percent tariffs on $50 billion in Chinese products, not to mention his tariffs of $3 billion on imported Chinese steel and aluminum.

All this is motivated by Trump's inane belief that trade is about winners and losers. Consider his claim that "When you’re almost 800 billion dollars a year down on trade, you can’t lose a trade war!”

Sorry, that's not even remotely the case. Furthermore, our country is running a trade deficit for one reason and one reason only. We spend far too much and save far too little. Since our pitiful national saving doesn't exhaust our nation's investment opportunities, foreigners invest their capital here (and amen to that). The importation of foreign capital shows up in the accounting as a trade deficit. In 1950 our country saved 15 percent of national income. We now save just 4 percent.

In short, our trade deficit reflects our overconsumption. Any decent trade economist will confirm this. Yes, there are unfair aspects of our bilateral trade relations. But the proper response is to fix each of such problems one by one with the help of the World Trade Organization. It's not to blow up world trade and our political alliances.

PS, My judgment that Trump represents a clear and present danger to our economy doesn't make me a lefty or a supporter of Hillary or any other form of political economist.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.