‘Wait and watch’ is boring but good investment advice

Citi’s chief U.S. equity strategist (and Montreal-born) Tobias Levkovich published a research report noting that overall first quarter S&P 500 earnings exceeded consensus expectations. Mr. Levkovich also reduced his own forecast for earnings in a way that provided a good example underscoring a pervasive sense of anxious ambivalence for portfolio managers and analysts.

“Gauging the impact of Chinese trade sanctions is nearly impossible, but we suspect trimming forecasts a bit is reasonable. We are pulling down our full year 2019 EPS [earnings per share] projections [for the S&P 500] to $170 from $172, recognizing that further trade war ramifications could lead to more downward adjustments.”

By ambivalence I don’t mean apathy – everyone still cares where the market’s going next. The sentiment is more a throwing up of hands, a “this could get really, really bad. Or not. I dunno, no way to tell.”

Risks of a major market calamity are certainly rising. Morgan Stanley’s global head of economics Chetan Ahya generated considerable media attention Monday with a report warning investors that they were not taking the economic risks of a trade war seriously enough.

“If trade tensions continue to escalate, with the U.S. imposing 25 per cent tariffs on the remaining [approximately] US$300-billion of imports from China and China responding with countermeasures, we believe that the global cycle will be at risk. We could end up in a recession in three quarters. Is such a prognosis alarmist? We think otherwise, for three reasons: (1) the transmission channels are pervasive, (2) the impact is non-linear and (3) any policy easing will be reactive, with lagged effects.”

Mr. Ahya prefaced all this by noting “Given the many twists and turns in the trade talks thus far, we admit that the outcome is highly uncertain.”

We all know the reason for trade uncertainty. When the leader of the free world seemingly announces trade decisions after spinning a big wheel of policy options written by moody teens, the usual forecasting methods go out the window. (Joke aside, it is also important to note that China’s global economic ambitions, regional military expansion and indifference about intellectual property rights would almost certainly have invoked a confrontation with the U.S. eventually, no matter the president.)

I am tempted to use the ‘eye of the hurricane’ metaphor to describe investors’ current predicament. The initial shocks from U.S. tariffs on China and Mexico have been digested by markets, at least in part, and asset prices have been adjusted accordingly. Markets are calm-ish for the moment but there is almost certainly a big market move ahead.

The hurricane comparison doesn’t work in the end because it implies certain market disaster ahead and that may not be the case. A breakthrough in trade negotiations would spark a significant rally and raise hopes that a slowing global economy can recover along with global trade levels.

The truth is, there is not enough information to make a bet either way and that’s always an uncomfortable position for an investor. ‘Wait and watch’ is not the most helpful advice but it’s likely the most sensible course of action for investors in the coming weeks.