Here’s Why Stocks Should Be Higher, And Why They Are Not

By Path Financial President and Chief Investment Officer Raul Elizalde

Photographer: Michael Nagle/Bloomberg

Photographer: Michael Nagle/Bloomberg

The stock market is close to record highs, and given how well everything seems to be going, they should have blasted through those records. Consider this:

• The latest quarterly GDP growth release was the highest since 2014.
• Initial jobless claims as a percentage of total civilian employment are at an all-time low.
• Interest rates are still hovering around the low end of a 100-year range.
• The percentage of companies reporting positive earnings per share surprises is the highest since Standard and Poors started tracking that metric 10 years ago.
• Company repurchases of their own stocks and cash dividends per share are at record levels

Despite these excellent conditions, stocks have been unable to rise above the January highs. Unless they do it soon, it may be time to consider whether stock prices have reached a cyclical peak.

What is keeping stocks from going higher? The only reasonable answer is that the market does not believe today’s conditions are sustainable. Here are some possible reasons:

A global trade war

According to a great number of observers this is probably the biggest threat to global growth. It started when the U.S. imposed tariffs on Chinese imports in late January, and it has escalated since then between the U.S. and China, but eased between the U.S. and other partners in the West, like Canada and the European Union.

Data, however, does not show any negative effect from the trade tensions. Research company FactSet compared second-quarter earnings growth for companies that generate more than 50% of sales outside the U.S. against those that generate more than 50% of sales domestically. The first group (with more global exposure) had 32% larger growth (29.4% to 22.2%). Revenue was even more lopsided, with the first group showing 57% larger growth (13.5% to 8.6%). This is not, however, some kind of proof that trade sanctions are actually a boon for global trade. Rather, it could mean that, anticipating escalation, global companies tried to squeeze through more activity during the second quarter in case tensions get worse later on.

Higher rates

The U.S. Federal Reserve has remained firm in its intention to raise rates twice more this year and three times in 2019. This, in turn, has strengthened the U.S. dollar by more than 9% since January – a side effect that is likely to deepen the U.S. trade deficit and exacerbate trade tensions that are already running high. It will also increase the cost of consumer debt such as mortgages.

Waning global growth

The global economy is slowing down. According to the latest IMF World Economic Outlook, “Growth projections have been revised down for the euro area, Japan, and the United Kingdom, reflecting negative surprises to activity in early 2018.” Emerging markets have been hit hard in the last few months, in particular Turkey, whose currency plunged this week, and Venezuela, which is struggling with runaway hyperinflation running at 83,000%.


The political landscape remains complicated. The U.S. midterm elections in November have the potential of changing the policy outlook significantly if, as some predict, the Democratic Party takes control of the U.S. Congress. Additionally, a report on Russian interference in the U.S. elections that Special Counsel Robert Mueller is expected to release in the coming month will certainly weigh on sentiment. Since the investigation has been shrouded in secrecy, any announcement will come as a surprise and has the potential to move markets.

These are just some of the most obvious concerns, but there are others, such as mounting public debt and ballooning fiscal deficit, and a slowdown in real estate sales due to combination of higher home prices, higher mortgage rates and stagnant wages.

Stocks, therefore, are caught up between excellent conditions today and worries about next year’s outlook. This being the case, even if current economic data continues to excel, any break above the record stock prices of January may prove to be short-lived unless the medium-term outlook improves substantially.

This analysis originally appeared in Raul Elizalde’s investment column. Click here to follow Raul on Forbes.


Raul Elizalde President Path FinancialRaul Elizalde is the Founder, President, and Chief Investment Officer of Path Financial, LLC. He may be reached at 941.350.7904 or

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Personal Finance Tips for Millennials

By: Oxana Saunders

pigAs Millennials are getting ready to outnumber Baby Boomers by 2019, many young people are still struggling with basic financial concepts. Unless they have a taken finance courses or are fortunate to have parents who made it their priority to get them up to speed on the financial aspects of life, they may run into difficulties that, with a little planning, can be easily avoided.

The article from, linked below, shares a few relatively easy and simple steps that you can take to improve your financial outlook. If you feel that you need some guidance on your personal finances, please contact us for a free consultation.


6 Investing & Financial Tips for Millennials

Oxana Saunders Vice President Path FinancialOxana Saunders is the Vice President of Path Financial, LLC. She may be reached at 941.894.2571 or

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Investors Are Main Lenders To U.S. Businesses, But May Not Understand Risks

By Path Financial President and Chief Investment Officer Raul Elizalde

today imageFaced with regulatory constraints and stricter guidelines, bank lending to businesses declined since the financial crisis. The business sector filled the void by issuing bonds, which were quickly swallowed by yield-seeking investors. This amounted to a transfer of lending risk out the banking sector and into the investor class. This is good news for the banks, which are now in better shape, especially in the U.S.. The bad news is that, unlike banks, the investor class has no safeguards if something should go wrong. Also unlike banks, the average bondholder is ill-prepared to ascertain credit risk. And there are signs that the risks bond investors face are increasing.

There is no doubt that the role of investors as lenders to businesses has become more prominent. In the U.S., for example, companies in the non-financial sectors now have well over twice as many bonds than loans outstanding. In Europe, although bonds are not a widespread source of private sector financing, the proportion of bonds still nearly doubled with respect to loans since the financial crisis.

first graph

Another reason to worry is that U.S. corporate bonds rated at BBB by Standard and Poors represent the largest group by far, at 37% of all non-financial corporate bonds outstanding, or $2.7 trillion. This is a credit rating category at the very bottom of the “investment grade” ladder. Bonds downgraded from this BBB category fall to the “non-investment grade” land where many investors are forbidden from entering. Thus, a downgrade that pushes a bond across that divide triggers selling that can drive the bond price even lower.

There is a large wave of bonds maturing in the next five years, which could be as large as $10 trillion globally according to the McKinsey Global Institute report. These bonds will be replaced with new ones that would be more costly if they are issued at higher rates than the ones maturing. This is likely to be the case, since interest rates are going up. Bonds at the threshold of investment grade quality could easily fall into the “junk” world.

There is also the issue of bond liquidity. The McKinsey report reminds us that “buying and selling corporate bonds often requires a phone call to a trading desk at an investment bank, and there is little transparency on the price the buyer is quoted”, a feature that can seriously curtail bond liquidity if a credit event were to take place.

Mutual funds – the largest holders of corporate bonds – can easily withstand the first wave of redemptions with their cash holdings, but because many funds hold similar positions, a selling wave could pose a problem when everyone is on the same side of the trade. Both practitioners and academics like Caitlin Dannhauser of Villanova University and Saeid Hoseinzade of Suffolk University have studied this point in depth.

A liquidity crisis is more likely today, when trading desks at investments banks that used to hold large bond positions are now restricted from doing so. Bond holdings of primary dealers, for example, have steadily declined and are now about a fifth of what they were before the financial crisis, even as the outstanding amount of bonds more than doubled.

Investors are now much more exposed to business lending risk because of their large holdings of corporate bonds, a risk that will increase if economic conditions suffer. While the economy is currently firing on all cylinders, it is vulnerable to the tightening efforts of the Federal Reserve, a slowing global economy and the risk that today’s trade disputes could turn into a full-scale global trade war.

Any of these issues could push some corporate bonds over the non-investment-grade category, severely affecting bond prices. While it is unlikely that bond weakness could turn into a broad crisis, bondholders will be hurt. They need to pay close attention to the risks they face, especially because nobody will be there to help them if their investments sour.

This analysis originally appeared in Raul Elizalde’s investment column. Click here to follow Raul on Forbes.


Raul Elizalde President Path FinancialRaul Elizalde is the Founder, President, and Chief Investment Officer of Path Financial, LLC. He may be reached at 941.350.7904 or

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2 Reasons Why Demand For Stocks Will Fall

By Path Financial President and Chief Investment Officer Raul Elizalde

today imageTwo sources of demand that contributed to driving up stock prices are going away.

Strong buying came in the last few years from the very companies who issued those stocks. Finding it cheaper to borrow money than pay dividends, they issued a large number of corporate bonds and used the proceeds to buy back significant portions of their outstanding shares.

Alongside companies buying stocks were retail investors who just wanted income, but could not find it anywhere as interest rates hovered around historical lows for years.

There are indications, however, that both reasons for buying stocks are becoming less compelling.

To begin with, there are fewer shares. This was the logical result of having interest rates at historical lows, which resulted in companies buying back stocks. This gave more fuel to an already booming stock market.

today first graph

According to the Fed, a net value of $3.1 trillion of corporate equity was retired by repurchases and mergers & acquisitions since 2011. This enormous amount is comparable to the entire GDP of Germany. The number of shares in the S&P 500 calculated by Standard & Poors shows the same trajectory as the Fed data. And the first quarter of this year set a new buyback record, even as rates rose.

But the feverish pace of repurchases may be starting to ease.

today second graph

The 2-year US Treasury rate is now above the average dividend yield of S&P 500 companies. Some companies may still be able to issue bonds at cheaper rates than their dividends, but the margins are getting thinner and fewer can still do this profitably. This may be the reason why the portion of companies retiring more than 4% of their outstanding stock fell to its lowest level since tracking started in 2014. If rates continue to climb, we believe that this portion will fall further.

Additionally, conservative retail buyers who had gravitated to stocks as the only source of income are now able to access the safety of bonds that offer higher yields. While rates are still relatively meager by historical standards, they are now at least at par with inflation. Investors who until recently had no choice other than dividend stocks to produce income may be warming up to bonds, thus reducing another source of demand for stocks.

Stocks went up for various reasons in addition to corporate buybacks and dividend-seeking retail investors, but there is no doubt that both have played an important role in driving up prices. As rates return to more normal historical levels, these two sources of demand may well evaporate. While this may not be enough to sink the market, at the very least it paves the way for higher volatility in the months ahead.

This analysis originally appeared in Raul Elizalde’s investment column. Click here to follow Raul on Forbes.


Raul Elizalde President Path FinancialRaul Elizalde is the Founder, President, and Chief Investment Officer of Path Financial, LLC. He may be reached at 941.350.7904 or

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Park Your Money in Four ETFs To Cut Market Exposure

By Path Financial President and Chief Investment Officer Raul Elizalde

raul imageFrom time to time investors look at reducing their market exposure and “parking” their money safely. Some choose plain cash, but cash has a negative real rate – it does not grow, and inflation eats away at its value.

Some ETFs can provide stability and a moderate return with very low exposure to market risk. While no investment is completely safe (even cash under a mattress can catch fire) these ETFs have solid sponsors, large portfolios and plenty of liquidity. Each one has different characteristics, so using them in combination may be better than settling on any single one.

SHY, for example, has $14 billion of U.S. Treasury notes and bonds with maturities between 1 and 3 years. Its liquidity is excellent and its sponsor, BlackRock’s iShares, is one of the strongest financial institutions around. Because all its holdings are in fixed-rate instruments, its value declines when interest rates go up. Quality is unmatched: the assets are backed by the full faith and credit of the United States Government.

FLOT, also from iShares, has $10 billion of floating-rate securities issued mostly by corporations with an average maturity of about 2 years. These underlying instruments pay interest that moves with market rates, so they tend to benefit when rates climb. Like SHY, it is a very liquid ETF.

CSJ is another iShares ETF. It resembles SHY in that it contains $11 billion in fixed-rate instruments with maturities between 1 and 3 years, but it is mostly comprised of corporate securities, which pay higher rates than the US Treasuries in SHY. Like SHY, its value tends to drop when rates go up. Roughly 16% of its portfolio is made up of supranational and government-guaranteed bonds.

Finally, SPSB is an ETF sponsored by State Street’s SPDRs, another very strong sponsor. Like CSJ, it contains corporate bond holdings between 1 and 3 years. However, there are no supranational or government-guaranteed bonds among its $4 billion in assets, which results in a higher return than CSJ but also higher volatility. Both CSJ and SPSB offer plenty of liquidity with very narrow bid-ask spreads, but their daily volumes are smaller than SHY or FLOT.

We ran a few combinations of these ETFs using approximately seven years of data, looking for an optimal blend of low volatility, high return and minimal drawdowns (i.e. declines from peaks) for that period. A mix that seems to satisfy these elements is a 65% FLOT, 10% SHY, 15% CSJ and 10% SPSB allocation rebalanced monthly, as shown in the graph below. Drawdowns and volatility were minuscule. Returns were moderate, as one would expect for a cash alternative, but accelerated in the last two years as rates rose.

graph one

We tried including other short-term and floating-rate ETFs such as BSV (Vanguard’s short-term bond ETF) and FLRN (State Street’s SPDR Floating Rate) but we found no measurable contribution to the portfolio metrics achievable with the four ETFs we focused on.

While this mix worked well in the past, the optimal blend going forward may contain a larger proportion of FLOT if rates rise, or a smaller proportion of CSJ and SPSB if credit spreads widen along with lower equity prices.

A word of caution: ETFs, like any instrument, can be subject to liquidity constraints. Unlike a mutual fund, owning an ETF does not give the holder direct ownership to the underlying instruments. A serious market dislocation can affect corporate bonds spreads and cause FLOT, CSJ, or SPSB to experience significant price drops or a wide gap between market value and net asset value.

However, barring the unknowable effects of abnormal market conditions, which in any case tend to be temporary, these ETFs offer investors an attractive alternative to cash.

This analysis originally appeared in Raul Elizalde’s investment column. Click here to follow Raul on Forbes.


Raul Elizalde President Path FinancialRaul Elizalde is the Founder, President, and Chief Investment Officer of Path Financial, LLC. He may be reached at 941.350.7904 or

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Earnings Forecasts Optimism Could Spell Trouble for Market

By Path Financial President and Chief Investment Officer Raul Elizalde

photoStock prices depend on future earnings expectations. The current consensus is for earnings per share (EPS) to grow through the end of 2019 by about 30% to record highs. These are risky forecasts: if numbers come out short, stock prices will take a hit. Can investors rely on these forecasts?

first graph

Operating earnings estimates from hundreds of analysts pooled by Standard and Poors’ Capital IQ show that optimism about earnings is strong. This is noteworthy because observers are also contemplating the possibility of a slowdown, or even a recession, in 2019.

The enthusiasm may be due in part to the strong acceleration of operating EPS growth that started in mid-2016. Remarkably, a related set of numbers – corporate profits before tax from the U.S. Bureau of Economic Analysis (BEA) – lack the same vitality. The BEA numbers, in fact, have more or less stalled since 2010, and there is little indication that they are ready to take off.

To be sure, the two sets are quite different. The S&P numbers only pertain to public companies belonging to the S&P 500, while the BEA numbers are intended to cover all corporations, public or not. Additionally, while both figures are calculated before tax, various other accounting items are treated differently.

Nevertheless, the rate of growth for both tends to move in the same direction, with peaks and troughs reached at the same time, as in 1994, 2003-04 and 2010-11. One key observation would be whether the gap between the BEA numbers and operating earnings narrows or widens at the end of the second quarter. If both measures continue to diverge, the chance that operating EPS will achieve the 2019 targets will diminish.

second graph

It is important to point out that the strong earnings growth rates of 2003-04 and 2010-11 were possible because of the low starting points caused by prior recessions. In comparison, the strong rate projected for 2019 would have to be reached after almost 10 years of expansion. It may be harder for earnings to accelerate from the current high base.

Plenty of research throws doubt on the ability of analysts to predict earnings far in advance, and this is borne by the evidence. According to Standard & Poors, only 9% of analysts were able to forecast current quarter EPS correctly in the last five years. Most forecasts exceeded the actual numbers, or came out short.

This is not surprising. Not only there are many exogenous, unpredictable factors affecting earnings, but also the accounting input needed to make forecasts is hopelessly complex. As Mike Thompson, S&P Investment Advisory chairman said on a recent TV interview, “you almost need forensics to understand some of the accounting that goes on to get to EPS.”

So is the current projection for the next seven quarters of earnings achievable? Yes, it is, but that is not saying much. Any projection is possible. One as optimistic as the current one may also need a generous serving of luck to come true.

This analysis originally appeared in Raul Elizalde’s investment column. Click here to follow Raul on Forbes.


Raul Elizalde President Path FinancialRaul Elizalde is the Founder, President, and Chief Investment Officer of Path Financial, LLC. He may be reached at 941.350.7904 or

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Why 2019 Recession Is Possible Despite Unemployment At 50-Year Lows

By Path Financial President and Chief Investment Officer Raul Elizalde

path imageBy most measures, employment is as strong as it has ever been. For example, initial unemployment claims as a percentage of the labor force are by far the lowest since records started. The May 2018 unemployment rate dropped to 3.8%, a level touched only once since 1969 – on April 2000, just as the stock market peaked before a 30-month-long bear market and the economy fell into a recession.

Strong economic indicators are always welcome, but they do not guarantee that growth can be sustained. Take retail sales, for example: they are now at a record high, but they were also at record highs just before the two previous recessions. How can this be?

first graph

Forecasting the economy is just as difficult as forecasting the stock market. Economists are very good at explaining what already happened and why, but not so at predicting what will happen next.

They know this. Prakash Loungani, an economist at the IMF, showed in a study that professional forecasters missed 148 out of 153 world recessions. This is not surprising: Economic indicators very rarely flash any warnings before a recession actually arrives. Economic downturns seem to come unexpectedly.

Regardless of the difficulties, analysts are always looking for clues. One measure that has received attention as a predictor of future recessions is the shape of the yield curve. It seems that when longer-term rates drop below short-term rates, a recession often follows. But this is also true for unemployment claims: a recession seems to follow whenever they drop below 300,000.

second graph

This is a difficult set of facts to rationalize. On one hand, it is easy to speculate that when longer-maturity rates drop below shorter rates it is because the market expects future economic activity to weaken. On the other hand, explaining why strong levels of employment precede a recession is not easy, even though it is also appears to be true.

While the yield curve today is not yet at levels associated in the past with approaching recessions, this may be due to technical reasons that could have moved the threshold upwards, such as negative rates still widespread elsewhere. But unemployment levels are well beyond recession-preceding thresholds, and in any case both indicators are moving in a direction that should cause concern.

Still, it is not obvious why economic indicators often show their best performance before the economy takes a turn for the worse. One explanation could be that it is difficult to rein in distortions when the economy is firing on all cylinders.

Sometimes this is due to politics. When the economy is sluggish, policymakers in charge are accused of ineptitude or lack of concern. To prevent this, they tend to stimulate growth regardless of consequences, and the strategy eventually backfires.

Other times, imbalances happen without blunt policy interventions, such as when asset values take off and build a bubble. Policymakers are leery of taking the punchbowl away when everybody seems to be getting rich, even though that is precisely what they should be doing. But bad policy is often good politics.

Are there any such dangers lurking in the US economy today?

To many, stock market valuations appear overstretched. In addition, the combination of a huge tax cut, a spending increase and an aggressive trade stance adopted by the Trump administration, while intended to keep the expansion going, may not end up well.

The Fed could raise rates too quickly, for instance, if it thinks that the economy is running the risk of overheating or inflation pressures start to mount. Given the enormous amount of private debt built up after years of rock-bottom rates, this could drive some debtors to insolvency and trigger a broad crisis.

Another scenario would be that lower taxes and higher spending cause public debt levels and budget deficits to explode, forcing a drastic reversal of policy that could choke growth. This is not idle speculation. Virtually nobody that has looked carefully at the details of current fiscal policy, among them the Congressional Budget Office, the Tax Policy Center and the Joint Committee on Taxation, believes that the current largesse could create enough growth and pay for itself.

The U.S. expansion may be close to its end just because of old age, given that it has lasted almost nine years and is now the second longest in U.S. history. While economic indicators are strong, they were also strong just before past recessions. And anyone who thinks that a recession is unlikely should keep in mind that it also seemed unlikely to professionals trained to predict recessions 148 out of the last 153 times.

This analysis originally appeared in Raul Elizalde’s investment column. Click here to follow Raul on Forbes.


Raul Elizalde President Path FinancialRaul Elizalde is the Founder, President, and Chief Investment Officer of Path Financial, LLC. He may be reached at 941.350.7904 or

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Business sectors are set for massive changes this fall

By Path Financial President and Chief Investment Officer Raul Elizalde

2018-06-04 14_05_27-Sector ETFs Are Set For Massive Changes This FallThe Global Industry Classification Standard (GICS) is a taxonomy system developed by MSCI and Standard & Poor’s that organizes companies into 11 economic sectors. This classification is applied to sector indices, which are in turn used to build ETFs and mutual funds that track them.

But the GICS system was created almost 20 years ago, and the world has changed a lot since then.

Facebook, for example, is no longer the online curiosity it was when it first started. It is now a huge delivery system for content, marketing and advertising. So it no longer seems appropriate that it should coexist in the same “information technology” box as Akamai, for example, which builds internet delivery networks and focuses on security and reliability.

To accommodate these changes the good folk at GICS have produced a preliminary list of more than 200 companies around the world that will be reclassified to reflect better what they actually do today. A final list will be published in July, and changes will be effective in September.

The technology sector will lose many big names to a new communications sector (a rebranding of the current telecommunications sector) such as Alphabet, Google and Twitter. Consumer discretionary will lose Comcast, Disney and Twenty-First Century Fox to communications as well.

These huge changes will fundamentally change the technology, communications and consumer discretionary sectors. Investors unaware of these changes will be in for a big surprise.

For example, the market cap of the communications sector will jump from today’s $1.7 trillion to perhaps as much as $10 trillion, according to a study from State Street, one of the largest ETF providers. Consumer discretionary and technology will shrink.

Additionally, as the State Street study points out, communications will be far more correlated to the S&P 500 than before. It will also include 13 stocks in the top 50% of returns in 2017, a huge change for a sector that today has a large proportion of high-dividend, defensive stocks. Furthermore, historical studies of sector volatility and correlation will be rendered largely useless. Investors who strive to build efficient portfolios using that data will find themselves in the dark.

ETFs, which have been the investors’ vehicle of choice to track indices, will be particularly affected. For example, State Street’s SPDR Technology Sector XLK, Consumer Discretionary XLY and Telecommunications XTL that track the S&P Select Sector indices (built around GICS) will be revamped to mirror the new compositions.

Vanguard, which also has sector ETFs (the Technology VGT, Telecommunications VOX and Consumer Discretionary VCR) structured as a class of their mutual funds adopted an interesting approach. Between May and September they will track custom MSCI Investable Market Transition indices to avoid sudden changes to the funds, in lieu of the current MSCI Investable Market Indices.

Fidelity’s U.S. sector ETFs track U.S.-only versions of the MSCI Investable Market Indices, which will change as well. On the other hand, some of Blackrock’s US-only sector ETFs will be unaffected, such as the Technology IYW and the Telecommunications IYZ, because they track US-only Dow Jones Sector indices that are not aligned with GICS. Adding to the confusion, Blackrock’s global sectors ETFs such as the Global Telecom IXP are linked to GICS definitions, and will change.

This is enough to make any investor’s head spin. What investors must remember is that some of the sector funds they use today may no longer represent their investment objectives after September. Keeping abreast of the upcoming changes will go a long way to avoid surprises down the road.

This analysis originally appeared in Raul Elizalde’s investment column. Click here to follow Raul on Forbes.


Raul Elizalde President Path FinancialRaul Elizalde is the Founder, President, and Chief Investment Officer of Path Financial, LLC. He may be reached at 941.350.7904 or

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Forbes Names Raul Elizalde as Contributing Columnist Covering Market Trends & Investing

Raul Elizalde President Path FinancialForbes has named Sarasota investment advisor Raul Elizalde as a full-time contributor for its website, which boasts a monthly digital readership of roughly 53.9 million. Elizalde has been a guest contributor for Forbes for over a year; beginning May 2018, he will write under his own byline ( covering market trends, investment mistakes, and overlooked risks. His first column, “Sector ETFs Are Set For Massive Changes This Fall,” is already online at Elizalde is the founder and chief investment officer of Path Financial, a Florida-registered investment advisory firm.

Elizalde focuses on analyzing historical trends to avoid current and future market risks and minimize investment vulnerability for his clients. As a former Wall Street strategist, Elizalde has advised portfolio managers across the US and the globe, and has made presentations at the World Bank, appeared as a market commentator on television (Reuters and Bloomberg TV) and has been quoted in the financial pages of The Wall Street Journal, The Washington Post, the Financial Times and The New York Times. Elizalde’s economic and investment analyses have been published online by some of the most respected financial media in the country, including Investopedia, Morningstar, Motley Fool, the Street and Yahoo! Finance. He also shares his insights monthly through Path Financial’s free, subscriber-based newsletter, “Straight Talk.”

In 2008, Elizalde relocated his family to Sarasota from New York City where his Wall Street career included positions as Global Fixed Income and Quantitative Strategist for ING Barings, Head of Research at Santander Investment Securities, and Fixed Income and Emerging Markets Strategist for Banc of America Securities. He holds an MS degree in engineering from University of Buenos Aires, Argentina, and an MBA degree from University of California at Los Angeles. He was licensed as a NYSE Supervisory Analyst and currently holds a NASAA 66 Investment Advisor Representative license.

Elizalde is the past chair and current member of the Asset Management Committee at State College of Florida. Path Financial, LLC, is located at 1990 Main St., in Sarasota, Florida, and is a Florida-registered investment firm, partnered with preferred account custodians Charles Schwab & Company and TD Ameritrade. For more information, call 941.350.7904, or connect on Twitter (@pathfin) and

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Why the trade tantrum is bad for stocks

today imageThe tariffs and penalties recently announced by the US represent a significant change in US relationships with its trade partners that creates uncertainty and stokes market volatility. Worse, they offer no outcome that would make the whole thing worthwhile. This is because the US has a lot to lose by alienating traditional partners who could help achieve its goals. This is not good for the stock market.

Let’s start with the botched attempt to impose steel and aluminum tariffs. The vast majority of economists opposed it and, in fact, Forbes did not find a single one who thought it was a good idea.

A tariff on goods imported into the US is a tax charged to US buyers. When a tariff is sufficiently high, the final price of the import becomes higher than the price of the same good produced domestically, which in theory should boost local production. This was the goal for the steel and aluminum tariffs announced in March.

All this may sound like a good idea. Yet, domestic buyers of those metals, who use them to make other things in the US, warned that they would have to raise prices for US consumers. Commerce Secretary Wilbur Ross argued tenaciously that the tariffs’ effect on local prices would be minimal (“less than six-tenths of one cent on a can of soda, less than half of one percent on a car”).

If what Secretary Ross says is true, then those particular tariffs served no purpose because such tiny price increases can be easily absorbed by consumers. Will anybody rush to deploy massive amounts of capital on new aluminum smelters or steel plants to replace imports? Most likely, any domestic substitution effect would come in the form of a small increase in capacity utilization.

The tariff gambit, in short, was ill-considered because it offered small potential upside compared to the possible downside of an escalation of tit-for-tat tariffs that could detonate a broader trade war. It is unsurprising that the administration eventually watered down the initial proposal as it also became clear that the main villain in its eyes, i.e. China, was unlikely to suffer much from tariffs on aluminum and steel.

The US then changed tack, announcing $60bn in tariffs and penalties specifically on Chinese imports, this time in response to US accusations of intellectual property theft.

The feeling that the US is itching for a confrontation with China is unmistakable. But the US has a lot to lose and the room for error is small.

The US is the largest exporter of goods and services in the world (China is larger just on goods) and therefore has the most at risk if a trade war unfolds. Additionally, foreigners hold 42% of all outstanding US Treasuries – 64% of which is held by governments. The fact that such a large proportion of US creditors are foreign is not a point of strength in negotiations.

More generally, a trade war could negatively affect the benign market outlook generated by other policies, such as the 2017 tax cut bill. While that bill created serious long-term problems (see How the tax bill made the next recession much more painful, 1.23.2018) there is no doubt that it gave stocks a short-term boost. A trade war, on the other hand, has no positive effects on the stock market.

A trade war will hurt US exports, corporate profits, and growth. US imports will also suffer, which will lead to higher inflation if cheap imports are substituted by more expensive local products.

While curbing intellectual property theft is a desirable goal, it is unlikely to be achieved through a trade war. Most experts agree that a coordinated approach by the US and other nations also affected by China’s actions would be more direct and have a higher chance of success.

For example, the US, Europe, and other allies could tighten restrictions on Chinese acquisitions of companies that own sensitive technology, or demand an easing on China’s regulations that force foreign companies to joint-venture with locals to establish a presence there. Alas, the US policy has so far been more directed at venting grievances with US allies over cars (Germany) or lumber (Canada), rather than convincing them to coalesce around common interests.

The US decision of abandoning the Trans-Pacific Partnership (TPP) also complicates the issue.

The TPP was advanced by the US to strengthen commercial and investment ties with much of the Pacific Rim. It excluded China, thus reining in its ambitions while reinforcing US influence on the region. When the US walked away from the TPP, China quickly moved in to revive talks on the competing, and far more advantageous (to China) Regional Comprehensive Economic Partnership, or RCEP. In addition, the US-less TPP’s successor – the Comprehensive Progressive Trans-Pacific Partnership, or CPTPP – now also includes China.

As the US surrenders influence in Asia, it cedes power to China. Pounding traditional partners over the head with tough rhetoric on trade simply drives them away, hurting US influence elsewhere. Meanwhile, confronting China’s ambitions in Southeast Asia is not made any easier by the rather inexplicable absence of a US ambassador to South Korea or the chaos in the State Department, which is currently awaiting the confirmation of a new Secretary of State after the sudden dismissal of Rex Tillerson.

In sum, the trade tantrum is not positive for the stock market. Since the bull run is already quite long in the tooth, some will see the trade issue as a possible catalyst for the rally’s end.

We believe that a full-on trade war is unlikely, but tensions need to be defused. The US must also formulate a coherent trade policy and refocus diplomacy on global cooperation favorable to US interests rather than confrontation with allies. Otherwise, the bull market could end soon.
What now?

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Raul cropped for facebookRaul Elizalde is the Founder, President, and Chief Investment Officer of Path Financial, LLC. He may be reached at 941.350.7904 or

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