I don’t speak often about the size of Iron Capital because to me we are a small, close-knit team and I like it that way. The world, however, judges investment firms by assets under management, not headcount or office space, so Iron Capital is consistently listed as one of the larger firms in the Southeast. That achievement and five dollars gets me a coffee at Starbucks. But, while that is usually much ado about nothing, every once in a while it can be helpful.
For instance, I get the occasional invitation to visit the Federal Reserve Bank of Atlanta (Fed). The last time was about two weeks ago, when I went to hear a presentation from Steven Durlauf, economist and public policy professor at the University of Chicago. He was speaking on inequality. I was interested because I’m not sure if there is a more important subject for the long-term viability of the American experiment in self-government. I found his talk disappointing because he offered no real policy solutions. Oh well.
Even when the speaker disappoints, these evenings are worthwhile because one often gets to talk directly to some of the economists at the Fed. I love talking to the people who actually do the work. That is true when I visit our corporate clients, and it is true at the Fed. Talking to the rank and file is how you find out the truth.
In this case, we spoke about what the Fed was hearing from the front line. For those who are not familiar, the Fed is mostly known for controlling short-term interest rates. Lots of analysis goes into these decisions, and they have teams of economists whose primary job is to collect data. Mostly, they talk to business owners and corporate managers and ask them how things are going. The conversations of late were all surrounding trade.
The big question for our economy is: How much of the good done by tax reform and regulatory relief is being undone by tariffs? From what I heard, quite a bit. It is important to understand that the goal of the tax reform was to stimulate corporate investment. In other words, make it more attractive for companies to expand their businesses through new facilities or even just new, updated equipment. This corporate investment leads to growth in productivity, which leads to wage growth. These are precisely the elements that have been missing from our economy since the dot-com bust.
All the data show that tax reform was beginning to show signs of working. One example I learned of that night was a company headquartered out of New Orleans that was about to break ground on a brand-new factory. They were putting their tax savings to work, just like the policymakers had hoped. Then came the talk of tariffs; construction cost for the factory rose with the tariffs on steel and aluminum. The company in question was a chemical company which, although small, sells most of its goods overseas. They are now concerned about retaliatory tariffs on their products. The factory is back on hold.
That means lost jobs and lost wages to their employees. This is the real-world impact of trade wars. The huge multinationals have locations everywhere and can work their way around almost any web of trade barriers; it is the small, locally owned and operated companies who will not be able to compete. The companies that can’t afford the rise in steel prices and the ones that can’t just shift production from one plant to another. These are the companies that really spur growth, the ones who finally thought they saw a light in the end of the tunnel with the first market-friendly policy shift in almost twenty years. Then the rug was pulled right from under their feet.
The Trump administration assures us that these are just negotiating tactics and that we may have to live with short-term pain to achieve long-term gains. Perhaps they are right; we certainly hope they are. In the meantime, second-quarter GDP growth came in at 4.1 percent, which is actually very good, but almost a full percent lower than what many had been predicting. A percent may not sound like a lot, but in an economy the size of the U.S., that is a lot of growth to leave on the table.
What does this mean for our investments? It means uncertainty and volatility. Hopefully, as long-term investors we can take advantage of this, but the second half of this year is likely to be a bumpy ride. We still think it will be mostly up, but it certainly won’t be smooth. We remain vigilant, as always.
Chuck Osborne, CFA