Upside and Downside Risk
Welcome to June! May was a very solid month with the typical uncertainty of this current year. Remember, uncertainty can go both ways, up and down. The standard deviation you see on my website measures both the upside and downside risk, whereas the Sortino Standard Deviation focuses on only the downside risk. For June we are still seeing more downside risk for the S Fund compared to its overall risk. From an expected average return, risk and downside risk, the C and I funds are looking pretty close to equal. It is pretty interesting (amazing) that with all the uncertainty surrounding tariffs, economic disruptions in trade (Red Sea/Yemen), and a continuing war in Ukraine, stock markets in the US and the World are able to post such solid gains.
We saw three drives this month that gave us such a fortuitous month –
First. Steep tariffs on Chinese, Canadian, and Mexican goods were rolled back 90 days, signaling healthy negotiations were underway. This impacted both the C Fund the I Fund in different ways.
The C Fund and the US markets were positively impacted as prices for imported materials would not double in price. Additionally, the US stands to win now that we are negotiating. A non-negotiable response from our trading partners would have been disastrous, but with negotiations on the table, the US can move the needle from where we have been to something more favorable, even if it is in the single digits. For an economy that sees low single digit GDP growth, single digit benefits are still powerful.
For the I Fund, those international markets that saw a reprieve from the tariffs saw significant spikes in their stock markets as their country’s leaders signaled they will not cut off their nose to spite their face.
Second. Due to the fear of tariffs, companies began to stockpile goods, and we actually saw global trade expand. This front-loading boosted industrial activity, benefiting U.S. large-cap companies (C Fund) and international companies (I Fund) alike. Therefore, despite looming tariffs and the Red Sea issues, World trade continues to be resilient. However, the carry cost of these goods will likely have an impact on company debt. Also, there could be an according effect where goods need to be sold off at lower prices or less goods are imported for several months. Either way, it will make it harder to track inflationary measures, consumer spending, and trade imbalances.
Third. While the US benefitted from the news of tariff delays, many international companies benefitted from looser economy policy, specifically the EU. They cut their lending rate in March and European investors and companies continue to see lower borrowing costs, propping up balance sheets and stock portfolios.
Of course, with all of these drivers there is both the upside and downside risk, we just saw less downside this month. Looking forward, we still have the uncertainty of the tariffs in the next few months. However, as long as negotiations are open, it is a devil we know now.
We also have the conflicts in Ukraine and the Red Sea. These are strange events in that they have the potential to kick off a larger war but as long as they simmer, very few countries seem willing to resolve them. The consequences of these conflicts growing larger is huge, but the probability that they will do so in the near term is, hopefully, still low. Should they expand, well, I don’t want to think about that. So, for the month of June I’m making slight tweaks to my investments and keeping a wary eye on the horizon. Keep investing!
