The death toll mounts. The number of cases worldwide builds. Every new update drives the stock market up or down. Where it will end is anyone's guess.

 

It is called a "geopolitical" event. We suffer through them from time to time. The assassination of Iran's key military leader followed by the Iranian rocket attack on two Iraqi military base that injured dozens of American servicemen was the last such event. We never know when they will occur and, in some ways, these events are simply the price of doing business in the financial markets.

 

Some market watchers, while recognizing the severity of the coronavirus outbreak, argue that the markets needed to correct anyway. This outbreak was simply the excuse investors needed to pull the trigger and take profits. I believe there is some truth to that opinion.

 

However, we should recognize that the coronavirus will most likely put a dent in economic growth around the world. Certainly, in the case of China and other nations closer to the epicenter of the outbreak, we can expect a slowdown in economic growth. After all, you simply can't shut down 16-plus major cities during the Chinese New Year, the largest consumer spending day in that country, without consequences to business.

 

In the U.S., a host of companies should also feel the heat as they too suspend business in their Chinese operations. This quarter's earnings season revealed that 25 percent of company managers expect some impact to their bottom line as a result of this calamity.

 

There have been some reports in the media (and accusations by others) that the number of cases reported by the Chinese government are being deliberately low-balled in order to soften the blow on business and to reduce the chance of whole-sale panic. So far, the World Health Organization, while sounding a global health emergency, is more concerned about the spread of the virus in countries with weaker health systems than what is happening in China, where more than 10,000 cases have been reported.

 

While no one can know for sure how long, or what ultimate impact this disaster will have on economies and markets, I believe that like all geopolitical events, they have limited impact and are of short duration.  I can see a 5 percent decline in the S&P 500 Index as a predictable outcome, but not much more than that. We are already off 3 percent from historical highs, so I am not talking about much, maybe a decline to 3,200 or a little below that on the index.

 

This week's Federal Open Market Committee's decision to hold interest rates steady turned out to be a snooze fest for investors. In the Q&A session after the announcement, Chairman Jerome Powell did mention that the Fed planned to begin tapering their purchases of short-term U.S. Treasury bills by the second quarter of this year. He reiterated that the purchases they have made since last September were "not QE" and the Fed could not be held responsible if the financial markets thought differently. Maybe investors are finally beginning to believe that, which may also have contributed to the present sell-off.

 

As of Friday's close, I suspect that we will have given back most (if not all) of the gains we have enjoyed since the beginning of the year. That should have been expected, since historically, we usually have a late January-into-February pullback in the markets. My advice is to look beyond this event and focus instead on regaining the record highs sometime before the end of the first quarter.

 

Over the last few years, investments that focus on environmental, social, and governance issues, or ESG, have been confused with socially responsible investing or SRI. There is a big difference between the two investment styles.

 

The simplest way to understand the differences between the two is the profit motive. ESg investments are focused on making money as a primary objective. They do so by identifying specific risks or opportunities now and in the future and investing accordingly. SRI investors, on the other hand, are willing to forego profits in companies that do not meet their ethical standards. They value ethics more than profits in the investment world.

 

For example, if an individual decides they do not want tobacco, energy, or firearms companies in their portfolio, then, despite the possibility that one, or all three sectors, might generate better returns than the market overall, these companies would be excluded from future investments. If, as a result, their portfolio returned less than the market (or fell further than the market overall in a downturn), the ethical return of knowing you are a socially responsible individual far outweighs the monetary return.

 

An ESG investor may exclude the same three investments, but for entirely different reasons. If, from an environmental point of view, an investor believes that future government restrictions, increasing carbon taxes, and civil or criminal lawsuits (as a result of pollution and oil spills) make the financial returns of energy companies a poor investment versus other areas,  oil and gas stocks might be excluded from an ESG portfolio.

 

Many investors, of course, want it both ways — to see their money invested in stocks or funds that are profitable and to reflect their social values.  Easier said than done, however.  In the past, the SRI world could be quite risky, and one person's values and portfolio choices could be much different from another's. Religion, personal values, or even political beliefs can sometimes create contradictions.

 

You may be anti-conflict, for example, and want to avoid firearm stocks, while having no problem with buying mining stocks in Africa, despite atrocious human rights violations there. You could be a hunter and want guns in your investment portfolio but reject alcohol and tobacco stocks on religious grounds.

 

Many socially responsible investment choices have been in companies and sectors that were overly dependent upon government tax breaks and credits just to achieve an acceptable level of profitability (think solar, water, and wind). If, as has happened many times in the past, governments chose to remove their support for political or budget reasons, these companies could collapse. Other issues involved liquidity, high expenses, and transparency,

 

But times are changing, and some of these areas are finally coming into their own.  Last year, for the first time, exchange traded funds assets began to see a sizable increase in ESG investing. More than $20 billion was invested and, while that is still only 0.4 percent of the $4.5 trillion invested in ETFs, it is growing. Better still, the premise of these ESG funds seems to be working.

 

Nine of the largest ESG mutual funds in the United States outperformed the S&P 500 Index last year. Seven of them topped their market benchmarks over the last five years, which is no small accomplishment given the strong performance of the overall market during that time period. According to Bloomberg, assets managed by the 75 retail funds in its ESP survey were up 34 percent to $101 billion in 2019. 

 

It just so happened that these fund managers during that time invested heavily in the technology and financial services sector, since both areas have historically been in low-pollution emission areas. Those same companies were the darlings of the overall market as well. Companies that are advising other companies on how to become more energy efficient, or helping to minimize nasty environmental impacts on society have also done well. Health care was another sector where ESG investments paid dividends.  

 

This kind of investing is also a good fit for those who are saving for retirement, since most money managers consider sustainability investing as a long-term investment  The jury is still out on how well ESG will do in the years to come but for those who might want their cake and eat it too, I believe the ESG approach trumps SRI at this stage of the game. 

 

The stock market is frothy. The great gains that investors experienced last year are extending into this year. As the indexes climb, more and more of those on the sidelines are jumping in. Is this a good sign?

 

No, it isn't. "The Fear of Missing Out," or FOMO is rearing its greedy head on Wall Street. Those who may have raised some cash in the past few months, fearing a trade war, or the impeachment proceedings, have watched the portfolios underperform the averages, ignore all the negative news and climb higher.

 

On the geopolitical front, we have seen the same thing. Selling on fear of an Iranian response to the killing of one of their heroes was the wrong move and, evidently, so was taking profits on this week's fears that the China-based coronavirus would spread, denting world economic growth.

 

Anecdotally, I have been getting requests from some of my tell-tale clients (those who want to buy at the top and sell at the bottom) to buy stocks at historic highs, where their prices exceed all rational measures of valuations. They are usually a good contrary indicator.

 

As is the U.S. Advisors Sentiment Indicator. This week's numbers underscore the gathering bullishness of market participants Those professionals who are positive on the market's future moved even higher to 59.4 percent. That is the highest it has been since September 2018.  And as the present rally broadens, we can expect that next week the bulls should top 60 percent.

 

In the past, a 60 percent bullish read would have had most who follow this indicator running for the hills, in the short-term. But so far, the opposite has occurred. Granted, investor sentiment, as a contrary indicator, is not the only variable used in trying to discern the stock market's next move. I believe that the actions by the Federal Reserve Bank will almost always trump sentiment as a determining factor. So, let's look at the Fed.

 

As I have predicted throughout the last several months, as long as the Fed keeps pumping money into the financial markets, I believed stocks would continue to rise. Since the beginning of December, the combined reserve management purchases, plus repo injections by the central bank, has been about $400 billion. The Fed argues that since they have only been purchasing notes (and not bonds with a coupon), their purchases do not qualify as quantitative easing (QE). The market doesn't care. To them QE is QE.

 

These "Not QE" purchases, however, have been so huge that the central bank is approaching the limit of purchases it can make of these short-dated securities without disrupting the market. At the present rate, there will be no notes left to buy in a month or two. As a result, traders are now betting (75 percent probability) that by mid-March, the Fed will have to expand their purchases to include longer-dated Treasury bonds.

 

The logical question to ask is why doesn't the Fed simply stop these purchases? It could be because the Fed has created its own version of "Frankenstein's Monster."  As I have written before, the Fed has dumped such an enormous amount of money into this market that by stepping back from more purchases (no matter how small), the Fed could disrupt the whole market.

 

The bet is that rather than risk that, the Fed might simply begin to expand its bond purchases to include longer-dated debt maturities with coupons. Of course, once that happens, the Fed would have to admit that, yes, they have embarked on yet another QE program. You might ask, "so what's wrong with that?"

 

The first question investors might ask is why? The stock market is assuming that everything is right with their world. Jerome Powell, the Fed's chairman, has said so over and over again. The president has said so even more times than the Fed. So why do we need another QE program after cutting interest rates three times last year? What's wrong? The Fed's actions, far more than anything else, have driven the stock market to its present record highs. Investors will demand an explanation — and soon.

 

The second, darker explanation may be that the Fed is no longer the independent body it claims to be. After all, Powell was appointed by the president. The president has voiced his unhappiness with his man's actions since he got the job. Trump is a staunch believer in easy monetary policy and wants the economy to grow as fast as it can to cement his election chances.

 

What better way to do that than by getting the Fed to pump money into the system via "Not QE," since few of us understand something as arcane as the "repo market." Whereas, cutting interest rates to zero at the president's request would be an extremely optic moment for all involved. Whatever the answer, the Fed's future actions should be watched closely.

 

America's intellectual property (IP) is worth more than $6.6 trillion and employs 45 million Americans and hundreds of millions more worldwide. It is estimated that IP-intensive industries account for one-third of the country's total Gross Domestic Product and 52 percent of U.S. merchandise exports. It is why we, as a country, are fighting so hard to protect these rights today.

 

The figures above come from the U.S. Chamber of Commerce. If anything, they understate the value of IP to all of us. So what, exactly is IP? Generally, it is any product of the human intellect that the law protects from unauthorized use by others. Inventions, literary and artistic works, symbols, names, and images used in commerce, really; just an endless list of things that people created that makes the world what it is today.

 

It is usually divided into two categories: industrial property, which includes patents for things like inventions, trademarks, designs, etc. and copyrights that cover most of the artistic world, including everything from television shows to the latest bestselling books.

 

Our founding fathers thought that IP was so important to the future of this country that they made it a point to protect the rights of authors and inventors in the U.S. Constitution. However, protecting these property rights has not always been the priority it should have been in our nation's history. The most recent example is the on-going trade dispute we are having with China over intellectual property and technology transfers.

 

A cynical investor might ask why, after over two decades of accelerating trade between our two countries, are these issues only coming up now? If IP is such a vital component of our national wealth, why did it take Donald Trump to shine a spotlight on a business practice that has been going on for more than 20 years, not only in China, but in a good part of the rest of the world as well?

 

Well, in the case of China, it was the price of doing business. There was nothing sneaky or underhanded about it. The Chinese were straightforward in what they wanted when they first opened the doors to their economy in the Nixon/Kissinger era. The message was clear — if you want to do business in China and sell to our billions of consumers, in exchange, we want to understand, learn, and license the intellectual property behind your products.

 

So why did we agree to those conditions? During those days, the markets were rewarding companies that managed to plant the first flag on Chinese soil. It was considered a "strategic advantage" to beat your competitors into China. Every company in the world wanted a piece of the action and to be first to crow over a foothold in the country. It was (and still is) the fastest-growing consumer market in the world. Visions of billions of additional hamburger or DVD sales filled the trade journals of the day.

 

The uncomfortable truth is that our U.S. corporations gladly transferred their secrets to Chinese companies in exchange for that new business.

 

And don't think our government was not complicit in helping U.S. companies gain an advantage in China. They knew exactly what was going on, in my opinion. And now, only after the horse has already left the barn, are we trying to slam the stable door shut. In hindsight, we have to ask ourselves this question:

 

"Was giving away our industrial property and looking the other way as our technology was pilfered worth the additional sales we received from the Chinese?"

 

Evidently not, if you listen to the rhetoric. The media, the public and of course, the outrage of politicians on both sides of the aisle are well known. The inconvenient truth is that we always had the opportunity to "just say no," but we didn't. We said nothing.

 

Sure, you can blame China for being unfair in the first place, as if business is ever fair or unfair (unless you lose). But from the Chinese point of view, as a country striving to raise itself up by its bootstraps 30 years ago, was it unreasonable or unfair? To me, it was simply a smart business tactic. They recognized the greed and profit motive of capitalistic societies and exploited it for their own benefit.

 

When asked, the members of the Federal Reserve Board continue to argue that the almost $500 million they have pumped into the overnight repurchase market since September is not quantitative easing. The stock market disagrees.

 

"Not QE" is the term most often used by the Street in describing this fairly hefty expansion of the central bank's balance sheet. Because the purchases that the Fed is making are categorized as debt instruments that mature in 12 months or less, they escape the hard and fast definition of what the Fed labels as quantitative easing. QE is the purchase of longer-dated maturities of debt instruments, so the Fed is technically correct.

 

However, traders are folks who like things simple. Over the past decade or so, when the Fed expanded its balance sheet (bought bonds) the stock market climbed. As far as the Street is concerned, it has happened again starting in September, and so far, there is no end in sight.

 

There are various explanations (none proven) for exactly why the Fed is making these purchases. Officially, the Fed argues the entire exercise is simply technical in nature. The Fed explained that for various reasons — quarterly tax payments, bonuses, etc. — corporations need more cash to make ends meet, but this trend will soon fade. The problem is they have been saying that for over four months.

 

Others worry that some big bank is in trouble, or that this is a new strategy by the central bank to ensure a soft landing in the economy by graduating over time from purchasing short dated debt to full-fledged QE purchases of longer majorities somewhere down the road.

 

I ask myself what could the Fed be worrying about that the market doesn't see quite yet? It is fairly obvious to most economists that the manufacturing sector in this country is in recession. We are also in our third quarter of falling industrial production. The good news is that the manufacturing sector represents less than 8.5 percent of overall jobs and less than 10 percent of the economy. So far, none of the woes in that area has spread to the overall economy.

 

There is a chance that if the downturn in manufacturing persists, it might at some point start to impact consumer spending, which is the locomotive that drives the U.S. economy. However, there is no evidence of that as of yet. In the meantime, the stock market continues to make record highs. And as long as the Fed keeps the spigot in the "on" position, the stock market's cup should continue to runneth over.

 

The signing of the Phase One China trade deal also cheered investors this week. The vast majority of Wall Streeters have not been fooled by the hours-long signing and celebration of the event by the administration. The deal, if one can call it that, is a win for China and not the United States. The fact that the really difficult issues remain and will not be resolved until after the election (if ever) reduces the upside from this event.

 

About the best that can be said for the deal is that it does reduce tensions somewhat going forward. It also gives the president a chance to claim another success (no matter how lame) among his followers.