Weekly Update: 'People will be happy'

07-13-2018

This was among President Trump’s comments in an impromptu press conference prior to heading overseas to meet with NATO leaders and Russian President Vladimir Putin. This is probably one of my favorite phrases that he says often, although comedian John Oliver says the president only uses the phrase when he “has got nothing” planned in terms of policy.  Trump’s actions of the past week do seem to reflect an administration willing to go it alone if need be to get what it wants, creating what Bernstein says could be the greatest risk to the bull market and expansion—a trade-war inspired volatility shock that could prove particularly menacing if growth slows in 2019 as fiscal stimulus starts to wear off and Fed policy accommodation is set to turn neutral if not restrictive. Global trade has underpinned both margin expansion and top-line growth for U.S. firms over the last few decades, and interlaced global supply chains have benefited businesses, consumers and countries all over the world. Perhaps this is why 53% of Britons now say they favor staying in the European Union.

With few historical precedents, assessing the damage from a global trade war is tricky. Capital Economics guesses if every country imposed blanket 25% tariffs on all imports, world GDP would decline 2-3%. Of course, this assumption has some holes. For instance, the proposed China tariffs are only 10%. And China doesn’t have enough counter-imports to impose reciprocal tariffs, meaning it would have to seek other ways to retaliate, possibly by slowing the work of U.S. multinationals already doing more than $220 billion of business there annually. It’s this reallocation of resources, and the resulting inefficiencies, that may represent the biggest potential negative from a full-fledged trade war. UBS fears the corresponding decline in earnings and P/E multiple compression could spark a 20%+ correction. But what if all this hand-wringing is overdone? Strategas Research is among those who believe negative press coverage is leading to faulty analyses. It notes current and proposed tariffs remain quite small, with the worst case only about a seventh of the $800+billion of fiscal stimulus from tax cuts and spending increases already in place. Dudack Research agrees trade-driven recession fears are overdone. The White House really has two main issues: 1) China’s theft of intellectual property and 2) China’s developing-country status within the WTO, which allows it to have high tariffs on goods relative to developed countries. Reforming either won’t be easy, which is why Trump may think he needs to use brute force. He arguably is dealing from a position of strength. Since his election, the S&P 500 has outperformed the Shanghai Composite by 4,313 basis points—2,104 points this year alone. And there’s his ZTE advocacy, helping build trust with China even as he goes after it on trade.

The market also seems to be obsessing about a flattening yield curve. But JPMorgan says it’s hard to get too worried as long as inflation-adjusted policy rates remain negative, as they are now. In the past eight cycles, one didn’t see an economic slowdown until real policy rates reached 2%, which doesn’t seem likely anytime soon barring a dramatic shift in Fed policy (doubtful) or breakout in inflation (also doubtful, more below). High-yield spreads are at or near cycle lows—typically, they widen for a while ahead of a growth slowdown. Bank balance sheets are capital rich, and lending standards keep easing. None of this is an issue for growth. As for the markets, multiples have pulled in even as consensus estimates keep being upgraded—extremely rare heading into reporting season. Bottom-up consensus now points to 24% earnings growth for Q2, which if it holds would mark a modest deceleration from Q1’s 26.6%. Sales growth is expected to be a robust 8.7% and margins 11.6%, both also slightly below Q1. Further, weekly momentum and market breadth indicators are supportive. So what if Trump actually does have a plan? What if despondent sentiment fed by trade-obsessed markets and the breathless media is setting the stage for an upside breakout? That should make the people happy.

Positives

Workers are confident The latest JOLTS report said voluntary quits spiked 6.3% to a record high 3.561 million, a sign of strong worker confidence and ability to find a better job. For an unprecedented third month in a row, the number of job openings exceeded the number of unemployed. A record share of respondents in the NFIB’s monthly survey, which found optimism near 2004 highs, reported few to no qualified applicants for openings.

Businesses are confident Accelerating merger & acquisition (M&A) activity suggests managements are confident as M&A is most sensitive to policy and market uncertainty. Small-cap M&A activity is at a cycle high year-to-date, and S&P M&As are tracking at $917 billion across 700 transactions so far this year, the second-highest of this cycle.

If we’re ever going to get inflation, this would be the year, although … The continued rise in prime-age labor force participation amid the exodus of costlier baby boomers should keep upward wage pressures subdued even as unemployment hovers near 2-decade lows. Add in expected productivity growth on increasing capital expenditures and it’s hard to see prices rising in any significant way, adding more runway for the expansion.

Negatives

If we’re ever going to get inflation, this would be the year, although … Headline and core PPI rose above expectations in June, lifting year-over-year (y/y) increases to a respective 3.3% and 2.8%, both near 7-year highs. The report reflected accelerating prices for trade services and tariff-related metals, and for personal consumption, which shot up 3% y/y, the most since January 2012. CPI for the month was more subdued, with clothing prices noticeably weak (I must get to the mall!). But the y/y headline rate still represented a 6-year high. However, import prices came in surprisingly low.

Are consumers starting to worry about tariffs? Michigan’s early read on July sentiment slipped to a 6-month low as the current conditions component fell on trade-war fears—38% of respondents cited them this month, vs. 21% in June and only 15% in May. Despite the decline, sentiment remains at levels historically associated with strong growth in consumer spending.

Where are we in the global economic cycle? As the trade rhetoric heats up, global economic sentiment has been souring, plunging at a record or near-record quarterly pace among countries. Even so, most global sentiment indexes are still higher now than in 2015 because they’ve been declining from high levels. But if this soft data leads the hard data, as it often does, it could be setting the stage for weakness by the end of this year or early 2019.

What else

On one hand Midterm elections traditionally experience a larger-than anticipated intra-year decline in stocks—an average 19% compared to 13% in the other three years of the presidential cycle, with sell-offs usually defined by a policy error. Examples include Republicans trying to impeach President Clinton (1998), steel tariffs (2002), geopolitics (2006) and Dodd-Frank (2010)—actions taken to try to mobilize base voters before the elections. Trump has made clear that trade and immigration are issues he needs to rally his base.

On the other hand Midterm elections tend to be great buying opportunities, with stocks up one year later by an average 31% from the low. The best-performing month for the S&P in the entire 4-year presidential cycle is October of the midterm election year, averaging a 4% increase. As such, just getting to the midterm election has been the inflection point for stocks. The S&P has not declined in the 12 months following a midterm election since 1946. This may be because presidents usually lose seats in the midterms and worry their own re-election is in trouble, prompting them to pursue pro-growth policies.

Have you heard about ‘ghosting?’ That’s the term for a growing problem confronting HR departments all over. The job market has become so strong that, in fields ranging from food service to finance, recruiters and hiring managers say professionals and potential candidates are abruptly cutting off contact and turning silent as they find better opportunities elsewhere and just leave or never show up again. “Where once it was companies ignoring job applicants or snubbing candidates after interviews, the world has flipped,’’ a LinkedIn article reports.

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