Weekly Update: Stable? Genius? Either would suffice

08-03-2018

The proposed Stable Genius Act, requiring all presidential candidates to undergo medical exams and publicly disclose results prior to a general election, was unveiled on Jan. 9, 2018, three days after President Trump called himself a "very stable genius"—a phrase he repeated at last month’s NATO summit. Since passage of Trump’s tax reform, bottom-up consensus has been revised up by roughly $15 per share for this year and next, and ultimately could go higher. And since his election, risk has returned in a big way, in the markets and the economy. While larger stocks have yet to revisit late January’s peaks, the Nasdaq and Russell 2000 have repeatedly set new highs. Heretofore weak productivity, arguably the biggest secular headwind, has started to trend up. Manufacturing is strong, confidence is holding at multi-decade highs and the job market has improved to the point that the share of workers earning poverty-level wages is now a record low. This all sounds pretty genius to me. The question now is, how much economic or stock market pain is Trump willing to take before backing off an agenda that could turn into a trade war? Cornerstone Macro posits that it’s more than most investors think. Trump has said taking risks with the stock market is like gambling with the bank’s money given the increase in market’s value since his election, a view that cautions against any sense of certainty that there is a Trump “put” on the S&P 500.

I strongly believe that Trump wants to get re-elected and to win the midterms, so he’s checking off that list of populist promises he made. Sounds pretty stable to me—and apparently to others. His approval is the highest of his presidency, according to the latest NBC/Wall Street Journal poll, and except for post-9/11 Bush, the highest ever among Republicans in the post-World War II era. For decades, Trump has complained about China “eating our lunch” and hollowing out our manufacturing base. He has said “winning a trade war is easy,” and may need to see significant economic pain to question his belief the U.S. has the upper hand. From Trump’s perspective, the data to date has to suggest so far, so good. But now he wants his Commerce Department to come up with a national security justification (?!) for imposing 20-25% tariffs on imported autos and auto parts. This would represent a massive broadening of trade tensions. Perhaps Trump’s just playing to his base—the 20% of Michigan voters and 12% of Ohio voters who work in the domestic auto industry. While Trump may believe America’s bilateral trade deficit means China may be less able to withstand a disruption to the current arrangement, 13D Research says the reality is more complex. It argues the U.S. does not possess the propensity for its historically robust pace of growth. Its birth rate is at early 20th century lows, income and wealth inequality are rising and productivity is struggling. China, meanwhile, is expected to account for a third of global economic growth this year vs. the U.S.’s 10%. Emerging markets as a group are expected to account for 80%.

Globalization over the past three decades has produced innumerable positives for U.S. multinational manufacturers, boosting their margins, lessening their capital intensity and creating a free-cash-flow bonanza. Relying on offshoring, overseas tax havens and wage savings, S&P manufacturing margins have nearly doubled since 2000; they’re up only modestly for the rest of the S&P in the same period. With China accounting for almost half of tech and capital goods imports that feed directly into U.S. multinational and manufacturing supply chains, any disturbance from tariffs could have serious market consequences. Manufacturing’s share of GDP may only be 10%, but manufacturing multinationals represent more than 40% of S&P earnings. Many, including us, believe the trade issues are likely to be resolved before midterms. But China may not cooperate. Evercore ISI thinks we’re at the beginning, not the middle, of a trade war and that it’s going to get worse before it gets better. China is almost certain to do all it can the next few months to prevent its economy from slowing (and thus weakening its negotiating position), from cutting rates to lowering taxes. It also can fall back on rising export markets in Brazil, Russia and India, which together accounted for $618 billion of its exports last year vs. $432 billion in the U.S. And it’s not just China. Sales at U.S. multinational subsidiaries operating in other countries that also are in Trump’s crosshairs (the autos and auto parts tariffs would hit those countries, too) are nearly four times as large as U.S. exports to those countries. If tit-for-tat tariffs intensify, these U.S. multinationals could be harmed. So strap yourself in as we see whether all this bellicosity and saber-rattling really works. For regardless of your views on our president, you’ve got to hope at least one of either “stable’’ or “genius’’ is correct.

Positives

  • The job market is fine July nonfarm payrolls missed forecasts but big upward revisions to the prior two months pushed the 3-month average to a robust 224K. One factor hitting July—a big drop in specialty retailing jobs on Toys R Us store closings. Elsewhere, ADP payrolls jumped and layoff trends hovered near multi-decade lows.
  • Manufacturing is fine July ISM and Markit PMI readings softened a bit but off very robust if not unsustainable levels. Both continued to point to above-trend growth, as did Dallas and Chicago regional readings that surprised sharply to the upside. ISM and Markit services readings cooled more than expected but still reflected solid growth. 
  • Consumers are fine July Conference Board confidence flirted with a 14-year high, while June spending came in strong. One reason: American workers received their biggest pay raises in a nearly decade in June (more below), a result of employers competing for scarcer workers.

Negatives

  • If we’re ever going to get inflation, this would be the year While core year-over-year (y/y) PCE inflation dipped a tick below the Fed’s target, the Employment Cost Index rose at its fastest pace since September 2008, as did the y/y wages and salaries component. Benefit costs climbed even faster. Cost pressures in the Markit manufacturing survey accelerated at their third-fastest rate in seven years.
  • Housing trying to hang in June pending sales rose more than expected but the y/y trend remained negative, prompting the National Association of Realtors to pare projected 2018 sales. The Conference Board’s confidence survey reported a big drop in plans to buy homes.
  • Worker shortages and tariffs hit constuction June construction spending unexpectedly weakened. Companies blamed difficulties in finding workers as well as rising construction material costs, particuarly lumber prices because of tariffs. 

What else

Midterm watch With the exception of 2010, every time the House has flipped, the Senate has flipped with it—and Republicans have only a 1-seat majority. While the odds have shrunk, polls still suggest the House will fall into Democratic hands.

What happens to yields when September comes? One narrative has strong pension demand acting as a restraint on rates this year. That could end in September, when corporate America no longer can deduct pension plan contributions at the old 35% corporate tax rate. Other reasons to be worried about the long end moving higher going into Q4: a potentially overheating economy and an increase in Treasury supply.

I’m not a fan of meetings, though I’m not on the CEO path either A Harvard study found of the 62.5 hours CEOs work on average each week, 72% is spent in meetings. Nearly a third of those meetings lasted an hour, 38% were longer and 30% were shorter. In their post-study debriefings, "CEOs confessed that 1-hour meetings could often be cut to 30 or even 15 minutes," the study’s authors wrote.

Connect with Linda on LinkedIn