Market in (Not-So-Much) a Minute: March 5–9, 2018
Global stocks enjoyed a strong rally last week, more than reclaiming the prior week's losses. Washington’s tariffs battle and the associated retaliation threats held center stage. The possibility new steel and aluminum imports tariffs might lead to a broader trade war was a major headwind. As trade war threats declined, tariffs from the headwind to the stimulant column.
Markets rallied Thursday following President Trump's proclamation on that steel and aluminum tariffs would exclude imports from Canada and Mexico. By the time we reached Friday’s government jobs report – though inciting the week’s best day – it came almost as the proverbial “cherry on top” of what had begun to look like an appealing tariffs sundae.
What’s next for the markets? Last week’s rally aside, we believe it likely that volatility stemming from trade negotiations, interest rate uncertainty, and inflation concerns will remain elevated. We maintain balancing optimism with caution is the most prudent approach. Because our allotted minute is up, we explore what we feel comes next and why in the Details: Domestically section. Be forewarned, it takes more than a minute to grasp this stuff! And, no, it’s not on the final – it is way too important for that.
The major items of the week:
1. The tariffs saga continued with some congressional Republicans and officials within the White House urging the president to reconsider his proposed duties on steel and aluminum imports, fearing that they could cause a trade war. The president refused to back down but, by mid-week, investors seemed to focus on the potential for “carve outs” from the tariffs for certain countries. Mr. Trump signed a proclamation to implement the tariffs on Thursday afternoon. To the market's delight, the tariffs he announced did (temporarily) exempt Canada and Mexico. The president suggested that other favored trading partners might also be excluded depending on their willingness to renegotiate trade deals.
What’s the Big Deal about Tariffs?
The crux of the tariffs problem is that they can lead to higher inflation and lower growth through the inefficient allocation of resources. Tighter overall financial conditions can result from the higher uncertainty. Economically speaking, the implementation of the steel and aluminum tariffs is likely to weigh on both the global and US economies.
Further, competitiveness of US sectors that are not protected by tariffs, (e.g., automakers) is likely to suffer from rising input costs. Competitiveness erosion tends to lead to a softer US dollar. While the sectors currently involved are likely to be too small to have any economically meaningful world impact ... this beginning of taxing imports could lead to broader trade actions.
2. The February federal Employment Situation Report (the “Jobs Report”) showed 313,000 new jobs, handily surpassing the expected 205,000 gain. More important in the current inflation-fearing environment, average hourly earnings came in at only +0.2%, creating a deceleration in year-over-year wage growth to 2.6% (vs. 2.9% a month ago). The participation rate increased to 63.0% (the labor force growing by the most since June 1983), balancing out the new jobs. This held the unemployment rate steady at 4.1%, its lowest level since 2000.
3. President Trump received and accepted an invitation to meet with North Korea’s Kim Jong Un. While no one knows where this will lead, it’s a step where none was being taken. Let’s think optimistically but be prepared for disappointment. How about, “Temper optimism with caution.”
4. Last week’s rally brought stocks rebound to more than 7% since their month-ago lows. The road back has been a bumpy ride. Daily stock market moves averaged over 0.8%. So,
What’s Next for the Markets?
The majority of signs suggest continuing strength. As detailed above, the job market continues to grow while wage growth cooled. Global growth continues, it also cooling a bit but still positive. A healthy labor market, continued moderate economic growth, and strong corporate earnings growth are the fundamental drivers of stock prices over time. Let’s look more closely at earnings, which have been nothing short of spectacular in our opinion.
About ¾ of S&P 500 companies beat both revenue and earnings expectations for 2017’s Q4. The percentage beating revenue is at a record high; that for companies beating earnings is the highest in more than six years. Moreover, many gave positive outlooks and increased earnings guidance for 2018. Something that makes this more striking to us is that, historically, earnings estimates decline in the first two months of a quarter. However, earnings estimates for the first quarter are rising, increasing by the most in over 15 years (since tracking it began). Earnings estimates for the full year have now increased by more than 7%, the most during the first two months of a year since in over 20 years (when measuring this began). We believe these increases have largely been driven by improving global economic growth and recently passed tax reform.
Almost in the same breath, we must caution that much of this optimism may already be priced into the market. Tax reform led to a significant run up in anticipation of improved earnings. Many stocks are overbought technically now. They can regain a more normal range (i.e., revert to the mean) either by pacing in place while earnings catch up or by falling back in line with current earnings. Both ways suggest returns in the near term (2018?) may be constrained.
In addition, Treasury yields increased slightly last week. Concerns about inflation were muted, but not resolved. We’ve seen some large market swings recently on days it has reared its head. We don’t expect those to have disappeared.
Temper optimism with caution. The fundamentals we mentioned should likely continue to support rising stock prices. The question is at what rate. There is no rule on how “overbought” a stock can get before a “reversion to the mean” sets in. If you want to get back in the water, dip a toe or two rather than jump off the high board.
Major European (Germany, a major steel exporter, excepted) and Asian markets gained last week. In addition to tariffs, the US/North Korea meeting announcement particularly bolstered Asian markets.
2. Trade War Perspective:
Over the previous weekend, European and Asian nations did not announce retaliatory measures to Trump’s tariffs, as many had feared. Early last week, European Commission officials presented EU members with a list of over 100 US products (valued at €2.8 billion) that could be affected in response to President Trump’s steel and aluminum tariffs. Unlike Canada and Mexico, European countries were not as of yet exempted. Hence, the possibility of a trade war lingers despite last week’s sigh of relief.
Eurostat said that the Eurozone economy grew by 0.6% in the final quarter of last year, taking 2017’s GPD growth to 2.3%, the fastest rate of growth since 2007. It projects even stronger growth for 2018
Japanese GDP growth expanded faster than the earlier estimate for Q4, taking 2017’s growth to 1.6%. The data confirm an eight-consecutive-quarter stretch of GDP gains — the longest period of expansion in nearly three decades.
China set its 2018 GDP target at 6.5%, one of several key targets as the country seeks to maintain steady growth while curbing financial risk. It reported its economy expanded 6.9% in 2017, marking its first increase in annual growth since 2010.
4. Interest Rates
Both the European Central Bank and the Bank of Japan left key policy rates unchanged. The ECB deleted a promise to increase its bond purchases if needed from its policy statement.
Nothing in the above is meant to be, nor should it be construed as, investment advice or recommendations to buy or sell any security. Individual securities, whenever mentioned, are for illustrative purposes only and may not be relied upon as investment advice.
All indices are unmanaged and are not illustrative of any particular investment. A direct investment cannot be made in any index.
Tax and/or legal information contained herein is general in nature and for informational purposes only. It should not be relied upon as advice. Consult your tax professional or attorney regarding your unique situation.
Past performance is no guarantee of future results.