Our view over the past four weeks was that the Trump Administration needed a win on trade (outside of China) to build support for larger escalation with China. This process is now in place. After weeks of rising trade tensions, the U.S. and EU meeting last week resulted in some rare positive trade-related news. It is unclear whether this marks a broader shift away from protectionism or is an isolated event. But at this point, the bar for positive surprises is so low that even news that negotiations are continuing is considered a win for supporters of free trade. The recent pattern suggests that President Trump will shortly resume his harsh trade rhetoric, so we are approaching the issue cautiously. But we would welcome any move away from trade protectionism.
So far, actual economic damage from imposed tariffs and harsher trade rhetoric has been minimal. However, politicians could still enact additional restrictive measures that could cause more serious fallout. The uncertainty over the future of trade policy is causing problems for equity markets, as expectations are rising that companies could delay investments or business plans as they await additional clarity.
The good news for stock markets is that corporate profits have been stellar this year and economic growth remains solid. These factors have kept stock prices from falling in the face of trade uncertainty and kept government bond yields relatively low. Any improvement in the trade backdrop should cause both stock prices and bond yields to move higher. For now, however, we expect financial markets to continue churning and stocks to remain in the same trading range they have been in since early February: a high of 2,875 and a low of 2,532 for the S&P 500 Index.
The markets were mixed last week as trade uncertainties, a somewhat disappointing Q2 GDP estimate (+4.1%), and several notable earnings misses clouded investor sentiment. For the week, the Dow Jones Industrial Average (+1.67%) led the major indices, the S&P 500? Index gained 0.61% while the Nasdaq composite fell 1.06% and the Russell 2000? Index lost 1.97%. So far, quarterly results from 53% of S&P companies report an average earnings growth rate of 21.3%, the highest since the third quarter of 2010. 83% of companies have exceeded earnings expectations; 73% exceeded revenue targets. Market results, especially for small cap stocks, suggest that investors are overlooking positive earnings reports and generally positive outlooks to reflect a “risk off” perspective.
Technology stocks reported mixed results: Alphabet posting strong results while Facebook and Intel missing earnings and revenue targets. Facebook lost almost 20% after reporting slower growth and higher expenses. The selloff, while perhaps overdone, nevertheless exemplifies investors’ high expectations for Technology stocks’ continuous earnings and revenue growth. Several other bellwether companies, including United Technologies, United Parcel Service and Verizon, reported strong earnings and outlook.
Transportation-related stocks underperformed due to concerns the sector is nearing peak contract rates which would lead to slower revenue growth. Company commentaries for trucking, rail and marine sectors, though, reflected a more bullish sentiment based on economic growth and supply constraints. Most companies reported minimal impact from tariffs; most believe the issue will not materially impact performance.
On the trade front, the European Commission and U.S. agreed to put proposed tariffs on hold in favor of trade negotiations. China and the U.S. remain at an impasse on trade; this week, Qualcomm abandoned its takeover of NXP Semiconductors after China failed to approve the deal on antitrust concerns. Somewhat more encouraging news on NAFTA negotiations suggests that the U.S. may moderate its demands; here, the White House strategy may reflect feedback from Republican legislators seeking to deescalate trade tensions. The markets may respond negatively if a resolution is not forthcoming.
On balance, last week’s news including strong GDP growth, earnings, and preliminary steps towards easing trade conflicts might have reassured the markets. However, uncertainties related to geopolitics and the mixed results from the Technology sector led investors to avoid risk; hence, the decline in small caps. And yet, investors will likely determine that tariffs have not impacted the markets; and the strong economy is providing momentum entering the second half of the year.
Source: Pacific Global Investment Management Copany
Chart reflects price changes, not total return. Because it does not include dividends or splits, it should not be used to benchmark performance of specific investments.
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