We note that the big story clients are concerned about remains the US trade policy, but the rapid acceleration of economic growth and the declining poll numbers for Democrats suggest that economic fundamentals are outweighing trade policy, at least for the time being. Fiscal policy (Tax Cuts) of $800bn this year dwarfs trade policy and most of the trade retaliation tariffs (Currently estimated at $80bn) are rounding errors in a $20 trillion economy. NAFTA remains the real risk and investors are pricing in a higher probability of termination. NAFTA deals with supply chain issues and is larger than just tariffs. Tariffs are more of a sector and company specific issue and we are keeping an eye on these issues. Tax reform-levered companies and domestic-based companies continue to outperform during trade uncertainty.
Given Last week's employment report, we're expecting a June Fed rate hike which will get the fed funds rate close to the inflation rate, a zero real rate after years in negative territory. Balance sheet runoff is expected to be in full swing by September, so skipping that meeting is probable. The FOMC will remain in a zone of safety as long as they raise the fed funds rate in line with inflation, but do not invert the yield curve. The Fed should follow the market, rather than lead it in this environment.
Market volatility continued last week as positive economic data was offset by concerns of escalating trade wars and political turmoil in Europe. Stocks sold off on Tuesday after Italy’s two populist parties, which prevailed in the most recent elections, were prevented from naming a euro-skeptic as finance minister; the President’s rejection of the appointment raised the specter of snap elections that could further divide the country. Two days of negotiations led to an agreement allowing the two parties to form a government on Friday; although questions remain about the policies the coalition may pursue. Meanwhile, Spain’s center-right Prime Minister Mariano Rajoy lost a no-confidence vote which ended his six-year tenure; the unprecedented vote handed the government to the center-left Socialist party and added to instability in Europe. The geopolitical unrest was compounded by the Trump administration’s decision not to extend exemptions on steel and aluminum tariffs for the European Union, Canada, and Mexico. These countries quickly promised retaliatory countermeasures. And, on Tuesday, President Trump reversed last week’s declaration that the trade dispute was “on hold” when he announced the imposition of duties on $50 billion of Chinese goods. The uncertainties created by these measures, which received strong criticism from politicians and many business executives, may weigh on investor sentiment.
Economic data remained positive: the May jobs report highlighted a tight labor market and rising wages; the unemployment rate reached its lowest level since April 2000; also, manufacturing activity continued to impress with increased construction spending and robust new orders. Energy stocks outperformed as fears of a significant increase in oil production by OPEC and Russia eased. And, Financials underperformed as interest rates declined. Also, last week the President signed a bill rolling back certain elements of the Dodd-Frank Act. Specifically, the bill raised the threshold for “systemically important financial institutions” from $50 billion to $250 billion; the designation will now apply only to the twelve largest banks. In addition, on Thursday, the Federal Reserve proposed revisions to the Volcker rule that would ease restrictions against proprietary trading; the rule had been criticized for unintentionally increasing risks in the financial system by eliminating the role of “market makers.” The exemption from the rule’s extensive record keeping and reporting requirements should also help small- and mid-sized banks increase lending activities. To date, business leaders and investors have reacted favorably to the administration’s deregulatory agenda. Indeed, despite this week’s volatility, the market’s performance in May, the strongest since January, contradicts the old Wall Street saying, “Sell in May and go away.”
*Source: Strategas & Pacific Global Investment Management Company
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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