Stocks fell sharply yesterday morning on a combination of weak economic data from Europe and reports that Presidents Trump and Xi no longer plan to meet before March 1 to stave off imposition of higher tariffs on Chinese exports to the U.S. The next scheduled time the two will be together is at the June G-20 meeting although, obviously, nothing prevents them from meeting sooner.
At the moment a full blown trade deal between China and the U.S. is unlikely any time soon. The two nations remain far apart on key issues of how to enforce violations related to intellectual property or how to open up Chinese markets to American companies. But a full blown deal isn’t necessary to get Trump to delay the imposition of higher tariffs if there is some progress on top of Chinese promises to import more American oil, soybeans and beef.
The decline yesterday, which was cut in half by the market’s close, was orderly but it served as two separate reminders. First, after almost 6 straight weeks of gains, investors had to be reminded that valuation matters once again. Stocks had returned to fair value quickly and were no longer bargains. That doesn’t mean they had gotten overpriced to any significant degree but they certainly weren’t cheap any longer. A little correction would make prices attractive once again. Second, the vast majority of observers believed that Mr. Trump wouldn’t choose to impose higher tariffs after just going through a government shutdown. He may still come to an eleventh hour agreement. That has certainly been the case before. But one can’t take that for granted. And lest anyone forget, we are less than two weeks away from another possible government shutdown. Yes, Mr. Trump could declare a national emergency to allow him to commandeer funds from the military or some other source within the government to fund his wall demands but that is a dicey moved filled with political risk. The odds that such a move could withstand Congressional or legal challenges are not good and, for that reason, the President would likely go that route only as a last resort.
For better or worse, Mr. Trump is going to have to find a path to be able to work with the Democratic House. Down the road are next year’s budget requests and the need to raise the debt ceiling. For both sides to behave like stubborn mules not only creates gridlock but also unwanted events like government shutdowns. It is easy to say that moderation on both sides is needed but, so far, no one has found a solution. Some in Congress are hopeful they can reach an agreement before February 15 but there is no assurance that President Trump will sign on.
February is one of the least important months economically and earnings season is fast winding down. In that vacuum of news comes the tariff talks, funding the government, progress or lack thereof on Brexit (whose deadline is March 29), and a whole slew of other geopolitical concerns around the world.
On top of all this is fear of an earnings recession. That is far different from an economic recession. What is happening now is similar to 2015 when an even stronger dollar than we see today, along we oil prices falling to near $30 per barrel, sent earnings of multinational and energy companies tumbling and left the stock market negative for most of the year. Back then, the year-over-year change in the dollar reached as much as 20%. This time around the maximum change in the dollar weighted index is about 6% and will impact earnings for the first 4-5 months of 2019. Oil prices are down again this year versus a year earlier but, once again, the rate of decline is nowhere near the extremes of 2015. Rig counts fell 60-70% back then. Today, they have barely fallen. Thus, while dollar weakness combined with a slowdown in growth rates could lead to flat or even slightly lower year-over-year earnings in the first quarter, unless the dollar surges from here, the likelihood and earnings comparisons stay negative in the second half of 2019 are relatively modest. That, of course, presumes that Mr.
Trump doesn’t further inflame a trade war.
Given that none will be settled this week and the likelihood is that none will be settled next week either, the headlines we will be reading over the next few weeks doesn’t look very heartening. Even if one problem gets solved (e.g. funding the government), the next one looms closer. None of these will have a dramatic impact on earnings, dividends or interest rates, but all impact the psyche. It is one reason February can often be a time of uncertainty in the financial markets. Lest we forget, last year was a vivid example. We also should remind ourselves that market emotions can changed suddenly. Look at last October, November and December for proof. Values today are sound. There is no need to do anything suddenly. Markets are not overpriced. But six weeks of steady rises can build in a sense of complacency that can, and should, be erased with a day or two like yesterday.
One should also pay some attention to my two-day rule. The trend is still up until there are two consecutive days of meaningful declines. Yesterday was one. We will see if today is the second.
Today, composer John Williams is 87.
James M. Meyer, CFA 610-260-2220
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