With earnings season winding down, news that move markets will come from a different direction.
The U.S. economic data to be released in February isn’t likely to change the market’s course. Most of the big numbers relating to January are already out and have generally been positive, especially the second straight month showing employment gains of over 300,000. European data is weaker but, unless that is a sudden deceleration or acceleration, there shouldn’t be a sudden change in financial prices.
With that said, there are several key events to watch. The first is the Chinese trade talks. Last week, when snags appeared, stock prices wobbled. This morning, on news Secretary Mnuchin is headed to China for more talks, there is a slight improvement. No doubt, these discussions will continue, with ups and downs, all the way to the March 1 deadline when tariffs will be raised from 10% to 25% on about half the goods we import from China unless either an agreement is reached or President Trump extends the deadline. Both China and Trump want an agreement, but we are not prepared to sign one without any substance relating to the protection of intellectual property or allowing greater access for American companies in China. Obviously, there would be a modest-to-moderate short term cost associated with higher tariffs, a cost investors won’t like given an economic cycle beginning to show its age.
The second short term event to watch is the pending government shutdown should negotiations fail to reach a compromise by Friday. Over the weekend, talks again stalled over wall funding and the need for additional beds to support detainees. These kinds of talks always go down to the wire and, given the deadline is midnight Friday, it would be no surprise for them to carry over through this coming weekend. Neither side wants to see another shutdown. President Trump would probably get the most blame if it happened. The President appears ready to declare a national crisis that allows him to defer funds from elsewhere in the budget but that would almost certainly be subject to both court and legislative challenges that he stands a significant chance of losing. If there are other alternatives available to him, none have surfaced so far. The impact of a second shutdown wouldn’t be severe economically, but it would be painful emotionally. Unpaid Federal workers, just getting back on their feet from the first shutdown, would likely not be a forgiving a second time around.
A third issue, one that doesn’t reach a deadline until the end of March, is Brexit. Clearly the Brits down like th original compromise deal the May administration reached with the EU. The EU says it won’t compromise further but a hard Brexit would be painful to all, especially Britain’s largest trading partners, Ireland, Germany, France and Italy. This too is likely to go down to the wire with emotional ebbs and flows that will impact financial markets.
While all this is happening, talk rises of a so-called earnings recession, i.e. two or more quarters of down earnings. This is something we flagged many months ago as a possibility based on only a modest slowdown in the U.S. GDP growth rate. The possibility has increased slightly as European economies have softened a bit faster than previously expected and first half GDP gets affected by at least on U.S. government shutdown. The biggest culprit, however, is the strong dollar. Year-Over-year differences in the value of the dollar will be most severe now through April after which they will moderate quickly. The impact on reported earnings will be most severe in the first quarter and I would not be surprised to see reported earnings down during the March quarter.
But the picture becomes much less severe each passing quarter. The year-over-year change in the dollar index goes from 6%+ in Q1 to less than 2% in the second half of the year assuming the dollar remains near current levels. Meanwhile lower inflation and falling interest rates could help interest sensitive industries like housing and autos to stage some recovery after Q1. Also, energy prices have bounced back a bit reducing fears of a sudden fall off in drilling activity this year. In fact, once new pipeline capacity is opening later in 2019, production in key basins should reaccelerate. Thus, after Q1 the earnings picture should improve.
One other event last week was the announcement by Rep. Alexandria Osacio-Cortez and Senator Ed Markey of a Green New Deal, a roadmap quickly endorsed by many leading Democrats including some already declared for President. Most in the business community scoffed at the plan as a progressive pipe dream. President Trump campaigned on a program to “Make America Great Again”. The details included a corporate tax cut, less regulation, a more conservative Supreme Court and, tougher immigration including the building of a wall along our Southern border. Whether one agrees with Trump or not, he campaigned on a list of achievable objectives and, over the first two years, made significant strides to get them accomplished.
The Green New Deal is a pipe dream. It is aspirational. Idealistically, it may have a point to make. But it can’t become a serious campaign platform without a sensible way to execute it. No one argues conceptionally with the ideal of a good paying job, proper housing and affordable health care for everyone. Few argue of a dream of a society with no carbon footprint. But even with a 70% tax cut on millionaires and billionaires, this isn’t a goal that can be achieved economically. Instead what the plan does is excite a progressive base that gives no thought to the cost of reaching their ideals while striking fear in others that view economic chaos not knowing what might be tried. Both the Democrats and the Republicans have to spend more time and energy trying to win the center and less time pandering to their respective bases. Obviously, we are barely into the 2020 campaign season, a time when Democrats do have to talk to the base more than the center. But if they spend the next 15-18 months publishing Green New Deals and derivatives, they will lose the center before the real campaign even starts. The Democrats have a lot of reasons to believe they can defeat Mr. Trump in 2020. But a march to socialist nirvana is probably not the best approach. If the ultimate nominee starts too far left, those of us in the political middle will become disenfranchised and distrustful of any attempt to move to the center.
So far, the 2020 campaign has no impact on financial markets. But if you remember some recent elections in places like France, Italy, Germany and Brazil, extremist platforms, whether they be left or right, can create havoc in financial markets during campaign season. We can scoff for now, but how the Democratic race for President plays out will start to have meaning a year from now. It isn’t today’s issue, but it is one to watch.
Today, Jennifer Aniston turns 50. Sheryl Crow is 56. Jeb Bush turns 65.
James M. Meyer, CFA 610-260-2220
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