Stocks closed up Friday on the heels of a strong employment report and a 50-year low in unemployment.

The economy continues to hum along with little inflation. But, alas, if only the economic data was the driver of stock prices.  When things look like they can’t go wrong, look to Washington to throw a fly in the ointment. 

One characteristic of President Trump to that he likes to pivot in unexpected ways keeping everyone off balance.  He particularly chooses to do so when he his being beaten up on a particular issue, in this case the aftermath of the Mueller report and the repeated efforts of Democrats in the House of Representatives to call current and former members of his administration to testify.  In the President’s mind, he feels vindicated by the report, at least to the extent that there isn’t enough in it to warrant further action.  He, therefore, wants the House to drop the subject and move on.  That apparently isn’t going to happen without a fight.  So, to turn the attention away from the Mueller report, the President has shifted gears. With the withdrawal of both Stephen Moore and Herman Cain as nominees to the Federal Reserve board, he is beginning to float names of other candidates.  He is stepping up the pressure to cut interest rates even though he has no power to get that done and probably won’t sway the FOMC to do so.  Indeed, the next meeting isn’t for another six weeks and it is highly unlikely, based on current information, that the Fed will move then. 

Overseas, North Korea has resumed missile testing but not nuclear weapons.  The President, not wanting to lose the sense of progress there after suggesting that he has made the world safer after earlier talks, is willing to give North Korea a pass, at least for now.

That leads to trade talks.  Mr. Trump has often described himself as a proponent of tariffs as a weapon to get what he wants on the trade front.  While he often has stated that he and President Xi of China have a great relationship and talks with China have been proceeding, over the weekend, Mr. Trump stated that he wants to raise tariffs on goods now subject to a 10% tariff to 25% on Friday and he suggested that without further and speedier progress he just might slap 25% tariffs on everything China exports to the U.S. shortly.

This tactic is classic Trump.  The Chinese clearly will not take this well.  Just a few days ago it was hoped that talks could wrap up soon with a Trump-Xi signing of an agreement happening perhaps as early as late May.   But clearly, the agreement that seems to be evolving was going to be weaker than Trump could accept politically.  The threat to raise tariffs immediately is a step to increase the heat on China to take seriously the enforcement mechanisms to get a deal through Congress.

Many have suggested that Trump will take almost any deal just to have one, and would claim it is the best deal ever with China.  But, while that may be politically acceptable short term, it is unlikely that conservative Republicans in the Senate, much less Democrats, are going to support a weak agreement.  Mr. Trump’s comments say, loud and clear, that if there is going to be an agreement, China must respect intellectual property, stop hacking and stealing, and allow American companies to do business in China in much the same way Chinese companies do business here.  

Will the tariffs happen?  Five days is still a long time but unless China responds with anything other than anger, the odds suggest the tariffs will be put into place and it will clearly add urgency to the negotiations.  As for Wall Street, clearly this is a kick in the head, at least for the short term.   Companies are not going to be able to adjust supply chains in five days.  How long these tariffs stay in place, assuming they are implemented, is anyone’s guess.  It clearly depends on the Chinese reaction. China could walk away from the negotiating table, address talks with new urgency, or anything in between.  The reality is that, after initial anger, China is going to have to take the U.S. stance that enforcement mechanisms need to be stronger seriously. The only question is how long will it take for them to come to that realization.

Futures are down sharply in the early going by 1-2%.  That is hardly a big dip given recent advances. We have noted many times lately that stocks are ripe for a correction and today’s news is clearly a catalyst.  This could be a one-day hiccup or the beginning of something larger.  While several leading averages, like the S&P 500 and the NASDAQ Composite have been setting record highs recently, the Dow hasn’t and the Dow Transportation index has been conspicuously weak.   “Sell in May and go away” is an old saying on Wall Street and not always right.  But clearly, after gains of almost 25% from the December lows, some sort of correction, even a small one, seems in order.   We will know a lot more about the status of trade talks in a few days.  In the meantime, I don’t think this morning’s apparent weakness is the buying opportunity.  Give this at least a few days to play out.

Today, George Clooney is 58.  Bob Seger is 74.  Willie Mays turns 88.

James M. Meyer, CFA 610-260-2220

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