Stocks finished higher yesterday. The Dow Jones Industrials extended their winning streak to 7 straight sessions.

But after pushing toward new all-time highs, stocks retreated in the afternoon and finished well off their best levels of the day. A 7-day rally showed signs of exhaustion, although futures are higher again in the overnight hours.

President Trump, in an after hours tweet, suggested that an “interim” trade deal was a possibility. Translation: there is no way that China is going to give in to all our demands any time soon so a compromise that releases some of the tariff pressure in front of elections may be a necessary step. That means no conclusions related to forced technology transfers, intellectual property theft, and all the other hard issues. But it also suggests China will buy more soybeans and make efforts to reduce its trade surplus with us. In other words, back to square one, saving as much face as politically possible while still keeping a modicum of political pressure on the Chinese to consider our wish list. For the past few weeks, markets have been on the rise expecting just such a path, one followed fairly often by the President since taking office.

From a stock market standpoint, this might all be good news. The chance that China would cave and give in to all our demands was always remote. President Trump picked a fight that was very difficult to win outright, if at all. With an election approaching, an interim deal was the best outcome. Interim takes away the opposition argument that the deal is weak or less than desired because the word interim defines the deal as a work in process. Of course, an interim deal may never result in a final deal that meets all our objectives, but that is the beauty of labeling it interim. There is no deadline to a final agreement. As we have noted many times, China has very little incentive to change its ways in any significant manner today. Over time, if it wants to sit on the same economic stage as the rest of the developed world, change will be necessary, but that will happen on Chinese terms, not because of American tariffs.

The stock market’s recent rally suggests that investors felt an interim deal was the most likely outcome. No one should have doubted that with an election approaching, Mr. Trump would play hardball all the way to election day. Of course, nothing is carved in stone. Should the President feel China is taking advantage of him, he could still escalate tariffs. But both sides want interim calm before the election, and that remains the most likely outcome.

Although trade optimism sparked the recent rally and sets the market up for an attack on all-time highs once again, valuation remains tied to interest rates and earnings, not tariffs. As a result, with earnings estimates still coming down a bit, and with the lows in long-term rates possibly now behind us, further gains in stock prices from the near-record highs of today demand either raised earnings estimates or lower interest rates. Both are problematic at best. That suggests with the good trade news now priced in, a further thrust must come from elsewhere. One might argue that fears of recession have receded, but there has been no real change in economic data recently that either increased or decreased the odds of recession. Today’s retail sales report for August is the one data item that could be market moving. The consumer has been the rock bed of this economy. A weak sales report wouldn’t be well received.

The short-term shift toward banks, energy, and industrials versus a decline in high-tech, big multiple stocks may have already run its course. Or, more likely, banks, etc. will still get attention from investors seeking value while the rapid retreat in growth stocks also sends investors looking for bargains. Yesterday, oil stocks gave back a bit and the growth stocks bounced. But the bounce needs to continue to be convincing. After seven straight up days, some consolidation is probably appropriate. What is apparent is that the growth stocks remain in an uptrend despite recent corrective moves, and the banks, industrials, and oil stocks seem to be better positioned than they have for months. That means all stocks are in better technical condition than they were a few weeks ago and an attack to new highs is therefore quite possible. But given that earnings estimates continue to fall and interest rates are rising from recent lows, one has to question how much further the rally can go without improved economic news. The good trade news is out. Central banks are easing but not as aggressively as expected just a few days ago. There is a better than 50:50 chance that the bond yields won’t revisit their recent lows. Serious forward progress that takes stocks meaningfully higher demands better earnings prospects. We will learn more as earnings season arrives about a month from now.

Today, Tyler Perry turns 50.

James M. Meyer, CFA 610-260-2220

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