Stocks rallied once again on Friday as trade talks with China reached an endpoint.

But they fell a bit at the close as the agreement appeared to be less encompassing than first thought.

Actually, despite efforts by the administration to label the agreement as important and pivotal, it wasn’t much of an agreement at all and remains subject to getting the written words to match the oral agreements. China will buy more agricultural goods and we will defer the October round of tariffs. There appears to be some language that forces China to support its currency as well. Beyond that, not much was finalized. President Trump keeps score by the numbers. If China fulfills its promise to buy more soybeans and our trade deficit with China is reduced, he can claim some level of victory. The door also seemed to be opened a bit wider to allow American financial services firms to operate more openly in China. But despite Secretary Mnuchin’s repeated comments that the agreement includes a chapter on intellectual property, there are no signs that China is changing its fundamental positions on intellectual property and forced technology transfer.

When President Trump began the trade war by increasing tariffs, the goal was to achieve some fundamental change in the way China does business. Many months later, as tariffs escalated, very little, if anything, has been accomplished on that front. That is not to say that a phase II or phase III won’t yield results, but any such conclusion would seem problematic at this point in time. To the extent there was substantive good news for the markets, President Trump removed the October tariff increases, slated to go into effect tomorrow. That will relieve some immediate term pressure. However, he did not take the more important December tariffs off the table, as some hoped.

The net result is that tariffs and an escalating trade war has moved off the front page but remains an active issue. Corporates who have been deferring capital projects waiting for uncertainties to be resolved are likely to still face the same level of uncertainty today. The front page, at least for the next several weeks, will be dominated by earnings. Based on current estimates, reported results should be a couple of percentage points below those of last year. However, historically, companies beat forecasts by 2-3%, and I would expect the same this time around. That suggests the best forecast is for flat year-over-year earnings and, perhaps, muted guidance for Q4 once again impacted by trade and tax policy uncertainties.

With last week’s rally, stocks once again are pushing toward record highs. To get through, my guess is that earnings are going to have to be much better than expected. That is probably a reach.

Beneath all of the trade headlines last week, the bond market was sending rather robust signals. The 3-month to 10-year yield curve uninverted for the first time in months, sending a dual message of better economic expectations and a firm expectation that the Fed will cut rates again at the end of October and perhaps once more in December. The absolute rise in yields along the curve suggests, at least from a bond market perspective, that the growth slowdown of the past two quarters, both here and abroad, is starting to abate, coincident with easier monetary policy. Economic data normally trails Fed actions by 6-12 months, suggesting the impact of the 2018 rate increases has finally been fully reflected in the economic data. The impact of the new cycle of rate cuts will begin to be reflected either this quarter or next. Those truths are consistent with the bond market’s message. If the bond market is right, economic activity and earnings should improve through 2019. That presumes no further escalation of trade wars, either against China or Europe, and it presumes that the presidential campaign season will not have an immediate economic impact.

Historically, year 4 of a presidential term is fairly good for markets. The current administration obviously wants to prime the economy for good growth. What is different this time around is that the current president faces impeachment proceedings and his opponent could well be a candidate with a highly progressive agenda that investors will fear. At this moment, those headlines need a lot of details filled in. No one knows what further damaging information will surface relative to impeachment proceedings, and it is much too early to label any democratic front runner as the next president. Current poll leaders clearly scare many conservatives, but they also scare independents and voting classes critical to their chances for election. We have a long way to go. Markets have yet to react to the election battle ahead.

Where that leaves us is (1) at the top of the recent trading range with no obvious catalyst to power stocks materially higher, and (2) at the cusp of earnings season where investors can separate the wheat (those companies doing fine in a soft economy) from the chaff.

The companies most likely to succeed are those most in control of their own destiny. These are companies that can:

1. Gain market share
2. Execute better than their competition
3. Are not dominated by macro factors beyond their control
4. Provide products and services that are most in demand

While this combination may suggest that technology is the key factor, it isn’t the only factor. Best execution is the most important factor. Owning world class companies isn’t the only way to win in the stock market, but it isn’t a bad place to start.

Today, Usher is 41. Stephen A. Smith is 52. Ralph Lauren turns 80.

James M. Meyer, CFA 610-260-2220

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