Renewed talk of trade negotiations with China is good but until China decides that Intellectual Property rights are part of that discussion, the stalemate remains. We will be better able to separate reality from political hype next week after the elections are over.
Stocks rose again yesterday as the trade differences between China and the U.S. seemed to moderate. Futures point to an even stronger open after a Bloomberg report quoted administration insiders saying they were working to draw up a draft of an agreement in front of the anticipated Trump-Xi meeting at the G-20 summit at the end of November. Talking is good and the market’s instant response is as expected. But until China is willing to make a discussion of Intellectual Property (IP) rights part of the discussion, nothing fundamentally changes.
With that said, the Trump pattern has to warn of dire consequences right up to the eleventh hour. He did that with Canada before a new treaty was signed. He did that with Europe promising 25% tariffs on cars shipped to the U.S. before backing off after meeting with ECB head Junker. He threatened to blow up North Korea before agreeing to meet with Kim Jong Un. In addition, it is the week before mid-term elections. Therefore, everything said must be taken into context. This week he has threatened to unilaterally revoke birthright citizenship, to send up to 15,000 soldiers to our southern border to stop a caravan that may never actually reach our border, to cut middle class taxes by 10%, and now to come to a trade agreement quickly with the Chinese. Next week, we can begin to separate fiction from reality.
I think the real news for the markets is that the correction is officially over, at least for now. Interest markets have stabilized, earnings reports continue good, and the heightened fears caused by the sudden market drop are disappearing. That doesn’t mean the correction had no message nor does it mean that the entire loss will be recovered overnight. Granted, if there is a pending treaty with China and all tariffs are revoked on both sides, we could see a blowoff bullish spike to new highs. But again, let’s look at the China/U.S. trade dispute next week after elections to separate hype from reality. If Mr. Trump decides to back away from tariffs without any concession on IP rights from the Chinese, that would be almost shocking and would undermine his entire game plan. I have to believe the odds of that happening are pretty small suggesting the shoe is really in Xi’s court and not in Washington. We can draw up all the trade agreements we want. Until IP rights are part of the discussion, there are no grounds for negotiation. One outcome, perhaps a likely one, is for Xi to put IP rights up for discussion without making or even suggesting any actual change in policy. That could give Trump the room to loosen tensions just as he did with Junker over car tariffs. There hasn’t been substantive progress with Europe yet and it will take quite a while longer for negotiations with China to reach resolution.
But perhaps the biggest point to note is that, to date, the tariffs actually in place have made relatively little difference to our overall economy. Yes, some companies and some industries have experienced headwinds as a result. But put that in context. Earnings in Q3 rose close to 25% including the costs of whatever tariffs are now in place. That suggests a conclusion that if tariffs haven’t been a substantive headwind so far, simply stepping away from instituting additional tariffs in January or beyond will have fewer economic consequences than market psychology changes might suggest.
Conclusion: always respect the market dynamics. As is always true at the end of corrections, there is usually a 100% mood swing, one that could carry through to Election Day and beyond. I think the only eventuality that will change the mood is a Democratic sweep of both the Senate and the House, an outcome most suggest is highly unlikely. But, at the same time, this brief (in time) feeling of euphoria will fade. The market is telling us:
- The bull market is aging.
- The fear of higher inflation and higher interest rates is probably more substantial than the fear of disinflation and lower rates.
- GDP growth rates probably peaked in the second quarter.
- Stocks were fully priced and needed occasional corrections to attract new buyers.
- When growth fades, more companies run into difficulties. We are seeing more stories of broken companies than we have seen for some years. Kraft Heinz last night was the most recent example.
- There is a difference between growth at a reasonable price and growth at any price.
Finally, today is the day of the monthly payroll report. 250,000 new jobs were created in October. The unemployment rate stayed at 3.7% and month-over-month increases in wages were 2.2%. The report was solid and there were limited signs of rising inflationary pressure. All good. If there was a negative takeaway, it would be that it has going to be hard to expand productivity if our economy keeps adding 250,000 jobs each month. To sustain growth well above 2.5%, productivity has to increase beyond where it is today. So far, there are no signs that is happening. Therefore, look for growth in the second half of 2019 to fall to or below 2.5%. If we get there with tame inflation, I would take that combination gladly.
Today, Nelly is 44. David Schwimmer is 52.
James M. Meyer, CFA 610-260-2220
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