Stocks continued to rise as companies reported solid earnings. By now, everyone should know that stocks perform against expectations, not simply against the actual numbers.

By now, everyone should know that stocks perform against expectations, not simply against the actual numbers. One also should consider that repeating the same storyline, good or bad, doesn’t beget buying or selling all over again. Yes, we all know that tariffs are a headwind. But, at least for now, they are not debilitating. That may change. President Trump and EU Finance head Junker are due to meet today and one shouldn’t expect them to come to any quick agreement. Trump wants the EU to drop all tariffs. Junker is likely to come to the meeting exploring a multi-national agreement, that would include non-EU members like Japan, to reduce or eliminate tariffs on automobiles. Mr. Trump hates multi-national agreements. He wants one-on-one agreements because he believes that gives him the most leverage. Thus, today’s meeting might find some common talking points for future meetings (e.g. lowering tariffs on cars) but won’t lead to any conclusions. If Mr. Trump keeps to his past patterns, one should expect a polite handshake followed by some nasty tweets as soon as Mr. Junker heads home. But don’t overread that. It is the Trump way of negotiation. One day is fire, fury and brimstone. The next day brings a summit. Mr. Trump seems to be willing to take the heat short term for what he believes is a long term win. How short term is defined and how much pain he will take most likely depends on how his base reacts.

So far, he has almost total support from his core base and from Republicans in general. There are a few in the Senate who complain but, for the most part, they are Senators set to retire at the end of this year. Others, like Rand Paul and Marco Rubio, voice concern but rarely vote in opposition. As for the Trump base outside of Washington, it seems as solid as ever. But the economic pain from tariffs is just starting to be felt. Mr. Trump yesterday promised $12 billion in short term relief for farmers, a sign that he hears their pain. But if the tariff wars escalate, he isn’t going to be able to provide the necessary subsidies to offset the pain. Even members of his own party see the absurdity of raising taxes (that is what tariffs are, of course) and then handing out rebates to offset the tax. Farmers are feeling the pain of Chinese retaliation and the President is taking income tax dollars received to alleviate the pain. It just isn’t good policy and, as the Trump team will tell us, the trade wars may just be beginning.

But on Wall Street, the reaction appears to be that we are still in the fire and brimstone stage of any war. Until the real fighting begins, Wall Street will ignore the words and follow the actions. For the most part, the big industrials that have reported Q2 results this week say that the tariffs imposed to date will impact earnings by less that 5%, not nearly enough to offset the benefits of lower corporate taxes. But that conclusion presumes that no further actions are taken either by the U.S. or by our trading partners. If the President actually moves to impose tariffs on imported cars, a small skirmish will turn into a real firestorm. While our trading partners understand the President’s concern that current tariff policies worldwide unfavorably disadvantage the U.S., it appears very few are willing to negotiate with a proverbial gun pointed at their heads. To be fair, there are some that will back down sooner than others. Germany, Europe’s biggest producer of automobiles, appears more eager to come to some conclusion than others. But the 800-pound gorilla in the trade battles, China, shows no sign of budging in the least. Since we import roughly $500 billion in goods from China and only export about $130 billion to them, the Chinese cannot match us tit-for-tat. But that begs the issue. Our economy is highly dependent on goods made in China. Supply chains around the world embrace many more countries than the U.S. or China. Throw a monkey wrench in the middle and the whole supply chain breaks down. Any country can cry “unfair” or “illegal” but that won’t solve a problem. Eventually, all sides have to 2

talk. In politics, caving in to pressure will be badly received back home, wherever home is. That is what has talks with China stalled. President Xi is not going to unilaterally give in to Trump’s threats. If there are going to be discussions sooner rather than later, someone has to break the ice with a conciliatory gesture.

Back to the markets, it’s earnings season. Tomorrow will be the biggest single day in earnings season so buckle your seat belts. It will all start to calm down just a bit next week and then slow materially the week after. August, being a slow month for economic data and a big month for vacations, can be a very slow month in the financial markets but it also can be quite volatile if news surprises occur. Given President Trump’s desire to stir the pot fairly consistently, don’t expect a typically quiet August. We are at the top of the 2018 trading range once again as 10-year bond yields approach 3%. The spread between the 2-year and 10-year Treasury yield is now down to 30 basis points and it is almost certain the Fed will hike rates 25 basis points in September. Depending on how forceful Fed Chair Jerome Powell is talking about future rate increases beyond September, the yield curve could invert in the second half of 2018 signaling a rising risk of recession as early as late 2019. While very strong earnings may provide enough near term oomph to push stocks to new highs over the next couple of weeks, it is hardly the time to sound the all clear horn.

Today, Matt LeBlanc is 51.

James M. Meyer, CFA 610-260-2220

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