What's On Tap: Trading Tariffs for Earnings

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  • JOLTS Data Supports Worker Confidence
  • Short-Term Bond Yields Rise—Recession Fears Premature
  • Looking Ahead: Earnings and Economic Reports

Mid-sized and small-company stocks were in the limelight this week as stock markets opened on a positive note. The S&P MidCap 400 and S&P SmallCap 600 indexes hit all-time highs on Monday. The NASDAQ Composite hit its own all-time high yesterday.

Those records bookmarked a week of volatility, however, as strained relations during Wednesday’s NATO meeting and prospects for another 10% tax on $200 billion of Chinese goods (and expected retaliation) upset traders. With a rebound on Thursday and some positive earnings reports driving markets today, we expect to end the week solidly in the black. 

Trade war or not, our longstanding investment view is that earnings, not politics, drive stock prices over the long term. As companies begin reporting their second-quarter financial results in the coming weeks, we’ll be paying particular attention to what management in affected industries have to say about tariff-related issues. And while expectations for earnings increases are lofty—20% growth from the same time last year—concrete numbers will provide a welcome reprieve from fixation on the politicized themes from trade wars to immigration.

For the year through Thursday, the Dow Jones Industrial Average has returned 2.0%, while the broader S&P 500 has gained 5.7%. The MSCI EAFE index, a measure of developed international stock markets, is down 2.4%. As of Thursday, the yield on the Bloomberg Barclays U.S. Aggregate Bond index has climbed to 3.30% from 2.71% at 2017’s end. On a total return basis, the U.S. bond market has declined 1.4% for the year.

JOLTS Data Supports Worker Confidence

Fully employed U.S. workers remain convinced of the economy’s strength and their ability to find more lucrative or interesting work. This week’s Job Opening and Labor Turnover Survey (JOLTS) found that 3.56 million people voluntarily left their jobs in May, lifting the “quits rate” to a 17-year high. A virtuous cycle of growth is at play here. When workers leave their current jobs for better ones, their open positions often provide opportunities for others to move into improved roles.

The U.S. economy benefits from labor turnover, even if it creates a growth-related problem for employers. According to the National Federation of Independent Businesses, finding qualified workers was the biggest problem facing small business owners in June. And this comes at a time when confidence is near all-time highs owing to tax cuts and regulatory reform that have boosted sales, profits and job creation. A solution may be at hand, though. The most recent data from the Bureau of Labor Statistics showed that 601,000 people joined the workforce in June, the largest increase since February.

The natural next step in this labor environment would be for companies to pay better wages than they have in recent years in an attempt to fill their openings and retain talent. We’re still waiting to see that happen in a major way. Once it does, American workers (read: consumers) will get another shot in the spending and saving arm.

Short-Term Bond Yields Rise—Recession Fears Premature

As we’ve noted before, Wall Street and the financial press have recently had a laser-like focus on the flattening of the bond market’s yield curve—a narrowing of the gap between short-term and long-term bond yields. While the headlines have some investors fretting that this narrowing will lead to an inversion, which in turn is believed to presage a recession, we don’t think these predictions comport with the actual facts on the ground.

The Federal Reserve’s policy adjustments have pushed yields on short-term bonds up dramatically and quickly. Though the price of goods and services (inflation) is trending higher—consumer prices are up 2.9% over the last 12 months—yields on longer-term bonds have held relatively steady over the past several months. In part, this is due to pension funds actively buying long-term bonds as part of their tax-planning strategy following last year’s changes to the code. Corporations have until September to purchase bonds and apply 2017’s higher tax breaks to their spending. The expectation is that their buying will slow this fall and longer-term bond yields will rise as demand falls. Stay tuned.

For the moment though, there’s been no yield-curve inversion, and even if it does occur, that doesn’t mean a recession is right around the corner. In fact, we were amused this week to dig up this old CNN Money article from December 2005 when the yield curve first inverted during the last economic cycle—the yield on the 2-year Treasury exceeded that of the 10-year Treasury—almost two years before the recession began in November 2007! And we noted a passage that could be cut-and-pasted into an article you might read today: “A heavy flow of overseas capital into the U.S. [has] driven the yield on 10-year notes to abnormally low levels—distorting the yield curve’s predictive abilities.”

Looking Ahead: Earnings and Economic Reports

Next week, earnings reports pick up from where they will leave us today; companies scheduled to share their results and outlooks include: Bank of America, BlackRock, JB Hunt, Charles Schwab, CSX, Goldman Sachs, Johnson & Johnson, Abbott Labs, Alcoa, American Express, IBM, Morgan Stanley, Bank of New York, Capital One, E*Trade, Union Pacific, GE, Honeywell, Schlumberger, State Street and many more. Management insights from this list will cover a wide spectrum of industries and will help begin to fill in the top-line (sales) and bottom-line (cost-cutting) trend lines that speak to more or less growth in the recent past and foreseeable future.

We will also get a fruitful slate of economic reports: Retail sales, manufacturing activity gauges, homebuilders’ confidence (as well as new construction and permits), the Fed’s Beige Book of anecdotal economic reports nationwide and the Leading Economic Index.

If you’d like to learn more about our tactical or fundamental strategies, please contact Steve Johnson at 844-587-7393 or info@bravercapital.com.

Please note: This update was prepared on Friday, July 13, 2018, prior to the market’s close.

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