- Trade-War Fears Temper IMF Estimates
- Early Profits Strong: Average Year-Over-Year Earnings Gain of 21%
- No Yield Curve Signal Yet; 10-Year Treasury Yield Has Held Steady
- Looking Ahead to Home Sales, Consumer Sentiment & More
This week, reports on second-quarter corporate earnings began to take the field; they battled against escalating trade-war fears for investor attention.
We’ve said it before, but fundamentals—earnings, economic facts, interest rates—continue to hold the high ground in our analysis. Even though it may occasionally feel as though markets have fallen off of a cliff, the S&P 500 sits just 1.4% below its all-time high (including dividends).
For the year through Thursday, the Dow Jones Industrial Average has returned 2.6%, while the broader S&P 500 index has gained 6.0%. The MSCI EAFE index, a measure of developed international stock markets, has declined 2.1%. As of Thursday, the yield on the Bloomberg Barclays U.S. Aggregate Bond index has risen to 3.28% from 2.71% at 2017’s end. On a total return basis, the U.S. bond market is down 1.2% for the year.
Trade-War Fears Temper IMF Estimates
We have shifted from tariff talk to tariff action—the goal of which is to force China to the trade-negotiations table. (The most recent jab came early this morning with an assertion that tariffs on all $500 billion of Chinese imports could be on that table.) Whether or not this gambit delivers on its goals remains to be seen.
Fears of a trade war have had their greatest impact in the emerging markets, where the major stock market benchmark is down 16% from its January peak—close to the 20% decline that defines a bear market. While long-term bargains are being created in these ever-volatile emerging markets, we are actively reviewing the near-term, trade-war-related risks to them.
The International Monetary Fund (IMF) is also reviewing their estimate for global growth based on the unknowns of tariff action and trade-war concerns. Its most recent prediction is that the global economy will grow 3.9% in both 2018 and 2019. That growth will be unevenly distributed due to some countries accelerating faster than others (a good reason to diversify your investments), but on the whole, it’s a solid figure. However, there is a caveat.
The IMF says its estimates are tempered by the acknowledgement that a trade war could have vast repercussions that jeopardize the entire forecast. And given the latest out of Washington and the responses from the U.K., China and others in the E.U., it’s understandable that many investors are anxious.
One example of how trade wars can impact major American companies is iconic laundry-machine manufacturer Whirlpool. The company appeared to be one of the early “winners” in this battle, as its South Korean competitors, Samsung and LG, face tariffs on exports of their washers and dryers. Now Whirlpool is feeling the pinch as the costs of aluminum and steel (also subject to tariffs) have risen. Whirlpool’s stock is down close to 10% since the announcement of washing-machine tariffs in January. But the real “loser” here may be the U.S. consumer: Washer and dryer prices jumped 20% in the second quarter!
The global economy is a complex machine. Tighten one screw over here and loosen a bolt over there and you don’t necessarily get the outcome you’re looking for. We believe there’s plenty of tariff impact and potential retaliation yet to come, and at the moment it is uncertain how this will all come out in the wash.
Early Profits Strong: Average Year-Over-Year Earnings Gain of 21%
We don’t need to speculate about the second-quarter earnings reports, however. About 16% of S&P 500 companies have shared their results so far and, on average, earnings have grown 21% from the same time last year, with an overwhelming number of companies beating analysts’ expectations.
Collectively, if unevenly, this week’s reports from bellwether companies including Bank of America (finance), J.B. Hunt (truck transport), CSX (rail transport), Goldman Sachs (finance and trading), Johnson & Johnson (drugs), Alcoa (aluminum producer) and IBM (computer services) suggest sales and lending activity correspond to the continued slow growth nature of this U.S. economic expansion. Businesses that are less prone to actual tariffs and trade-war narratives are cautiously optimistic about prospective earnings in the quarters ahead. For the reasons noted above, companies subject to (or the subject of) tariffs have reported mixed outlooks—Alcoa is chief among them.
No Yield Curve Signal Yet; 10-Year Treasury Yield Has Held Steady
The Federal Reserve has been methodically increasing its key short-term lending rate every few months. Meanwhile, the 10-year Treasury’s yield has held steady in the 2.8% to 2.9% range. This dynamic is leading to some concern—misplaced at the moment, if you ask us—about the narrowing difference (or “spread”) in the yields of 10-year and 2-year Treasury bonds. You can read more about our view on yield spreads and what they may or may not portend in our most recent Quarterly Outlook, which we’ll be sending to you soon.
Looking Ahead to Home Sales, Consumer Sentiment & More
Next week, the second-quarter earnings reporting floodgate opens, which should give us an even better feel for near-term business risks and opportunities across the economy. In terms of economic reports, we’ll see reads on existing and new home sales, durable goods, consumer sentiment and the first estimate of second-quarter economic growth.
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Please note: This update was prepared on Friday, July 20, 2018, prior to the market’s close.
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