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It’s That TIME Again to Address the Hot Spots of the Week

Recent announcements from the White House have raised the anxiety of markets that are extremely fearful of a trade war escalating from the tariffs announced against Canada, Mexico and Europe. We wrote about the potential of a Trade War back in March, however, there are new developments. The largest difference is the inclusion of Canada and Mexico who were, at the time, excluded and the addition of Europe in the targeting of tariffs.

The scope of the announced tariffs and reciprocated action announced by Mexico and Canada (expect Europe as well) is all still part of the larger negotiating wish from the White House regarding NAFTA. The original exclusion of NAFTA back in March was always meant to expedite negotiations. When those failed, it was always on the table this might occur, and with broad metal composite prices down nearly 5% year to date, this was somewhat priced in.

The number one rule in negotiating is that you must be willing to walk away from the table. If you don’t have that gumption, you will never be able to strike a deal that you are hoping for. It appears this announcement is a deeper line in the sand, but also a clear message to China who will hold a meeting on June 1 with Commerce Secretary Wilbur Ross.

Another aspect of the timing of this announcement is the following:

  • Canada’s 1st quarter GDP was expected to come in at 1.8%, but disappointed with a 1.3% actual. Their raw material price index declined from 2.1% in March to a 0.7%, meaning profits on raw materials are a bit strained.
  • Mexico trade balance for the month of April was expected to be a trade surplus of $500mm, however, it came in at negative $289 million. Inflation is running at an annual rate of 4.55% which is slightly above the 10-year average.
  • Europe is seeing some softening of their macro-economic data, and the anxiety of the Italian political situation has created a “flight to safety” within the region. This uncertainty is best expressed as the increasing number of headlines comparing Italy with Greece.

The following chart from Bloomberg’s Chief Economist Michael McDonough is very telling in not only the timing of the current tariffs but as well as significant shift in the overall trade metrics since 2000.


Source: Bloomberg

The timing of the announcements of tariffs both enforced and future continues to point to a broad-based negotiating strategy that will be elevated and exacerbated in the media, but will more than likely prove to be a bridge to balancing the trade deficit. We see the more negative impact on the markets to be the disruption of funding the budget deficits that are increasing in the United States with the overall trade deficits. We detailed this last week in the blog The Rates Rubik’s Cube.

Italy’s political dilemma in shining the light on the challenges the European Union has had with dealing with focused fractures with a broad brush. Many of the challenges that have arisen are more related to the structure that set forth over 20 years ago when the euro currency was introduced. While there has been increased concern with Italy’s political future, the steps that need to be taken prior to the fear of a populist policy being broadly introduced is long and methodical. The shock of recent events seems to only slightly resemble the shock of the BREXIT vote almost two years ago.

The fear of the populist gaining more control may be a bit farfetched and anxiety about nothing. Consider the two most recent, and more extreme, examples of populist political transitions and their impacts on the equity markets.

  • United Kingdom FTSE average annual total return 1996 to 06/20/2016 was 5.05%. Since 06/23/2016, after the Brexit vote, the average annualized total return is 14.53%. The UK gilt 10-year has only marginally gone up in yield, though it has a dynamic range.
  • The S&P 500 average annual total return 2010 to November 2016 is 11.59%. Since November 8, 2016, the average annual total return has been 18.38%. Also note that the U.S. 10-year has moved from a 1.85% prior to the election to a 2.88% currently.

While we believe the political uncertainty will continue without resolution, we still maintain Europe and Italy offers long-term potential and maintain our equity focus there. As we mentioned in our 2018 outlook, the sheer number of elections this year would cause a bit of anxiety across the region, but we still see more upside relative to the risks.

The Macro measures of the U.S. economy continue to show increased momentum. Consider the following:

  • The employment addition of 223,000 in new jobs in May corresponded with an overall and unemployment rate of 3.8%.
  • Continuing Jobless claims are running at 45-year lows.
  • ISM (Institute of Supply Management) manufacturing data came in at a robust 58.7 with the ISM employment number coming in at 58.7. New order continues to be robust with a current measure of 63.7, well above the 30-year average of 55.0.
  • Manufacturing new jobs have averaged nearly 20,000 per month gains in the last 18 months, well above the monthly average loss of 13,000 jobs over the last 30 years.
  • The sentiment numbers continue to be strong: NFIB (The National Federation of Independent Business) small business optimism is running at levels that have only been higher 4% of the time since 1974. The consumer sentiment numbers continue their ascent to higher levels and are near cyclical highs since the end of the last recession.

Lastly, on the earnings front, we have seen a shift we have not seen in some time. We are seeing earnings being revised upward versus the traditional downward path. Though we see leverage in the lower grade and junk-rated corporate balance sheets and are beginning to see some strains on the issuance of Treasuries to fund budget deficits, we see some increasing earnings arising from U.S. companies. As reported by Credit Suisse, first quarter 2018 earnings growth came in at 16.5% with projected forward earnings to grow by another 11.6%. As such, they have raised earnings estimates for 2018 to $158 per share for the S&P 500 and raised 2019 estimates to $170 per share from their original $165.

One might question why equity markets have not ascended with the positive economic and earnings backdrop. The market is always discounting future events and the current trading range represents a skepticism about future earnings growth, trade scuffles turning into trade war and fatigue in general about political landscapes on a local and national level in November. This trading range should continue for the short term as general investment fatigue is rarely resolved overnight. 

It’s that TIME (Tariffs, Italy, Macroeconomic data and Earnings) again to assess the hot spots and attempt to add context to it. As we are prone to do, we continue to confuse hiccups with heart attacks, and although hiccups are annoying, they are often forgotten in short order. Eventually, the slight escalation in tariffs will continue to point to a more moderate broad-based solution. Italy’s political uncertainty is a symptom of a bigger challenge regarding the recalibrating of the European Union, but should be seen as the potential for a more dynamic region than the anemic growth that they have seen with an average GDP annual growth rate of 1.5% since 1998. We believe the combination of slight moderation of regulations and a currency that is under pressure could generate an uptick in economic growth.

CRN: 2018-0601-6688 R

This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at commentary-disclosures. For additional commentary or financial resources, please visit www.aamlive.com.

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Effective, June 10, 2016, please note that Gene Peroni left Advisors Asset Management (AAM) to become President of Peroni Portfolio Advisors, Inc. Peroni Portfolio Advisors, Inc. ("PPA") is an investment advisor independent of AAM.