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Financial Industry Insights from Advisors Asset Management
On June 01, 2018
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:
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.
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:
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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