2018_06_21 — Healthy Economies versus FUD (fear, uncertainty, and doubt)

June 21, 2018

Healthy Economies versus FUD (fear, uncertainty, and doubt)

Among developed countries, Germany and the U.S. enjoy the healthiest economies, but then there is FUD (fear, uncertainty, and doubt).

• Trade tariff barbs will not lead to long term market damage, but will probably persist longer than most of the Trump Administration’s rough market patches
• FUD (fear, uncertainty, and doubt) continues to keep significant institutional capital out of equities and on the sidelines
• Stocks will cheapen as we roll through the summer and rising earnings further compress PEs
• The path to break above previous equity highs will be normal, i.e., volatile

In the near term, the lingering dispute between Beijing and Washington may keep large U.S. firms cautious, and Merkel’s woes, condemning headlines on VolksWagen and Deutsche Bank, and on-again Iranian restrictions may keep German firms hesitant to invest. Nevertheless, forward multiples reside well below their Trump term peaks and following last winter’s correction, have room to appreciate. The route back to late January’s highs has been and will continue to be serpentine, however, until S&P 500 CEOs point to dark clouds on the horizon, the path of least resistance will lead up.

For those trying to assess who is the biggest loser in the current U.S.-China trade spats, look at the respective stock markets. The Shanghai SSE Index has descended over the past month and the S&P 500 has ascended as Trump and Xi Jinping trade barbs. The corresponding economies are also drifting in opposite directions; China is slowing (albeit from a fast pace) while the U.S. picks up speed. Hence, the Trump Administration could hardly select a better time to improve the business practices between the two; and any deleterious consequences that may result from a conflagration would slow the hawkish Fed down as it moves toward normalization which would cushion the blow.

A more rapidly restrictive monetary policy still presents the biggest equity rally risk. If the threat and implementation of tariffs do negatively impact growth, then Jerome Powell and his FOMC colleagues may choose to slow their hawkish normalization drive. Such a concession from the Fed would cushion any deleterious ramifications from the barbs exchanged on both sides of the Pacific and encourage investors with idle cash to boost their risk exposure.

Extremely elevated U.S. corporate profit forecasts for the next few quarters, a 3.8% and declining Unemployment Rate, and soaring sentiment on Main Street suggest that the White House will win this game of chicken. Escalating rancor will ultimately lead to a compromise that both sides will claim as a victory and may even blend in some North Korean side deals. Any compromise will similarly encourage risk taking amongst investors.

Stocks will cheapen as we roll through the calendar which will breathe life into the rally. Managers are sitting on idle capital pulled to the sidelines when volatility ramped earlier this year. Money flow indicators have been very weak, and some technicians see this as an ominous sign of more downside, but the flip side of this is that excess capital is not in the market and — although we may not see it until after summer — will probably seep back in, pushing index levels to and through previous highs in the fourth quarter.

Meanwhile, there is the FIFA World Cup until July 15; most trading floors and most of the world will really focus on the competing 32 teams, followed by a bit of an August summer recess.

Michael Ashley Schulman, CFA

~~

Disclosure: The views and opinions expressed are those of Michael Ashley Schulman, CFA and are subject to change without notice. The views and opinions referenced are as of the date of initial publication, may be modified due to changes in the market or economic conditions, and may not necessarily come to pass. Forward-looking statements cannot be guaranteed; neither can backward-looking nor current-looking statements. This material is provided for informational purposes only and does not constitute an offer or solicitation to purchase or sell any security or commodity or invest in any specific strategy. It is not intended as investment advice and does not take into account each person’s or investor’s unique circumstances. Information has been obtained from sources believed to be reliable, but its accuracy, completeness and interpretation cannot be guaranteed. Past performance is no guarantee of future results.