November 15, 2018
The Art of the deal
Why does the current market tone feel different from the February and March stock market selloffs? 
By lisa James & Lori Zager
The Fed:
  • Earlier in the year, the market discounted the number of Fed hikes for 2018. As late as August, market pundits thought the December rate hike might not happen. 
  • Now, a December rate hike is considered a certainty due to strong GDP and job growth in the 2nd and 3rd quarters. With this hike, the Fed is delivering the largest annual tightening in more than a decade.
  • Rising rates are expected to continue. Fed Chairman Jerome Powell, is not worried about stock market indigestion. He is focused on growth, jobs and inflation, and plans to raise rates 3 more times next year.  
Tariffs and Trade Wars
  • The concept of a trade war hurt the market earlier in the year, while the actual consequences have weighed on recent stock market performance. On 3rd quarter earnings conference calls, several company managements warned that tariffs impacted earnings and earnings growth due to rising input prices and supply chain disruptions.
  • The 2017 tax cuts were supposed to encourage companies to make capital investments that would lead to productivity growth. The trade war with NAFTA, Europe and China has thrown a wrench in company confidence and forward outlook. After strong growth for the first half of the year, companies slowed their capital investments in the third quarter.
Now we have 2 problems- Both the E and the P/E.
  • Earnings (the E) are being negatively affected by tariffs, rising wages, and lower demand from markets outside the US.
  • What people are willing to pay for those earnings (the P/E) is affected by higher interest rates and slower earnings growth.
Who can address these problems?
President Trump Can Influence the E (earnings).

After the midterms, as Presidents worry about their own reelections, they typically ramp the economy. In fact, since 1946, the stock market has risen in the 12 months following midterm elections. This doesn’t preclude a correction like the one we are experiencing, however. If Trump wants to get reelected, making a deal with China will be the easiest and cheapest way to goose the economy. 

Fed Chairman Jerome Powell Can Influence Rates (and maybe P/E).

The Fed may be willing to pause their anticipated rate hikes if the economy slows and inflation continues to be moderate. The wildcard is inflation and investor appetite for the growing supply of U.S. government and corporate debt issuance. We expect continued volatility (with a potentially deeper correction) until either the Fed chair or the President intervene. 

The art of the deal meets political reality.  

Happy Thanksgiving!

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