No Change to the Bullish Playbook
So far, the economy is moving as we expected:
- Fed raised rates and remains hawkish (aka more rate hikes coming)
- Trump’s economic sabre rattling is working. Canada folded this weekend and re-negotiated the NAFTA deal. That makes new trade deals with South Korea, Mexico and Canada. Even China started to show a little flexibility with some tariff reductions. The E.U. & China are playing for time: they want to see what happens after the elections. I don’t think this is the right strategy because the Canada deal provides Trump with all the ammo he needs to keep Congress in line with his trade approach.
- Manufacturing and other aspects of the economy are very bullish. We saw the release of some business surveys (PMI, ISM) that underscored ongoing strength.
That’s the background for earnings releases in this upcoming quarter.
However, there are reasons for concern. So let’s review the bricks in the “Wall of Worry” – how the market climbs without getting overly exuberant.
- End of tax cut benefits. The tax cuts drove up EPS and some investors may be looking out to Q1 of 2019 and wondering what comes next.
- Rising costs of business: From higher interest rates to costlier steel and oil, margins are getting squeezed.
- Peak Housing: A major wealth driver and contributor to the economy is the wealth effect from the housing boom. There are clear signs that the top is in. Let’s face it: interest rates have risen enough that affordability has dropped. And with rates likely to rise a further 100bps (or 1% point) in the next year, housing will just continue to slow.
- End of the auto boom. Autos have been holding 17 million annualized units and not more for years. This means flat demand for aluminum, steel and other key components.
The key takeaway is the Federal Reserve is removing their punch bowl exactly when housing and autos are weakening – the two key drivers of the U.S. economy.
I would suggest the tariffs will offset a lot of the softness because they are driving on-shoring of manufacturing and related business. That is, the auto sector may not pull the economy forward, but other segments will pick up the baton and run with it.
Editor of Moneyball Economics