Eq: Total Market
Donald Trump did something many might not have expected when he met Xi Jinping recently at the G20 conference: he told him he would dial down the criticism of China regarding the demonstrations in Hong Kong in order to get Beijing back to the negotiating table. The offer apparently echoed a previous one he had made to Xi in the week leading up to the conference. The plan worked and China has agreed to resume trade talks.
FINSUM: While many may disagree with the concession to China, we think this shows one thing very clearly: Trump does not want to let the trade war derail the US economy or markets and will likely do whatever is in his power to keep them afloat.
Greedy is not usually a word associated with anything positive, but in this instance it seems fair. What we mean is that the market’s performance through the first half of this year has been so good, that investors need to double down on stocks. That likely sounds counterintuitive, but history tells us otherwise. When stocks have a good first half (and they surely have), then they are 60% more likely to finish the year strongly as well. On that basis it would make sense for investors to put more money into equities or at least don’t take any chips off the table.
FINSUM: We like this logic. While we do have some bearish reservations about the market right now, we think Trump is going to make sure to not do anything to derail stocks, as doing so might derail his re-election campaign.
Investors need to take note, as one of the biggest equity research divisions on Wall Street has just turned overwhelmingly negative on equities. And this is not the “stocks will struggle in coming years” kind of call, it is an argument for right now and published yesterday. The bank has lowered its allocation to stocks, saying that the outlook for markets over the next three months is very poor. Morgan Stanley says equities prices are way too high and expectations for major rate cuts are already priced in, leaving little room for appreciation. They also think valuations are too high given deteriorating manufacturing and economic data.
FINSUM: Morgan Stanley is basically saying that the market is primed for disappointment because all the positive outcomes have already been priced in. Not unrealistic.
Here is a data signal most of the market is not paying attention to when it comes to recession forecasting: nationwide capital expenditure, or Capex. Morgan Stanley’s index of capex has shrunk to its lowest level in two years, as the high from the Trump tax cuts wears off for companies and they tighten purse strings. Capex growth is likely to weaken from 11% last year to just 3% this year. According to the deputy CIO of State Street, “Low capex growth is very worrying … You’re starting to see the trade tensions and the macro growth concerns play out in business confidence — companies won’t open a new factory if they think we’re on the cusp of a recession”.
FINSUM: This is a worrying sign but not wholly unexpected given the waning benefits of the tax cuts. However, even though this is expected, it does not mean it won’t hurt the economy.
Don’t let the cooling of the trade war between the US and China fool you, the markets are not in a good position, at least that is the position of Bank of America. The bank thinks there won’t be a deal between Washington and Beijing until the US market feels real pain. They think the looming Q3 correction will be the stimulus that gets a deal done because Trump operates under a “no pain, no deal” paradigm. “The markets are likely to view the summit as a modest positive in the short run. But stepping back, we see several reasons for concern”, says Bank of America.
FINSUM: The “no pain, no deal” concept makes a lot of sense to us. The bigger question, though, is what would cause the pain because markets certainly aren’t hurting from the threat of a trade war. Maybe a big earnings miss? (See below)
Earnings recessions don’t always hurt that much, but they don’t help. Just look at the 2015-2016 period, when earnings didn’t perform well. Markets didn’t lose much, but they were mostly flat. Now we are re-entering that paradigm, as many companies are cutting earnings and it looks like the first earnings recession in three years is coming. Earnings are very likely to fall in the second quarter, with average analyst estimates calling for a nearly 3% decline across the board. So far, 20 of the S&P 500’s companies have reported and the average earnings fall has been 15%.
FINSUM: A bigger than expected decline in earnings could seriously change the risk-reward outlook of markets. This seems like an important risk right now.