Global political turmoil pummeled markets this week and immigration policies were at the center of disruptions in both Germany and the US. Ironically, German Chancellor Merkel’s political coalition is on the verge of crumbling due to Merkel’s open border policy. In sharp contrast, President Donald Trump is under extreme pressure as a result of enforcing US immigration laws. The US debate focuses on the 1997 Flores consent decree and under the terms of this agreement the government must release children from immigration detention as quickly as possible to parents or other adult relatives, and if this is not possible, to licensed programs that will care for the children. It is the interpretation of this law that is being debated. But rather than protecting immigrant children by passing a law to change or define existing statutes, US politicians on both sides of the aisle are using these children as an opportunity to grab media attention. It is a sad statement about the priorities of Washington DC, in our view. Prime Minister Theresa May has also encountered political pressure this week after her Brexit plans were rejected by parliament’s upper chamber. This will set up a confrontation with pro-EU lawmakers later this week and test her ability to lead a minority government.
Last week President Trump announced tariffs on $50 billion of Chinese imports that will go into effect on July 6, and then quadrupled the pressure by threatening to add a 10% tariff on an additional $200 billion of Chinese goods. China said it would retaliate by suspending previous trade agreements with Trump’s administration and placing duties on American exports, including crude oil.The threat of new tariffs against China pits the two largest global economies against each other and risks disrupting international supply chains for many industries including two large sectors, technology and autos, which rely heavily on outsourced components. President Trump’s tough stance triggered a global sell-off in equities and commodities this week and sent investors running to the safety of the dollar and government bonds. However, in our view if investors really believed a trade war were on the horizon, prices would be much lower. Note that the Chinese Yuan (CNY – 6.48) is down 1.7% in recent weeks and the Shanghai Index (SSEC – 2,907.82) is at its lowest level since June 2016. Financial headlines emphasized that the DJIA lost all its gains for the year, but the DJIA has been the underperforming index. The SPX is up 3.3% YTD and the NASDAQ is up 11.9% YTD. In short, the US remains the safe haven for global investors and none of this changes our view that the popular equity indices remain in a broad trading range. The underlying breadth of the market remains bullish and our SPX target of 2800+ is unchanged for 2018.
Valuation Remains Solid
Although consensus earnings estimates for calendar year 2018 were basically unchanged this week; the Thomson IBES forecast shows a 22.0% YOY gain, up substantially from its 12% estimate at the end of 2017. S&P Global’s estimate ratcheted up to 26.5% YOY this week, which is up from S&P’s 16.3% forecast at year end. Bearish strategists are focusing on the possibility that 1Q18 may be a peak earnings growth rate and this threatens the bull cycle. Thomson Reuters has quarterly forecasts for this year estimated at 26.6% YOY, 20.2% YOY, 23.1% YOY, and 20.1% YOY, respectively. Calendar 2018 and 2019 are estimated to be 22.3% YOY and 9.7% YOY. Therefore, one could say that 1Q18 might be a peak quarterly growth rate. Nevertheless, this fails to address that earnings continue to grow and support equity prices. We believe that a 10% YOY earnings growth rate for next year is bullish. See page 3.
The War with China
We believe the US equity market is outperforming the Shanghai Index because global investors believe the US can better weather a trade war than China or most countries. Although trade wars are never a good policy, and we doubt that threats will end in a real trade war, we thought looking at trade statistics could be helpful.
China is clearly the most significant problem for the US in terms of trade and trade deficits. As of March, the four-quarter-trailing $348.1 billion deficit in goods and services with China was larger than the sum of deficits with the European Union, Mexico, Japan, India, Taiwan and South Korea combined. Note that Germany represented $69.0 billion, or 63%, of the European Union’s $109.1 billion four-quarter deficit with the US and on its own, our trade deficit with Germany would rank third in terms of the largest trade deficits with the US. See pages 4, 5 and 7.
It is also worth noting that as of March 2018 our four-quarter deficit with China was down slightly from the calendar 2017 trade deficit of $375.2 billion. China represented 47% of the US’s 2017 overall deficit of $796.1 billion, yet this deficit is even larger if services are excluded. As of March, the four-quarter trailing deficit in goods with China was $389.2 billion or nearly 2.5 times as large as the goods deficits with the entire European Union. Trade with China has grown exponentially in the last 20 years but imports have grown much faster than imports in recent quarters resulting in a seasonally adjusted deficit of $93.4 billion in 1Q18. See page 6. Our trade deficit with the EU ranked second although the quarter was steady at a seasonally adjusted pace of $30.4 billion. Our trade deficit with Germany in 1Q18 ranked third at $18.75 billion and represented 62% of the EU’s 1Q18 deficit with the US. See pages 6 and 7.
What About NAFTA?
When we look at US trade statistics in terms of NAFTA, we were slightly surprised that Mexico has one of the largest trade deficits with the US. In terms of overall trade and trade in goods, Mexico’s deficit ranks third after China and the EU; but in terms of single countries, Mexico ranks second to China in terms of trade deficits with the US. Mexico’s four-quarter trade deficitin March was $69.9 billion and its 1Q18 deficit was $18.1 billion on a seasonally adjusted basis.
In sharp contrast, the US had a four-quarter goods and services trade surplus with Canada of $6.9 billion as of March 2018 and a surplus of $4 billion in 1Q18. When services are excluded, Canada’s trade shifts to a deficit of $18.7 billion in the four quarters ending March 2018 and a $2.5 billion deficit in 1Q18. Energy products play a significant role in Canada’s pattern of trade deficits in goods versus surpluses in overall trade; the same pattern is seen with Saudi Arabia and OPEC. See highlights on page 4. Trade statistics make the confrontation with Canada’s Prime Minister Trudeau all the more interesting, particularly since Canada has been a declining influence in US trade. In 2005, Canada represented 23.5% of all US exports but this has ratcheted down to 18.3% in 2018 YTD. Canada was 17.4% of all US imports in 2005, but this was 12.9% in 2018 YTD. Canada ranks third after China (20.1%) and Mexico (13.7%) in terms of its percentage of total US imports in 2018 YTD. See page 5.
All in all, trade statistics show our trade imbalances with China are clearly severe. Even small changes could prove favorable to our overall trade balance which now stands at 4% of GDP. See page 9. Conversely, Canada may generate a trade deficit in terms of goods, but has a surplus overall.
The DJIA slipped below its 50-day moving average this week, but all the broad indices remain above their 200-day moving averages and are bullish. The AAII Sentiment Survey showed bullish sentiment rose to 44.8% as of June 13 but this percentage is well below 50% and our indicator remains neutral.
Regulation AC Analyst Certification
I, Gail Dudack, hereby certify that all of the views expressed in this report accurately reflect my personal views about the subject company or companies and its or their securities. I also certify that no part of my compensation was, is, or will be, directly or indirectly related to the specific views contained in this report.
“Overweight”: Overweight relative to S&P Index weighting
“Neutral”: Neutral relative to S&P Index weighting
“Underweight”: Underweight relative to S&P Index weighting
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