JUL. 16, 2018
• We often hear about investors “buying the rumor, selling the news.” This environment feels like “sell the rumor, buy the news” with respect to tariffs, with the S&P 500 Index gaining in six of the seven trading sessions since the U.S. implemented tariffs on China. Growth stocks and small caps are at all-time highs, while the S&P 500 Index is 2% below. Year to date, the S&P 500 Index has returned 6%, the Russell 1000 Growth index 12%, and the Russell 2000 index 11%. Despite a constant rotation of worries since January, we are positioned for double-digit returns.
• Recent warning signs from domestic housing and economic sluggishness in Europe seem to have stabilized, but there are growing worries from the flattening of the yield curve and widening of credit spreads.
• Economic data continues to be strong domestically, led by small business confidence and consumer sentiment. The NFIB small business survey warned against wage growth and availability of skilled workers. This is worth following, given that the payroll data does not seem to agree.
Positioning for trade war
I have been very encouraged by the market action surrounding the trade debate. Our markets are at or near all-time highs, while China is in a bear market. I still expect a reasonable conclusion to this process that results in lower trade barriers globally. During the process, small caps and domestically-focused companies will likely continue to outperform, but technology and industrials will recover when a conclusion is reached.
Earnings will be an increasing area of focus this week, led by banks. This could be the next catalyst for the market. We will get greater evidence with what is being done with tax savings and repatriated cash. Watching the market reaction will be important. In the past four quarters, a high percentage of companies beat estimates, but in three of the four quarters those companies traded flat to down in reaction.
The market has been receptive to IPOs, following a prolonged period of weakness. Total outstanding shares have been shrinking through acquisitions and share repurchases, resulting in a crowding-out effect on stocks. IPO acceleration is not uncommon as the cycle ages, and if it gets excessive, it is a negative sign, but at this point it may be necessary to keep the supply of shares in balance, given that share buybacks may approach $1 trillion this year.