Surprise NAFTA deal sets the stage for the week
OCT. 01, 2018
- Last week saw a minor pullback for equities, though most indexes remain close to an all-time high. September ended with a 1% gain for the S&P 500 Index and the third quarter had its best quarterly return in three years. We are now in the seasonally-strong month of October, which has been the best month for returns over the past 20 years, and is particularly strong during midterm election years.
- The news last week focused on the Fed Funds hike, which was widely expected, with few changes to the commentary. There were slight upward adjustments to the outlook for economic growth, though the bond market took it in stride, with short and long rates roughly unchanged for the week. Economic data last week was mostly encouraging, including tame inflation, improving personal income, spending and confidence, though durable goods orders and pending home sales were weaker than expected.
- We received news overnight that the U.S. and Canada have reached a deal to overhaul NAFTA, adding them to the agreement that was already reached between the U.S. and Mexico. This came as a bit of a surprise to investors, as talks seemed to have stalled last week, and as a result, futures are pointing to a strong open this morning. The inclusion of Canada was encouraged by Congress, who will have to pass the revised legislation after the midterms, so passage is far from certain.
With the end of the third quarter behind us, we will slowly transition to earnings season. Pre-announcements have been notably weak, with three-quarters to the downside, but this is a less important metric than in the past, as only about one-in-five companies in the S&P 500 Index issued pre-announcements. Growth is expected to be 21% on 8% revenue growth. This would be a slight deceleration from the 25% from the past two quarters, but still very strong. Commentary around trade tensions will be closely monitored, as will be the headwind from a strong dollar.
While progress on the NAFTA deal is encouraging, relations with China remain strained. China cancelled trade talks that were scheduled for last week, and have cancelled the annual security meeting with Defense Secretary Mattis after the Trump administration imposed sanctions on a Chinese state military company for buying weapons from Russia. Vice President Pence is expected to give a speech this week on concerns over China’s international behavior. Meanwhile, September manufacturing activity in China slowed, with PMI readings at the lowest level since February.
PMI readings were also quite weak in Europe, falling to the lowest level in two years. Export activity was weak, and uncertainty around trade is impacting confidence. Leaders in Italy agreed to a budget that will expand spending programs and bring the deficit to 2.4% of GDP. The E.U. commission is planning to reject the proposal, further highlighting geopolitical risk in Europe.
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