Earnings season is coming to a close. It looks like companies have grown earnings by about 13% over this time last year, which is very good growth. Tariffs have created quite a lot of uncertainty on earnings calls, however, with some companies suspending their earnings guidance for the year.
Over the weekend, the Trump administration announced “substantial progress” in their trade talks with China. As a result, the administration has announced large, but temporary, cuts to tarrifs on Chinese imports to the United States while negotiations continue. Markets have rallied strongly on the news. My view is that this rally is a bit premature.
First, tariffs on Chinese imports were cut from 134% to about 40%, and 40% is still a substantial tariff (about 4x higher than previously). One analysis suggests that a 40% tariff could still push imports from China down by a third. Second, there have been no real details nor concessions from China in the currently-announced deal. It appears that China just more-or-less called Trump’s bluff, and my suspicion is that Trump won’t like that. Whether this reprieve holds in longer-term negotiations remains to be seen.
Lastly, lots of damage has already been done. It takes 50 to 60 days for container ships to reach the US from China, so we are just now seeing the results of the first round of tariffs from back in April. Container volume has been cut by 25% to 30% by major carriers, and much of that affect is likely not going to be fully seen until July. In my own economic model, a slowdown in shipping is typically strong evidence of slowing economic demand, so this level of contraction in the sector is evidence to me that a recession is likely forming (or has already formed). The point is, even if all trade policy were to revert to pre-April status, we would still have stubstantial fallout from current policy that will take some time to work itself through the economy.
And all of this has said nothing about the Fed meeting last week! As expected, the Fed held interest rates steady. Of more interest is that investors have now pushed a rate cut to almost September (only a 60% chance of a cut in July), and generally expect rates to be higher for longer. Again, this is the stagflation trade — slower economic growth with inflation running hot.
In summary: While the recent market rally has been strong, I am not convinced it will hold. The Fed’s hands are somewhat tied by inflation, and the damage of the trade war is only just now working its way through the economy. The economic data is still poor, though corporate earnings are a bright spot. I am still recommending caution in this environment.
Chart of the Week
This week’s chart sums up our view of the status of the economy. After dipping into a recessionary market environment, the recent market rally has pushed our indicator back into the pre-recession phase. As mentioned above, my view is that this is likely temporary as markets do not take a straight line down to their bottom.
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