Markets finished the first quarter strong on Friday and look to extend gains this morning. Today’s driver is a report from China showing an uptick in activity. China has been taking both monetary and fiscal actions to stimulate the economy for the past several months and now it appears the impact is beginning to flow through its economy. While China’s GDP is still just a fraction of ours, China’s growth rate has been and continues to be so much larger than that of the U.S. or Europe that changes in Chinese growth have a bigger overall impact on world growth than changes in our growth rate or that of Europe.
Growth in the U.S. in the first quarter appears to have slowed. Part of that is seasonal. For whatever reason, the first quarter almost every year is the quarter of least growth. Part relates to the impact of government actions, notably the Federal partial shutdown in January and the ongoing impact of tariffs on trade. Part is weather. Last week, for instance, DowDuPont# said that its agricultural business will be hurt by the ongoing floods in the Midwest. While we have seen hardly any snow here in the Northeast this winter, other areas of the country had record snowfall. Days of snow and rain held back many outdoor construction-related activities. In the recent past, weak first quarters have often been followed by strong second quarters. It’s only April 1, so obviously we can’t show any evidence yet of better times ahead. But the sharp decline in mortgage rates should result in improved housing demand. We do see signs already of increased lot traffic.
This will a big week for March data. What we want to see is some improvement from earlier months in the quarter. The first numbers out, which were for February, was a very dour government report on retail sales. Sales fell 0.2% in the month after a revised +0.7% in January. Ex-autos and gasoline, sales fell 0.6%. Listening to retailers that recently reported Q4 numbers, February did see a slowdown but few saw an absolute decline. I wouldn’t overread this report. Later this morning, we will get a read on March manufacturing. Already today we have seen a pickup in manufacturing both in China (mentioned above) and the U.K.
Of course, the big data point this week will be Friday’s employment report for March. Most expect that growth will continue at a steady pace. The numbers for both January and February were distorted by the government shutdown. The number for March should be well in excess of 100,000 but as we get closer to full employment, the number of jobs added each month should be a bit reduced from the very rapid pace of recent quarters. Weekly jobless claims remain depressed, lending further support to the expectation of continued steady growth.
Earnings season will start in about two weeks. We could see some early preannouncements this week as companies get a first peek at numbers. Overall, the expectation for Q1 is for an earnings decline of 2-4%, mostly related to the strong dollar which, on average, will hurt international earnings by 8% or more. In other words, with the dollar approximately 8% higher this Q1 from last year, international earnings will translate back into fewer dollars for reporting purposes. The sharp negative year-over-year contrast will dissipate beginning about the middle of the second quarter and could disappear entirely by the second half of the year for many companies. By this time, analysts have largely factored the dollar translation impact into their earnings estimates.
The other factor impacting 2019 earnings is investment spending. While it continues to rise, it hasn’t been doing so at a robust rate for several quarters. This largely stems from trade uncertainties. Without tariff and tax considerations, companies normally place plants close to where end market demand is greatest. Since the greatest growth is coming from Asia, that would be the natural place to locate additional plants. But with ongoing uncertainties related to trade, tariffs, and politics, companies have been deferring investment decisions as long as they could hoping for resolution of these issues. President Trump’s new threat to close the border with Mexico certainly isn’t calming to business, although we have all gotten used to threats that aren’t carried out. Mexico is one of our largest trading partners and our trade with it is still governed by NAFTA. The auto industry, for one, would be impaired severely should there be a hard closure of the border. Despite the threat, at least for the moment, no one expects that to occur. But the President shut down the government (partially) for 35 days over border wall funding. We can’t simply presume that logic will trump (pun very much intended) politics.
Thus, as we look forward into Q2, the fate of markets will depend on the following:
- Q1 earnings results, including management forward-looking commentary.
- Progress on Chinese trade talks. Both sides want a victory; hopefully some kind of deal can be reached this quarter.
- Stabilization in the bond market. This morning, the 10-year bond yield is back up to 2.44%. Two-year Treasuries are stable at a yield of 2.28%. Any steepening would be welcome. While commentary last week about the impact of yield inversion on markets took over the front page, the 2-10 year spread of roughly 15 basis points has been consistent the entire time rates moved lower.
- Any sign Congress might get down to business and stop all the non-productive nonsense. Included in the non-productive category would be more and more time spent on investigating what has already been investigated, resolutions promising never to say nasty things about each other, and time wasted on pipe dream ideas like the New Green Deal that have no chance of passage. I am not trying to disparage the ideals of single payer health care or caring for the environment. I am simply saying that if any program is going to get serious consideration, it has to be reasonable to a majority and has to be paid for. There may come a time post-2020 when progressive candidates control the White House and Congress. Until then, Congress should try to find common ground around such topics and controlling the costs of health care and entitlements, and infrastructure spending. Frankly, the economy is doing well enough that it doesn’t need too much help from Congress beyond funding normal government activity without widening the deficit significantly. But in the months ahead, we might find these minimal needs to be overwhelming if partisanship continues to deteriorate.
In summary, left alone, the economy is just fine and stocks should do OK. After double digit gains in the first quarter, one can’t expect a Q2 repeat. But stocks look ahead and once we get past a pretty lousy first quarter, skies should brighten. Most of the risks to the economy going forward are centered in Washington, both at the White House and in the halls of Congress.
Today, British singer Susan Boyle is 58. Ten years ago, she became an instant celebrity with her rendition of “I dreamed a dream” on the TV show Britain’s Got Talent. As Andy Warhol noted, she got her 15 minutes of fame and hasn’t been heard from since.
James M. Meyer, CFA 610-260-2220