Despite the fact that the US cycle is long in terms of time (9 years), there still seems to be pent-up demand and momentum in the economy, and we're adding fiscal stimulus on top of that. Inflation will rise in this environment, but only slightly, and we think more investment is likely, which will boost output per hour and release some strain on the system.
The ability to fully deduct capital expenditures for the next 5 years and the shift to a territorial tax system that frees up trillions of dollars in un-repatriated profits provide major incentives for companies to invest in their own businesses. As a result, this could boost productivity, support profit margins, and keep unit labor costs low enough for the Fed to stay on its current (gradual) path for rate increases.
As markets continue to climb the wall of worry, we believe that the bar is set low enough for an upside surprise in the markets later this year. Midterm election years tend to be more volatile than most with a majority of the year's gains coming after October. The average S&P 500 decline in midterm election years is 19% and midterm election selloffs have proven to be great buying opportunities with stocks up an average of 36% one year later in every occurrence.
Markets were up-and-down last week as geopolitical headlines continued to dominate investor sentiment. Two weekends ago, Treasury Secretary Mnuchin announced that the U.S. and China are “putting the trade war on hold”; both sides agreed to drop the threat of tariffs while they work towards a broader agreement. Under the preliminary framework, China would import more energy and agricultural products from the U.S. Separately, China also announced a reduction (to 15%, from 25%) in import duties on passenger cars. Investors applauded the easing of trade tensions with China; President Trump, though, maintained an aggressive posture on NAFTA negotiations which have stalled due to U.S. demands for increased American content for imported vehicles. On Wednesday, the Commerce Department launched an investigation into whether automotive imports “threaten to impair the national security,” the same rationale used to justify the March steel and aluminum tariffs. The action is seen as a negotiating tactic designed to extract concessions from Mexico. And, on Thursday, President Trump cited the “tremendous anger and open hostility” in North Korean leader Kim Jong Un’s recent statements in cancelling the upcoming summit. As of Friday, though, both U.S. and North Korean officials suggested that the summit may still take place; or it may not.
Oil prices, and Energy stocks, pulled back this week over concerns of increased supply. On Wednesday, the Energy Information Administration reported unexpectedly high crude oil and gasoline inventories. Also, reports indicated that OPEC and Russia were each considering production increases to offset expected output declines in Venezuela and the re-imposition of sanctions against Iran. As a result, West Texas Intermediate crude, the North American benchmark, fell 5.3%; the S&P Energy sector fell 4.5%; and, the PHLX Oil Service Sector Index fell 7.6%. Notably, the prospective production increases by OPEC and Russia would be aimed at maintaining oil price stability rather than growing market share. They are likely targeting a $60 and $80 per barrel price range which would be sufficient to sustain the recent increases in oilfield project activity. Meanwhile, the U.S. manufacturing sector remains an economic bright spot; the “flash” PMI report rose to a four-year high in May with business optimism reaching its highest level since February. And, a 1.0% increase in core capital goods orders, a proxy for business investment, outpaced analysts’ forecasts for a 0.6% rise. Geopolitics will likely continue to dominate headlines in the near-term, but companies have thus far looked past these concerns in pursuing growth strategies.
*Source: Strategas & Pacific Global Investment Management Company
Chart reflects price changes, not total return. Because it does not include dividends or splits, it should not be used to benchmark performance of specific investments.
Last Week's Headlines: 5/28/2018
1. New Home Sales of new single-family houses in April 2018 were at a seasonally adjusted annual rate of 662,000, according to estimates released jointly today by the U.S. Census Bureau and the Department of Housing and Urban Development. This is 1.5 percent (11.8 percent)* below the revise...
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