A "Tale" Part 2

Last month we wrote about the best and worst of times, taking liberties with Dickens’ masterwork, A Tale of Two Cities.  Fast forward one month, and we find ourselves taking liberties again with Dickens’ work.  Although this time the opening line might read, “it was the worst of times, no wait, it was the best of times, or at least it is back to ‘business as usual’.”  Here is what we mean.  At the beginning of February, markets were very concerned about inflation, tariffs and trade wars, volatility and political turmoil.  All bad things.  But by the end of February and first few days of March, the economic sentiment and equity sell off had reversed course.  We had a strong market rebound, excellent employment numbers, subdued inflation data and potential historical developments on the geopolitical front. All good things.

After plunging by over 9% in early February, US equity markets strongly rebounded +8% from mid-February to present.  Early inflation fears have been replaced by strong job growth that is having little impact on wage and inflation indicators.  Former Federal Reserve Chair Janet Yellen often argued that wages won’t shoot up because there are still plenty of folks who haven’t been working or looking for jobs but are getting back into the work force because of the abundance of opportunities.  This is important because rising wages are typically one of the key drivers of inflation and potential threats to economic growth going forward. 

Other major threats to economic growth are protectionist US trade policies. In mid-February the Trump administration began discussing ideas for protecting US steel and aluminum manufacturers. You can’t get much more protectionist than that. President Trump then announced his idea for broad sanctions on the first of March. The countries that would be hit the hardest were Canada, Mexico, and the European Union.  China was not on that list because most of its steel exports to the US are already subject to sanctions.  The announcement was criticized by many experts and was met with extreme negative sentiment in the markets.  Gary Cohn, the President’s chief economic advisor and director of the National Economic Council, disagreed so strongly with the plans that he resigned from his position. Several countries reacted with threats of counter sanctions on exported US goods.  Early March certainly had the look of a trade war in the making.  But as the dust settled, a more tailored approach landed on Trump’s desk and he signed an executive order that provided loopholes for certain countries.  Both Canada and Mexico were specifically mentioned as excluded from the tariffs with the understanding that future negotiations over NAFTA would address this topic.  Equity markets responded very favorably to these developments.

The final and most unexpected favorable bit of news might have been inspired by the Olympic games recently held in PyeongChang, South Korea.  It was the first time since the 1950’s that leaders from North and South Korea were able / willing to meet.  There was a healthy skepticism, however, toward North Korea’s true intentions and many thought this Korean show of unity was mainly for the cameras, especially after all the harsh language and military posturing between the US and North Korea.  Perhaps it was more than just a show.  It would seem that there is a willingness between the two Koreas and the US to at least discuss the North’s denuclearization.  A letter delivered in early March to President Trump by South Korean diplomats expressed Kim Jong-un’s (North Korea’s Supreme Leader) desire to meet with Trump specifically to discuss the North’s nuclear weapons program.  This meeting is tentatively set for May and could provide significant geopolitical stability for the region. 

Whether it is the best, the worst, or perhaps just the most ordinary of times, we are not quite ready to put this bull market out to pasture.  We still believe the majority of the economic data coming out is more positive than negative.  We are also very interested in seeing the impact of the tax reforms on 1st quarter corporate earnings.  Inflation and global growth remain the keys to both market sentiment and direction.   Inflation at the present appears to be subdued.  Impacts on global growth will require our full attention as trade policies and reforms continue to develop.