Weekly investment commentary

Economic and earnings growth collides with rising trade tensions

Robert C. Doll, CFA
Senior Portfolio Manager / Chief Equity Strategist,  Nuveen Asset Management
  • Investors have been focusing on good economic data, still-low inflation and strong corporate earnings. These fundamentals remain critical sources of strength for the ongoing bull market in equities.
  • Trade restrictions, however, are escalating and present a growing risk. For now, we think markets can overcome these issues, but we are growing more concerned.

Investors generally focused on the positives of continued solid economic data and expectations for strong corporate earnings last week. The S&P 500 Index rose 1.6% and, in a reversal of a trend that has dominated markets for much of the year, small cap stocks lost ground.1 From a sector perspective, technology, industrials and consumer discretionary outperformed while telecommunications and utilities were laggards.1

Weekly top themes

1. The “Goldilocks” economy of solid growth and low inflation is persisting. The U.S. economy appears to be growing solidly and is generating a healthy number of new jobs each month. Despite these trends, however, wage inflation and price increases remain relatively contained. The June Consumer Price Index showed a relatively modest 0.1% advance, making for a 2.8% year-over-year rise, while core CPI was up 0.2% for the month and 2.3% over the last year.2

2. U.S. consumption in particular appears to be contributing to growth. We expect to see a healthy increase in consumer spending when second quarter gross domestic product growth data is released. Rising trade issues have the potential to damage that strength, but we have yet to see any evidence.

3. We expect GDP growth will have climbed 3.5% or more in the second quarter. Growth will most likely slow a bit from that level in the second half of the year. We are sticking with a forecast of 3% growth for all of 2018.

4. Slowing Chinese economic growth appears to be negatively impacting the world economy. Chinese growth appears to be slowing modestly, and that deceleration has the potential to pick up. A combination of tighter financial conditions, rising trade tensions and limited policy support are putting downward pressure on the country’s economy.

5. Second quarter earnings growth should once again show impressive strength. Current estimates for growth are 20%.1 This would be down slightly from the 25% level seen in the first quarter, but would still mark the second strongest quarter since 2010.1 Tax cuts remain an important driver of strength, but sales growth also appears to be boosting results. We expect forward guidance to be closely scrutinized to gauge how trade issues might affect capital expenditures and profitability.

Trade issues create higher levels of market uncertainty, but are not dragging down equity prices

It may still be premature to call what is happening today an all-out trade war, but at the minimum, the world appears to be in the midst of the most serious trade dispute since the end of World War II. The United States officially enacted $34 billion worth of new tariffs on Chinese manufactured and capital goods a couple of weeks ago. In response, China launched $34 billion of tariffs on U.S. goods, mostly agricultural products.

The actual monetary amounts, however, are not the most important piece of the puzzle. The key to the escalating trade dispute is the uncertainty over what happens next. Rising trade restrictions have the potential to damage economic growth, and the effects are likely to accumulate and cause long-term issues.

Together, China and the United States account for over 30% of global gross domestic product,3 meaning a potential trade war would have far-reaching effects. Immediate negative issues may be price increases and lower levels of demand. Possible secondary negative effects could include a sharper rise in the value of the dollar, problems with global supply chains and a broader avoidance of American goods and services in China and elsewhere.

History suggests that protectionism is a slippery slope that ultimately results in a lose/lose proposition for all parties. So far, trade restrictions and the accompanying uncertainty have not caused an end to the economic expansion or the U.S. equity bull market. But we think stock prices would be higher today were it not for trade issues. Fortunately, stock prices have been buoyed by solid economic data and very strong corporate earnings. For now, we are hopeful that second quarter earnings results will continue to allow investors to focus on fundamentals. But we are growing increasingly concerned about what escalating trade issues could mean for the global economy and financial markets.

“History suggests that protectionism is a slippery slope that ultimately results in a lose/lose proposition for all parties.”

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Midyear outlook Asset allocation views from Nuveen’s Solutions team
1 Source: Morningstar Direct, Bloomberg and FactSet
2 Source: Bureau of Labor Statistics
3 Source: World Bank

The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy. The Dow Jones Industrial Average is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange and the Nasdaq. The Nasdaq Composite is a stock market index of the common stocks and similar securities listed on the NASDAQ stock market. The Russell 2000 Index measures the performance approximately 2,000 small cap companies in the Russell 3000 Index, which is made up of 3,000 of the biggest U.S. stocks. Euro Stoxx 50 is an index of 50 of the largest and most liquid stocks of companies in the eurozone. FTSE 100 Index is a capitalization-weighted index of the 100 most highly capitalized companies traded on the London Stock Exchange. Deutsche Borse AG German Stock Index (DAX Index) is a total return index of 30 selected German blue chip stocks traded on the Frankfurt Stock Exchange. Nikkei 225 Index is a price-weighted average of 225 top-rated Japanese companies listed in the First Section of the Tokyo Stock Exchange. Hong Kong Hang Seng Index is a free-float capitalization-weighted index of selection of companies from the Stock Exchange of Hong Kong. Shanghai Stock Exchange Composite is a capitalization-weighted index that tracks the daily price performance of all A-shares and B-shares listed on the Shanghai Stock Exchange. MSCI EAFE Index is a free float-adjusted market capitalization weighted index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. Bloomberg Barclays U.S. Aggregate Bond Index covers the U.S. investment grade fixed rate bond market. The BofA Merrill Lynch 3-Month U.S. Treasury Bill Index is an unmanaged market index of U.S. Treasury securities maturing in 90 days that assumes reinvestment of all income.

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