Late last week, the market was hit with the news that the US and China had reached an understanding on a number of contentious questions, with Washington agreeing to not impose additional tariffs and Beijing agreeing to purchase more agricultural goods. There were also some minor deals on currency and intellectual property. However, this was not really a resolution to the trade war; rather, it was more like a temporary de-escalation. Here are the reasons why markets need the rollback to continue.
Falling earnings
There is much debate on whether the US economy is heading for a recession. Certainly, it has not performed nearly as well this year as it did in 2018. A recent research note from Morgan Stanley (MS) highlights the ways in which it is underperforming:
“US corporate profit growth is now below 0, approaching negative double digits territory on a year-over-year basis for the average company. This slowdown in profits is the main reason companies are spending less on capex and other business expenses. They’ve even started to reduce the number of hours worked for employees, and wage growth has decelerated from 3.4% to 2.9% over the past six months”.
The labour market in the United States is currently quite strong. However, employment can only be as good as the prospects of the companies that employ workers. Accordingly, a slowdown in corporate earnings could presage higher unemployment. The Morgan Stanley note goes on to explain how earnings expectations have decreased in 2019:
“Over the next few weeks, US companies will report third-quarter earnings. As usual, companies have done a good job of managing expectations for the current quarter by telling equity analysts to lower their expectations. At this point, bottoms-up EPS growth expectations for the S&P 500 are down to -5% year-over-year. For smaller and mid-cap companies the expectations are down to -9% year-over-year. For a little context, a year ago these expectations were closer to positive 10% growth”.
To me, the one thing that could contribute to pulling corporate earnings out of the slump that they are currently in would be a prompt resolution to the trade war. It may not be enough, but it would certainly be a start. Regardless, this initial trade detente does not contain nearly enough good news to cause a sustained uptick in the economy - more action is needed. It’s true that this de-escalation is a much more positive step than anything that has happened previously.
China has made it clear that only a total removal of all new tariffs installed by President Trump will lead to a resumption of business as usual. With an election year coming up, it remains to be seen whether the White House would do so, and if they do, how they would massage the move into political expediency.
Disclosure: The author owns no stocks mentioned.
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