No Change to the Bullish Playbook

So far, the economy is moving as we expected:

  • Fed raised rates and remains hawkish (aka more rate hikes coming)
  • Trump’s economic sabre rattling is working. Canada folded this weekend and re-negotiated the NAFTA deal. That makes new trade deals with South Korea, Mexico and Canada. Even China started to show a little flexibility with some tariff reductions. The E.U. & China are playing for time: they want to see what happens after the elections. I don’t think this is the right strategy because the Canada deal provides Trump with all the ammo he needs to keep Congress in line with his trade approach.
  • Manufacturing and other aspects of the economy are very bullish. We saw the release of some business surveys (PMI, ISM) that underscored ongoing strength.

    • That’s the background for earnings releases in this upcoming quarter.

    However, there are reasons for concern. So let’s review the bricks in the “Wall of Worry” – how the market climbs without getting overly exuberant.

  • End of tax cut benefits. The tax cuts drove up EPS and some investors may be looking out to Q1 of 2019 and wondering what comes next.
  • Rising costs of business: From higher interest rates to costlier steel and oil, margins are getting squeezed.
  • Peak Housing: A major wealth driver and contributor to the economy is the wealth effect from the housing boom. There are clear signs that the top is in. Let’s face it: interest rates have risen enough that affordability has dropped. And with rates likely to rise a further 100bps (or 1% point) in the next year, housing will just continue to slow.
  • End of the auto boom. Autos have been holding 17 million annualized units and not more for years. This means flat demand for aluminum, steel and other key components.

    • The key takeaway is the Federal Reserve is removing their punch bowl exactly when housing and autos are weakening – the two key drivers of the U.S. economy.

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