- Weekly global market focus
- US/Chinese trade war expands as China announces retaliation
- Q2 earnings season starts to wind down
Weekly global market focus — The U.S. markets this week will focus on (1) trade tensions after China last Friday announced retaliation on $60 billion worth of U.S. goods, (2) Washington politics as the Manafort trial enters its second week, (3) oil prices as Iran conducts military drills in the Persian Gulf and as the first phase of reimposed U.S. sanctions on Iran go into effect today, (4) the wind-down of Q2 earnings season as 45 of the S&P 500 companies report this week, (5) this week’s $78 billion Treasury refunding operation of 3-year, 10-year and 30-year securities, which is $5 billion larger than May’s refunding, and (6) this week’s light U.S. economic schedule, which features Thursday’s June PPI report and Friday’s June CPI report (expected unchanged from May’s +2.9% y/y headline and +2.3% y/y core).
Last Friday’s July U.S. payroll report of +157,000 was weaker than market expectations of +190,000. However, the report was largely a wash since May/June payrolls were revised upward by a total of +59,000, producing a strong 3-month (May-June) average of +224,000. In addition, the July unemployment rate fell by -0.1 point to 5.9%, as expected, which was only 0.1 point above May’s 48-year low of 3.8%. July average hourly earnings came in as expected at +2.7% y/y, which was a relief to the bond market since the series has yet to break above this year’s narrow range of 2.6%-2.8%.
In Europe, the markets will focus on the Italian-German 10-year yield spread, which rose sharply by +18 bp last week to a 5-week high of 252 bp as the Italian budget process began. The populist Italian government is expected to force a showdown with EU officials as it blows up the Italian budget deficit with a sharp tax cut and an increase in social spending.
This Friday’s UK Q2 GDP report is expected to show a mild improvement to +0.4% q/q and 1.3% y/y from the Q1 pace of +0.2% q/q and +1.2% y/y. The Bank of England last Thursday raised its policy rate by +25 bp to 0.75%, but another rate hike is not expected until at least mid-2019 when the BOE sees whether the UK in March 2019 crashes out of the EU without a Brexit agreement.
The Asian markets will mainly focus on how the Chinese markets react to the Chinese government’s announcement late last Friday of tariff retaliation on $60 billion of U.S. products and a margin increase that is designed to support the yuan by making it more expensive to short. The Chinese yuan last Friday posted a new 1-1/4 year low but then rallied back and closed the day +0.23% higher on the margin announcement. The Chinese yuan in the past six weeks has plunged by 6.7% due to US/Chinese trade tensions and signs of slower Chinese economic growth.
The markets this week will also get a better idea of where the BOJ wants the 10-year JGB yield to trade. The BOJ at its policy meeting early last week expanded the upper limit of its 10-year JGB yield target to 0.20%, but then intervened last Thursday near 0.14% to prevent a test of the upper end of the range. The 10-year JGB yield ended the week up +0.6 bp at 0.110%.
US/Chinese trade war expands as China announces retaliation — There is no sign of any significant US/Chinese trade talks as the two sides ramp up tariffs. China last Friday announced tariffs on $60 billion worth of U.S. goods that will be implemented if the Trump administration goes ahead its 25% tariff on $200 billion of Chinese goods, which is currently in the public comment period. The public comment period is due to end of September 5, which means the tariff could be implemented shortly thereafter, triggering China’s retaliation. Friday’s Chinese retaliation involved tariffs ranging from 5% to 25% on $60 billion of U.S. goods and was not fully proportional to the Trump administration’s threat of a 25% tariff on $200 billion of Chinese goods, which may represent an attempt to end the tit-for-tat. If all the announced tariffs go into effect, the U.S. will have tariffs on $250 billion of Chinese goods and China will have tariffs on $110 billion of U.S. goods.
Separately, the Trump administration at any time could announce the implementation of the 25% tariff on $16 billion worth of Chinese goods since the public comment period and other procedural requirements have been met. That would trigger the Chinese retaliation that has already been announced of a 25% tariff on $16 billion of U.S. products, including U.S. energy products.
Q2 earnings season starts to wind down — Q2 earnings season is now winding down with only 45 of the S&P 500 companies scheduled to report this week. The market consensus is for very strong SPX Q2 earnings growth of +23.5% y/y, according to Thomson I/B/E/S, which would be down from Q1’s +26.6% but would still be a very strong figure. Q2 SPX revenue is expected to show a strong increase of +9.2% y/y. Q2 earnings expectations have been stronger than market expectations. Of the 406 SPX companies that have reported, 78.6% have beaten the consensus, which is above the long-term average of 64% and the 4-quarter average of 75%, according to Thomson I/B/E/S.
Looking ahead, earnings growth is expected to remain above 20% in the second half of this year at +22.7% in Q3 and +20.6% in Q4, according to Thomson I/B/E/S. On a calendar year basis, the consensus is for very strong SPX earnings growth this year of +23.2%. Earnings growth is then expected to decelerate to +10.1% in 2019 as the effects from the Jan 1 tax cut start to wear off.
Valuation levels have become more reasonable due to the strength in earnings and the downward correction in stock prices seen since February. Still, the current forward P/E for the S&P 500 index of 17.6 is mildly above the 5-year average of 17.3 and is moderately above the 10-year average of 15.6.
