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The Coming Melt Up, Or What You Need To Believe For It To Come True

2019년6월10일 - 4 분 읽기

If these propositions hold out, then there is likely upside in risk assets globally. If more than a few are wrong, then you will be see the unraveling before your very eyes.

The gloomy case for financial markets is pretty clear: faltering earnings, overstretched balance sheets and tariffs that slap a tax on U.S. consumers and undermine global business confidence. Why wouldn’t all of this darkness cause markets to head straight down?

But where could this overwhelming consensus be wrong?  If I told you the S&P 500 may be only halfway through its rise this year, what would it take to make you believe it? You’d have to buy at least a few of these seven predictions about the second half of 2019:

  • U.S. households, representing two-thirds of the economy, will remain the powerhouse driving steady growth. While student and auto loans may trigger worries, overall household balance sheets look solid. There have been recent hiccups in the latest jobs and consumption data streams, but with unemployment at 50-year lows and wages rising, this pillar of the current recovery still looks solid. Certainly, slightly higher prices from tariffs on imports from China aren’t going to be enough to knock it off course. 

WAGE GROWTH

Source: Factset, as of May 31, 2019

  • Corporate earnings will endure. The most recent season was hardly a disaster, and the direct damage from tariffs will likely be limited to firms with no alternatives to current suppliers or end-markets. Weaker renminbi rates have absorbed most of the direct costs anyway. The real impact from the uncertainty around trade policy will play out far beyond this year as firms delay their capital expenditures until the dust settles a little more. For now, however, the noise should continue to have little impact on current results.

U.S. AFTER TAX CORPORATE PROFIT MARGIN

Source: Factset, as of May 29, 2019

  • And there’s more good news ahead for earnings in recent productivity data. The numbers are a little squishy, but they are encouraging for the first time in a while. If they persist, they will not only alleviate concerns about rising wages cutting into bottom lines, but they will also validate predictions that new technologies – especially around data management and the Internet of Things – may be delivering lasting outcomes.

U.S. PRODUCTIVITY GROWTH

Source: Factset, as of May 29, 2019

  • U.S. fiscal policy will be more of a tailwind for now. No incumbent president who wants to win again runs on a tax increase going into an election year (Remember: “Read my lips: no new taxes”?). It’s also unlikely that a Democratic sweep to power will bring about a significant fiscal contraction either. Any modest hike in income taxes will likely be more than offset by new spending – maybe even on those elusive infrastructure programs. In the meantime, current public construction spending is rising.

U.S. PUBLIC CONSTRUCTION SPENDING

Source: Factset, as of April 30, 2019

  • The Chinese economy will bounce back. Recent attempts to reflate demand have sputtered amid trade friction that no longer seems headed to a quick resolution. Nevertheless, it strains the imagination that China’s government won’t offer more fiscal and monetary support to show that it can withstand any further trade pressures from Washington. This will do little to help rebalance Chinese demand toward more productive private sector investment, but it will put a floor under growth near the government’s targets.

CHINA INDUSTRIAL PROFIT GROWTH

Source: Factset, as of April 30, 2019

  • Europe will exceed expectations, if only because expectations are so low. Lackluster data and complex politics are rarely a source of optimism on their own, but markets tend to price in too much pessimism around the European Union. A messy British exit from the European Union remains a distant prospect as both sides will likely prefer extension and delay to unwarranted shock. Italy’s government may soon fall, but that means any real budget confrontation with Brussels will be delayed, and there will be marginally more government spending that boosts demand. Meanwhile, a weaker currency and lower oil prices should provide a steady tailwind as unemployment grinds slowly lower.

EURO ZONE UNEMPLOYMENT RATE

Source: Factset, as of April 30, 2019

  • And when all else fails, there’s always the Fed put. If you don’t believe any of these trends will overcome the current market pessimism, then you can always fall back on the fact that the world’s central banks stand ready to ride to the rescue. The Bank of Japan and the European Central Bank may not have many more robust tools at their disposal, but the Federal Reserve has leeway to both cut rates and resort to fresh quantitative easing if necessary. Purists would argue that the Fed should pay more attention to the hard data and less to Wall Street nervousness, but the signals from the rate-setters themselves suggest the markets are right to expect some relief.

FED FUNDS FORWARD CURVE​​​​​​​

Source: Bloomberg, as of June 7, 2019

Is this enough of a case for risk assets when there is so much pessimism afoot? Are these arguments little more than grasping at straws? 

The optimistic case is surely harder to make now than it was a year ago--and not just because we are setting a record this month for the longest U.S. expansion. There’s a lot of cash on the sidelines and equity valuations are attractive, but ultimately the logic puts a lot of weight on enduring U.S. consumer strength and near-term corporate resilience. And both are ultimately vulnerable to rising economic uncertainty. Trade wars and political uncertainty continue to mount, and even surprise deals with China, and the one with Mexico announced Friday evening, will not remove the threat of new tariffs on the European Union’s automotive exports. 

Still, when the consensus seems overwhelmingly one-sided, the careful investor will keep the contrarian case in view. If these propositions hold out, then there is likely upside in U.S. equities and risk assets globally. If more than a few are wrong, of course, then you will be see the unravelling before your very eyes.

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