Updated: Mar 11
On Top of the Radar
Last Friday (05/10/19), the U.S. raised the tariff rate on $200bn of imports from China from 10% to 25%, bringing back the “ghosts of the past”, after a relative period of calm. We still believe that negotiations will eventually bring either the percentage rate or the amount that taxes are imposed, down from the current level.
Despite Friday’s announcement of an immediate tariff hike, goods that left China before May 10th and will enter the U.S. before June 1st, will be subject to the lower 10% tariff. This window (~3 weeks) creates an opportunity for negotiations to progress towards a “better” final agreement. But the risks increased that the U.S. will impose some kind of tariff to the remainder ~$300bn of goods that are not being taxed today.
Unfortunately, most of the consequence of the 2018 tax rounds has fallen on the shoulders of U.S. businesses and households, with no obvious reduction in the prices charged by Chinese exporters. As such, some estimates of inflation expectations have increased, which negatively impacts forecasts of real income and inevitably the level of GDP.
The Fed, will have to be alert in order to balance out the downside risks to growth from a re-escalation of the trade war (lower rate bias) and the lingering impact of tariff taxes on inflationary pressures (higher rate bias).
Under the Radar
Other Concerns Besides the Trade War
Yes, Trade War Redux is again in the spotlight, but there are other issues under our radar:
Tension is once again building round Iran and the Middle East;
The Fed is not overly concerned with a further decrease in inflationary pressure;
North Korea has resumed missile testing;
Apparent U.S. efforts to remove Maduro from power in Venezuela has failed for now; and
Italian budget problems are also back in focus.
U.S. market scenario analysis
Despite the recent selloff in equity markets, the outlook for the S&P500 hasn’t changed that much. The risk-reward at/close to the peak (~2950) was poor to begin with, as the market is always priced to perfection at those levels and any negative news/developments will most likely have a larger than warranted impact.
The 2020 EPS number (light blue line) had upside risk as CQ1 earnings evolved, but investors may discount some of the potential to account for the recent Geo-Macro concerns (“Trade War +” mentioned above).
On one hand, applying a 16x forward multiple to the 2020 S&P500 consensus estimate earnings of ~185, pushes the market towards ~2,960 (upside from today’s 2,850 of ~4%). But on the other hand, it’s not prudent (at least today) to expect a 10% plus growth in earnings from FY2019’s estimate of ~166. As such, today we estimate downside risk based on a 5% growth on FY2019 earnings (from the current ~166 to ~174), which puts the S&P500 at 2,784 or another 3% downside).