May Markets Trump Along Despite Trade Talks and Italian Politics

Published on Jun. 8, 2018

May Markets Trump Along Despite Trade Talks and Italian Politics

Market Overview

Despite turbulence in trade negotiations and Italian politics, US stocks enjoyed a strong May, with the S&P 500 advancing 2.2%. With seemingly improved economic activity following a subpar first quarter of 2018, we expect corporate profits will remain strong and we maintain our positive outlook on the market.

Trade remains a focal point for investors. US aluminum and steel tariff exemptions expired for the EU, Canada, and Mexico, and the Trump administration announced tariffs would be imposed on certain imported Chinese products starting on July 1st. Meanwhile, the failure to make progress with NAFTA negotiations has dimmed the prospect of reaching a deal by year end. Although we are seeing retaliatory tariffs imposed on US exports, we do not believe that these actions will have a materially adverse impact on US economic growth. However, the uncertainty of Trump’s rhetoric and capricious negotiating tactics may create a challenging environment for corporate management to make long-term capital investment decisions.

Trade related headwinds aside, US stocks have been quite resilient. In our view, a strong economy and positive corporate earnings have created a buffer against negative trade headlines. We believe that investors are viewing most of the White House’s rhetoric as means of negotiation, and that the President’s positions may suddenly change. Therefore, we think markets are reacting less to policy announcements and are waiting on concrete policy action.

Italian politics briefly rattled capital markets after President Mattarella vetoed the 5 Star and League party’s choice for Minister of Economy and Finance. Amid the uncertainty of whether Italy would be able to form a coalition government, Italian 2-year government bonds had their worst day since 1989 (when Thompson Reuters began tracking the data), as yields jumped more than 150 basis points to close at 2.4%. Upon reaching a compromise that keeps the coalition government intact and avoids the potential for snap elections, Italian bonds recovered as 2-year yields retraced nearly half of the advance from the previous day.

We believe that the odds of an Italian exit from the Eurozone are low and we will continue to monitor the situation, but we are not overly concerned by the dramatic headlines. Another potential issue to consider is whether the country’s bonds might have to be restructured, although we view this as unlikely over the near- to intermediate-term. Moreover, we would not expect US capital markets to be directly impacted in the event of a restructuring, since the majority of Italian government bonds are held by Italian citizens and European banks. However, we are cognizant that some degree of contagion might transpire.

Outlook

We continue to hold a positive view on the market and expect that a healthy economy will help to sustain strong corporate profits. In recent years, economic growth has slowed during the first quarter, and recent data suggests that growth is progressing. Regional Federal Reserve surveys aimed at capturing economic activity in various parts of the US have been robust, and forecasts for second quarter GDP growth are in the 3-4% range. Additionally, while we have yet to see a meaningful impact from the recent tax reform, we expect that it will soon give a boost to both corporate investments and consumer spending.

A key risk for markets in our view is trade, as we see the tariff announcements as potentially increasing trade friction with multiple countries. As noted, we think that capital markets can continue to show resilience despite these risks, given a healthy economy and strong profits. However, if the situation were to escalate, we expect that markets would price in weaker fundamental conditions, putting stock prices at risk. We are also keeping close tabs on inflation, as a sharp pick-up could compel the Fed to raise interest rates at a faster pace than markets are currently expecting. This could curtail GDP growth, leaving the economy more vulnerable to exogenous shocks, such as the aforementioned potential trade negotiations. Fortunately we are not yet seeing any signs that inflation is rising to levels that would force the Fed’s hand in this regard.

Leave a Reply

Subscribe to Our Insights Today

Roosevelt Investments