September 15, 2019

Deal? Or No Deal?

Waddell & Associates

Beginning with the Bottom Line:


Markets have regained their composure and upward bias as Trump has taken a Twitter nap.  Those with high hopes for a trade deal have bid up more economically sensitive areas of the market including small caps, more cyclical sectors like industrials and financials, and re-entered the beaten-down emerging markets.  Expect markets to rally and reward shorter term traders should a cease-fire arrive.  However, for longer-term investors, focus must remain on global economic data releases.  We have had three environments of worrisome economic growth trends since the Great Recession.  Weak growth in 2011 prompted the Fed to inject $600 billion into the economy through Quantitative Easing 2.  It worked.  Weak growth in 2016 prompted US voters to elect Donald Trump, who injected $1 trillion into the economy through the Tax Cuts and Jobs act of 2017.  It worked.  Reversing the current slide will require similar sizable stimulus.  Even if we consider the removal of the US/China tariffs as a tax cut, it only reverses the recent hike, and it only liberates a maximum of $150 billion.  For short term traders, this may be enough.  For longer term investors…it may not be.  



The Full Story:


Markets have felt like a gameshow lately as prospects for a trade deal rise and fall…leaving interest rates and stock valuations rising and falling in response.  Trump’s Twitter feed provides us with colorful negotiation status reports.  However, markets prefer fewer Tweets as JP Morgan’s newly released Volfefe index (a combination of Volatility and “Covfefe”, Trump’s famous Tweet typo) indicates.

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For validation, over the market’s recent run since August 23rd (the day Trump threatened to increase tariffs another 5%), Trump’s Twitter feed has been somewhat sleepy and nearly silent on trade talks.  Clearly, the markets have interpreted no Trump Twitter news as good news, providing us a preview of what to expect should Trump suddenly Tweet “Mega Huge Trade Deal Cut with China!!”


The Trade: Deal or No Deal?



Over the past 14 Twitter-tempered trading days, markets have nearly reclaimed new highs on high deal hopes.  Beneath the surface lies a major rotation message for those who believe a trade deal brews.  Most notably, the stalwart large cap growth leaders (Facebook, Amazon, Netflix, Google) gained 5% over the period, well below the performance of the comatose small cap value laggards who vaulted over 12%.  Analyzing the performance of some broader asset categories provides a preview of the trade to come should a trade deal arrive:

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While the rotation likely finds roots in algorithmic trading tied to the path of the 10-year US Treasury rate, the fundamental case for the winners does make sense.  If we get a trade deal, economic growth rates will rise, long term interest rates will rise, earnings expectations will rise, and offshore currency values will rise.  Therefore, traders should overweight small cap stocks (more economically sensitive), the value style (more cyclical sectors like financials and industrial), and emerging market stocks (undervalued and highly currency sensitive).  Oh, and they should short the 10-year Treasury bond.  Over the period, the yield on the 10-year Treasury climbed from 1.51% on 8/23 to 1.90%.  Remember that higher yields mean lower prices for bonds.




Unsurprisingly, the no deal trade simply inverts the deal trade.  Given that trade hostilities have been brewing over the course of the last twelve months, let’s look at the same categories as above and their trailing twelve month returns:

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In a no deal environment, you would expect lower economic growth rates, lower long-term interest rates, lower earnings expectations, and lower offshore currency values.  Therefore, traders should overweight large caps (less economically sensitive), the growth style (companies capable of growing earnings organically), and domestic stocks (a stronger dollar means weaker offshore currencies, further chipping away at offshore stock returns).  Oh, and go long the 10-year Treasury bond.  Over the trailing twelve months, the yield on the 10-year Treasury bond fell from 2.99% to 1.90%.  Remember, lower yields mean higher prices for bonds.


The Investment: Deal or No Deal?


It May Not Matter


Investment time horizons differentiate traders and investors.  Traders rely on shifts in short term sentiment while investors rely on shifts in longer term fundamentals.  Traders concentrate on what might be, investors concentrate on what will be.  The arrival of a trade deal will certainly boost sentiment.  The market should quickly levitate to new highs and handsomely reward the deal-trade traders positioned as above.  However, once the euphoria fades, the fundamentals must follow sentiment higher to justify the gains.  Trump will likely announce a deal (to some degree) in advance of the election.  But for businesses pressured by rising wages and softening demand, this may not be enough.  Even with a resolute US consumer, and even with 60% of S&P 500 revenues generated within our own borders, current and future earnings expectations continue to fall.

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Additionally, leading economic indicators worldwide depict waning economic growth momentum according to a release from the OECD this week.


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Clearly, global growth has lost momentum.  The last time we saw worldwide growth deterioration was in 2016.  In response, the US elected Donald Trump who quickly provided a $1 trillion fiscal stimulus package through his corporate tax cut.  While the removal of tariffs would amount to a tax cut, the total value if the US and China go to zero tariffs still only adds up to a maximum of $150 billion.  That’s far short of the $1 trillion Trump tax cut, and also far short of the $600 billion the Fed injected into the economy in response to the 2012 slowdown also seen above.  Therefore, while traders will celebrate the trade deal, investors will likely remain skeptical without a much larger stimulus plan in development.


Have a great Sunday!


Sources: OECD, Yahoo! Finance, Yardeni, Morningstar, Bloomberg
David Waddell
Author: CEO Chief Investment StrategistAfter graduating from the University of the South with a BA in Economics, David began his career with Charles Schwab & Co., Inc. in Phoenix, AZ. Having been recognized for his outstanding business development record, David was promoted to the San Francisco- based Institutional Strategic Accounts Team, which interfaced with the Big 5 accounting firms and Schwab’s largest customers. David left Schwab to continue his education at the graduate level in Boston. While earning his MBA degree with a concentration in finance and investments at the F.W. Olin School at Babson College, he was appointed by the college Trustees to manage a team of seven portfolio managers overseeing the student-managed portion of Babson’s endowment fund. David also founded the Babson Investment Management Association to assist undergraduate and graduate students with training and career path planning in the investment management field. As the firm’s Chief Investment Officer, David chairs the W&A investment committee and combines macro economic forecasting, macro market analysis and macro risk assessments to design portfolio strategies utilizing public market securities worldwide. A civic leader in Memphis, David currently acts as Chairman of Epicenter Memphis, and Co-Chair of the Memphis Chamber Chairman’s Circle while also serving as a board member for LaunchTN and the New Memphis Institute. David previously served as chairman for The Leadership Academy, the RISE Foundation, and the Economic Club of Memphis. He also chaired the capital campaign to build the “Live” stage at the Memphis Botanic Garden. David was a member of the 2004 Leadership Memphis class and has been recognized as one of Memphis’ “Top 40 under 40” by the Memphis Business Journal, and as a finalist for “Executive of the Year” in 2007. In addition to weekly columns in the Memphis Daily News and the Nashville Ledger, David has appeared in the Wall Street Journal, USA Today, Forbes, Business Week, Investment News, Institutional Investor News, The Tennessean and Memphis Business Journal. He has also made appearances on Fox Business News, Yahoo Finance, Bloomberg TV, CNBC, and CBS News and ABC News Channels. Read some of David's articles on his author page in Inside Memphis Business. David has two wonderful children, Easton and Saylor, an obedient Labradoodle named NASDAQ, and a devoted Goldendoodle named Ripley.


David S. Waddell


Chief Investment Strategist

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