For more than a year, financial markets have focused on U.S. trade deals with Europe, Asia, and North America. The consensus has always been that deals would be reached with each region. The announcement last fall of a U.S.-Mexico-Canada NAFTA replacement was positive. In May, Chinese trade talks not only collapsed but existing tariffs were increased and bath countries appear to be targeting each other's companies. The administration gave itself an additional six months to put tariffs on Japanese and European cars and announced new tariffs on 100% of Mexican imports. At this point, all bets are off for quick and comprehensive deals. The high level of trade uncertainty has led to an unstable business environment which has reduced business investment. U.S. economic growth has slowed and growth overseas is even slower. Morgan Stanley and other investment banks have highlighted that rising trade tensions increase the chance of an economic slowdown or a recession. All eyes will be on the G20 Summit in Japan to see if trade tensions can be reduced.
U.S. GDP growth in the first quarter was revised down slightly from 3.2% to 3.1%. While this isn't a significant amount, the source of the downgrades—lower corporate profits and investments—is concerning. In fact, profits of U.S. corporations have actually fallen for two consecutive quarters, which is the definition of an earnings recession. According to FactSet Earnings Insight, the earnings of public companies, as measured by the S&P 500 Index, fell slightly in the first quarter of 2019 and are currently expected to fall in the second quarter. Estimates for the fourth quarter this year are more positive, with S&P 500 year-over-year earnings growth expected to be 8%. But as the economy has moved later in the economic cycle and the one-time boost from tax reform has fallen away, even this growth is well below 2018's S&P 500 earnings growth of more than 20%.
We are positive on the market and we view the May sell-off as an opportunity.
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