Trade fears recede as US profits jump

Only last year it felt as though “volatility was AWOL and stocks moved steadily higher on a path that could be traced by a ruler”, as Randall Forsyth puts it in Barron’s. These days America’s Dow Jones index swings by hundreds of points on a daily, or even hourly, basis. Global markets had a positive start to the week as there was no immediate reprisal to the strike on Syria, while receding fears over trade have also buoyed sentiment.

The worry is that the US and China could fulfil their threats to impose 25% tariffs on $150bn of each other’s exports. But Donald Trump’s sabre-rattling
may merely be a bargaining strategy, Keith Wade of Schroders told The Times. Trump “has been wary of putting tariffs on goods which the US consumer would notice, such as iPhones”. He expects China and the US to reach a deal on trade that could be “held up as a victory” ahead of the US midterm elections in November.

The world can shrug off this trade spat

Trump last week again said he wanted to negotiate with China. This also suggests that a deal is the most likely outcome, according to Capital Economics. But even if the tariffs go ahead, there will be little direct impact on the world economy: $150bn worth of exports comprise just 0.8% and 1.2% of GDP in the US and China respectively. Other big economies are “generally not that exposed to US-China trade through global supply chains”. There would, of course, be a short-term effect on market and business confidence, which would undermine global growth.

While investors have become a bit more upbeat on the trade outlook in the past few days, they are also looking forward to a “monster” US earnings season, says John Authers in the Financial Times. Usually, firms talk down their expectations as the earnings season approaches, ensuring that their shares bounce when they exceed their lowered expectations. This time they’ve dispensed with this charade and become increasingly bullish.

Can profits keep climbing?

This is due to the corporate tax cut agreed late last year, which analysts reckon will add 7% to year-on-year earnings-per-share growth in the first quarter of 2018. Profits are expected to have risen by over a fifth overall. This prospect explains why stocks have not fallen through their February lows. In the last 25 years, “share prices and earnings per share have tracked each other almost perfectly”, says Authers; in the past five years 80% of the S&P 500’s gains have come during earnings season. Still, given the forecasts, stocks bear “an unduly heavy burden of expectation”. With valuations so high, there is little room for error, while historically high margins look set to come under pressure as the labour market tightens in the months ahead. So while earnings may boost stocks for now, in the longer term the momentum they provide is likely to ebb.