Strategy I: What Do We Know? We know that the fundamentals driving earnings are very strong. We know that the US economy is performing well. The US labor market is essentially at full employment, with initial unemployment claims falling to 210,000 last week, the lowest since December 1969 (Fig. 1). We know that the number of job openings is equal to the number of unemployed workers, suggesting that most of the unemployment can be described as “frictional,” resulting from geographic and skills mismatches (Fig. 2).
We know that the global economy is experiencing widespread synchronized growth. Our Global Growth Barometer, which is simply an average of the CRB raw industrials spot price index and the price of a barrel of Brent crude oil, remains on an uptrend that started in early 2016 (Fig. 3). Eurozone retail sales (excluding motor vehicles) is also on an uptrend, and in record-high territory (Fig. 4).
Most impressive are all the global export statistics suggesting that the economies around the world are benefitting mightily from a global exports boom. Consider the following:
(1) United States. Debbie and I are impressed by the strength in the volume of US exports during December (Fig. 5). It rose 6.1% y/y to a record high of $1,578 billion (saar). The problem is that the volume of imports rose 7.2% y/y to a record high of $2,399 billion, causing the monthly inflation-adjusted trade deficit to widen to $821 billion, the widest gap since March 2007.
Debbie and I have found that the sum of US real exports and real imports is a very good proxy for the volume of global exports (Fig. 6 and Fig. 7). Both rose to new record highs during December, with y/y gains of 6.8% and 4.5% respectively.
Another useful indicator of global trade is the sum of the US M-PMI’s new exports order and imports components (Fig. 8). It soared from 118.2 during January to 123.3 during February, the highest reading on record. This index is highly correlated with the y/y growth in the volume of global exports.
(2) G6 economies. The sum of the exports of the G6 economies (i.e., the G7 excluding the US) is up 17.5% from December 2015 through December 2017 (Fig. 9 and Fig. 10).
(3) Global revenues. We know that the widespread strength in global economic activity, as evidenced by the latest trade data, is boosting the revenues per share of the All Country World MSCI stock price index (Fig. 11). Industry analysts are expecting revenues (in local currencies) to rise 5.9% this year and 4.5% next year, pushing forward revenues per share to a record high. The latter has been recovering since early 2016 from the global energy-led mini-recession during 2015.
Similarly, S&P 500 revenues per share is expected to increase 6.4% this year and 6.9% next year (Fig. 12). The estimates for 2018 and 2019 have increased by 2.9% and 2.6%, respectively, since the first week of September. We believe these upward revisions have had more to do with the pickup in global economic growth than any spillover effect from the Tax Cut and Jobs Act (TCJA) passed late last year in the US.
(4) US earnings. We also know that S&P 500 earnings will get a huge boost from the TCJA this year. During the 11 weeks since the TCJA was enacted through the week ended March 1, industry analysts have raised their 2018 consensus estimate by $11.72 per share from $146.26 to $157.98 currently (Fig. 13). So they are forecasting a 19.0% increase this year. Next year, they are projecting another double-digit gain of 10.0%.
Strategy II: What Don’t We Know? So we know what we know. On balance, the list of what we know is fundamentally bullish for stocks. We also have a list of known unknowns that might be bearish for stocks. Here are the items at the top of this list:
(1) Protectionism. Jumping from near the bottom of the list to the top of the list since late last week is a trade war. President Donald Trump signaled during January that the passage of his tax reform plan now allows him to move to the protectionist plank of his campaign platform. He did so by slapping tariffs on imports of solar panels and washing machines during the first month of the year. Last Thursday, he stated that he aims to do the same on imports of aluminum and steel. Since then, he has bobbed and weaved around the subject, which suggests that he might be posturing to get a better deal out of the current process of renegotiating NAFTA with Mexico and Canada.
I continue to believe that Trump won’t end globalization by triggering a worldwide trade war. Rather, I think he will do what he can to convert multilateral trade deals into bilateral ones that can more easily be adjusted as circumstances change. However, I know this is a known unknown because the President is hard to predict.
(2) Inflation. Reflationists are making a good case for reflation. They note that the US labor market is very tight and wage inflation may have started to pick up in January finally. They observe that commodity prices have been trending higher. Fiscal policy has turned more stimulative as a result of the TCJA and the recent deal by congressional Republicans and Democrats to keep the government open by spending more money! If Trump proceeds with raising more tariffs, that will drive up prices of import and import substitutes in the US.
On the other hand, inflation remains subdued. The PCED inflation rate was 1.7% y/y during January, while the core rate was even lower at only 1.5% (Fig. 14). Fed officials are still expecting the core rate to rise to their 2% target this year. Debbie and I continue to believe that the powerful secular forces of competition attributable to globalization, technological innovation, and aging demographics will keep a lid on inflation.
(3) Interest rates. We know that the Fed is on a course of gradually raising the federal funds rate at the same time that it is reducing its balance-sheet portfolio of US Treasuries and mortgage-backed securities. We don’t know how the bond market will respond to the Fed’s policy normalization. If inflation does make a comeback, then the bearish reaction in the bond market would be more severe than otherwise. If protectionism prevails, bond yields might move higher if foreigners retaliate by selling their US bonds. Or, yields might go lower if protectionism depresses global economic activity.
For now, we are putting much more weight on the known knowns that are bullish for stocks than on the bearish known unknowns. As for the unknown unknowns, we don’t know.
Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research.
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