Strategy: Trade War Over Already.
Investors have fretted over plenty of issues during the current bull market. Many of these were passing concerns. As a result, the bull market has been buffeted by panic attacks when the “fret level” got especially high only to be followed by relief rallies when the worries subsided.
The latest panic attack was mostly about Trump turning into a protectionist trade warrior. The relief rally may already be underway after Chinese President (for life) Xi Jinping last Tuesday responded in a conciliatory fashion to Trump’s complaints against China’s unfair trade practices. Xi said that tariffs on imported autos would be cut and more would be done to protect foreigners’ intellectual property rights. Then, last Thursday, Trump unexpectedly reversed course and directed his trade team to reconsider joining the Trans-Pacific Partnership trade agreement after having pulled out of it early last year.
I’ve frequently opined that Trump favors free trade as long as it is fair trade. I predicted that he would be much more like Ronald Reagan than Herbert Hoover on trade.
In my new book, I wrote:
“Donald Trump won the presidential election on November 8, 2016. He did so to an important extent because he promised to bring jobs back to the United States by either renegotiating trade agreements or imposing tariffs if necessary. His policies could pose a threat to global trade. However, the threat level seems more like what it was during the Reagan years than the debacle of the Hoover administration. Reagan succeeded in promoting fairer trade and bringing back lots of jobs in the auto industry as foreign manufacturers moved some of their production facilities to the United States.” I added:
“Trump might also succeed in forcing some of America’s trading partners to eliminate unfair trade practices. His approach is bilateral rather than multilateral, which is a different approach to negotiating free trade deals than the one that has prevailed since World War II. That’s alright by me as long as the result is free trade. All the better if it is also fair trade.”
Last Wednesday’s Morning Briefing was titled “Trade War Over Already?” Today, I’m using the same title for this section, brazenly dropping the question mark. Am I being impetuous? No more so than our fearless leader! The S&P 500 rose 2.0% last week and is only 7.5% below its record high (Fig. 1 and Fig. 2).
US Economy: Inflation Warming? The latest panic attack was initially triggered by concerns about inflation rather than trade. Recall that on February 2, January’s employment report showed a higher-than-expected wage inflation rate of 2.9%. Subsequent inflation indicators quickly dissipated this concern only to be trumped by Trump’s trade war rhetoric. If the trade war is over already, perhaps we’ll start worrying about inflation again.
Debbie and I would like to assure you that there is nothing to worry about, but we can’t. Inflationary pressures are building at the producer price level. The question is whether cost-push inflationary pressures will push consumer price inflation higher. We don’t think so. Competitive pressures should keep a lid on the CPI inflation rate at the same time that PPI inflation is rising more rapidly. That means that either productivity will suddenly improve or, more likely, profit margins will erode. But don’t fret: Profit margins have been boosted significantly by Trump’s corporate tax cut. So there is room for companies to absorb cost increases by lowering profit margins rather than raising prices. Let’s take a deep dive into the latest inflation data:
(1) ISM surveys. The monthly ISM survey of purchasing managers includes a prices paid index for manufacturing and nonmanufacturing companies (Fig. 3). The former jumped to 78.1, the highest reading since April 2011. That’s a significant rebound from the second half of 2014 and all of 2015, when this index was below 50.0. The nonmanufacturing prices-paid index has been on a more muted uptrend since early 2016, rising to 63.0 in March.
(2) NFIB survey. The NFIB’s March survey of small business owners found that 16.0% of them are raising their average selling prices (Fig. 4). That’s not a lot, but it is the highest percentage since September 2008. The percentage planning to raise their average selling prices rose to 25.0% last month, also the highest since September 2008.
(3) Regional Fed surveys. Five of the 12 Federal Reserve district banks (FRBs) conduct monthly business surveys in their regions. All of them (Dallas, Kansas City, New York, Philly, and Richmond) ask questions about both prices paid and prices received (Fig. 5). Interestingly, the diffusion indexes for prices paid almost always exceed the diffusion indexes for prices received. As is the case with the ISM series, there have been noticeable upward trends in both indexes for the five districts since early 2016.
Not very surprising is that the average of the five FRBs prices-paid indexes is highly correlated with the ISM manufacturing prices-paid index (Fig. 6).
(4) Producer prices. Also not surprising is that the regional average prices-paid index is highly correlated with the PPI for final demand (Fig. 7). During March, the former was the highest since May 2011, while the latter matched its highest rate since January 2012.
(5) Consumer prices. The average prices-paid index based on the Fed’s regional surveys seems to reflect pricing pressures in the goods sector more than in the services sector. That’s evident from its high correlation with the ISM manufacturing prices-paid index and with the PPI for final demand. So far, the recent pricing pressures evident in those three prices-paid indicators are not showing up in the CPI for goods, neither including nor excluding food and energy (Fig. 8).
(6) Import prices. Also not showing up in the CPI for goods excluding food and energy is any pressure from the weaker dollar, which is down 6.8% y/y through the end of March. That’s because the index of imported consumer goods excluding food and energy has been hovering around zero on a y/y basis since early 2017 despite the weaker dollar (Fig. 9).
(7) Services. So far, our analysis has focused on various measures of goods inflation. In the goods CPI, most of the upward pressure has been energy related. This index is up 1.5% y/y through March, and slightly negative excluding food and energy commodities. The cost-push inflationary pressures evident in the ISM, FRB, and PPI prices-paid indexes may be mostly related to the rise in oil prices since early 2016.
On the other hand, the CPI services inflation rate is up 2.9% both with and without energy services (Fig. 10). The overall CPI services inflation rate was depressed last year by a sharp drop in wireless telephone service fees (Fig. 11). They are still falling this year on a y/y basis, but not as fast as last year. On the other hand, tenant rent in the CPI seems to have peaked during Q1-2017 at 3.9% y/y (Fig. 12). It was down to 3.6% during March. This development may be starting to weigh on owners’ equivalent rent as well (Fig. 13).
(8) Medical care. Also helping to dampen inflationary pressures last year in the CPI was a sharp decline in medical care inflation, led by physician services and prescription drugs (Fig. 14). The same cannot be said for the PCED medical care component, which has maintained a more subdued inflation rate around 2.0% for the past couple of years.
Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research.
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