Market Strategy 10/7/2019

• We right size our expectations ahead of this week’s trade negotiations between the US and China in Washington.
• A new round of trade negotiations at the end of this week along with the minutes of the Fed’s last FOMC meeting and a brace of economic data will provide traders and investors plenty to ponder.
• Last week’s drama brought about by a weaker ISM manufacturing index was favorably offset by the non-farm payroll gain and the lowest read on unemployment since 1969.
• S&P 500 valuation is now back at its five-year average suggesting equities are attractively valued versus fixed income.

This week is poised to provide traders and investors with plenty to focus on with high level trade negotiations between the US and China scheduled for the latter part of the week and the mid-week release of September’s FOMC Fed minutes providing details of the Fed’s decision last month.

Add to that a diverse palette of economic data that’s scheduled to cross the transom over the course of the week that should proffer some opportunity for market participants to gain further insights into the health of the economy including those tied to producer and consumer gauges of inflation (PPI and CPI), job openings (the JOLTS index), real hourly earnings, wholesale inventories, export and import prices and at week’s end a key measure of consumer sentiment.

This Sunday night as we prepared to go to press news crossed the Bloomberg tape that China might prove reluctant to agree to the type of broad deal the US is looking for and instead be more amenable to a partial agreement. Stock futures naturally showed some weakness on the news item and Treasury prices edged higher.

We’d be reluctant to arrive at foregone conclusions as to how this week’s negotiations will proceed. Our efforts have been to right size our expectations ahead of these meetings considering the results of prior trade meetings between both countries. In consideration of what came to pass in those earlier meetings we will at best look for progress not perfection.

The complexity of a deal that could make a substantive and positive difference in trade between the two countries dictates a longer rather than a short process to reach such a deal. A progress not perfection outcome for this week and next week’s negotiations would look to us to include a truce instead of further escalation (and subsequent retaliatory actions) with an outline of an agenda and time line projecting a more comprehensive agreement that would include eventual withdrawal of tariff regimes by both sides.

Hopefully both sides can avoid drawing lines in the sand and walking away from the negotiating table this time around. The United States and China as well as the rest of the world could benefit substantially if the negotiations can avoid a stalemate that leads to geopolitical grand standing.

Cuts in global trade forecasts by the World Trade Organization in the past week signal the risk to the world economy if the US and China fail to avoid a protracted trade war. Ironically so far it has been the trading partners of the two combatants that have suffered the most damage economically. However, year two of the trade fracas points to the pain spreading further should the impracticality of the trade war and the reasons for it to have taken place continue to go unrealized.

Last week’s market volatility stateside centered around a worse than expected drop in the ISM Manufacturing Index to its lowest level in ten years along with a weaker than expected read on the ISM Non-Manufacturing Index (see page 4 of this report for details). The markets’ reaction to the manufacturing gauge read was what we’d describe as “of the knee jerk variety” and lacked consideration of the fact that the fall-off in manufacturing signaled in the highly qualitative gauge should not have come as such a surprise in light of the existence of a still unresolved trade war.

We can’t help but think that some 18 months into the trade war negotiators on both sides should be feeling pressure from their respective constituencies to get the tariff war behind them before it does further damage to their respective and the world’s economies. A Presidential election stateside in 2020, a need for greater focus for all sides towards fiscal stimulus to combat cyclical and secular sluggish growth as well as corporate diversification of supply chains away from China should be more than enough to induce some progress. Time will tell soon enough.

Last week’s non-farm payroll gain for September and the upward revision to August’s hiring and a drop in headline unemployment to a level not seen since 1969 provided enough positive offset to the negatives in the ISM manufacturing number to rally stocks on Friday stateside and in Europe reminding us once again that the fundamentals likely remain strong enough (if not robust) to provide stocks with enough reason to consider climbing further up the proverbial wall of worry for now not withstanding occasional detours.

We continue to overweight US equities while maintaining meaningful exposure to both developed and emerging market equities. We persist in favoring cyclical sectors over defensive sectors based on relative valuations, interest rates and prospects for a trade resolution.