If Only President Trump Would…

21 Aug 2017

  • Geopolitical concerns and turmoil in Washington are creating uncertainties in risk markets.
  • Overall second quarter results show continued earnings strength, but the much anticipated pickup in capital expenditures is not materializing and outlook for 2018 is also being lowered.
  • Strong July retail sales set the third quarter economic growth on solid footing; however, the US political situation could raise uncertainties in the second half of the year.

The much anticipated, late-August calm in financial markets has taken a backseat amidst rising geopolitical concerns, increased uneasiness in response to the rhetoric from Washington and a few weaker-than-expected earnings releases this past week. After a strong first quarter earnings season, overall results for the second quarter, so far, is also better-than-expected, with mid-single digit top line growth and earnings growth almost doubling that of revenue. We are seeing margin expansion in the most cyclical companies and as long as revenue growth continues and wage pressures remain muted, profit and profit margin expansion should persist in the near term. As global growth increases, companies with larger international exposure are increasing earnings at a faster pace than their domestic only peers. The European region is seeing stronger economic growth than many anticipated heading into the year, and the Japanese economy expanded its growth streak during the second quarter, while the picture in Latin America remains mixed. We expect earnings to benefit from currency translation gains in the second half of 2017. Leverage for US corporate remains elevated and the much anticipated pickup in capital expenditures is not materializing. Based on a recent Standard & Poor’s survey of corporate issuers, North American companies are expected to increase 2017 capital expenditures by 3.5% over 2016. While the trend is better than recent years, it is underwhelming, and with the expectation for meaningful tax reform fading, along with reduced outlook for energy prices, 2018 capital expenditure budgets may be lowered as well.

Absent any major shocks, many economists expect the US economic expansion to continue for the next 12-18 months, the longest on record. However, events over the past couple of weeks have created some angst in markets, especially for the riskiest segment. Equities and high yields saw outflows over the past week, as investors flooded to traditional safe havens. Market moves were further accentuated by the terrorist attack in Spain (see VIX Index chart of the week). Deteriorating support for our President is coming from all directions, domestically and internationally, and we remain concerned that the political turmoil in Washington is contributing to a loss of confidence.

Economic data released this past week, while mixed, is largely supportive of continued growth in early third quarter. The 0.6% gain in retail sales in July and upward revisions in May and June, showed an accelerating consumer demand in the third quarter 2017. The strength in retail was broad based, with even the department stores, in secular decline, posting growth. Total business inventories increased by 0.5% in June, also signaling a slight upward revision to second quarter GDP data. US Industrial Production and Capacity Utilization data came in positive during July, with Industrial Production up 0.2% and Capacity Utilization up 0.1% sequentially. Homebuilding data was mixed. Housing starts and building permits were below expectations, while homebuilder confidence increased, ahead of expectations, and may be indicative of the difficulties that builders face in finding suitable land.

From a fundamental perspective, the current cyclical backdrop remains supportive for U.S. earnings growth in the second half of 2017, and consumption data started off the third quarter on a strong footing. With a strong job market and household wealth at record levels, the favorable consumer indicators remain supportive to the U.S. economic growth narrative. However, a deteriorating political situation could raise uncertainties in the second half of 2017.

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