Will the US come a cropper over trade?

Graham Smith
Graham Smith
Market Commentator11 July 2018

President Trump has never been one to do as the Romans do when in Rome. Whether speaking to car workers in Detroit, a globalised audience in Davos, a NATO summit in Brussels or, presumably, Theresa May at Chequers, the message is unwaveringly “America First”.

One big problem arising from that transcended from concern to reality last weekend as China imposed tariffs on US$34 billion worth of American imports – an amount equalling US tariffs on Chinese imports1.

It’s fortunate, therefore, that US companies have a lot of other positive news to talk about as the latest quarterly results season gets underway. Current estimates point to earnings being up by about 20% compared with the same three-month period a year ago – a notable achievement2.

History tells us earnings estimates tend to be revised down during a quarter, but not by an amount that would challenge this broadly positive picture. So where is the growth coming from?

As might be expected, a strong rise in the oil price has helped America’s energy sector, but technology and telecoms services companies have been performing well too. Even the weakest sectors – consumer staples, real estate and utilities – probably grew their earnings last quarter.

However, don’t expect the stock market to get overly excited about it. What matters even more than a stellar set of backward-looking results are year-ahead expectations.

Company earnings are currently subject to a complex cocktail of positives – tax cuts, strengthening consumer spending, subdued wage inflation – and negatives – rising interest rates, a strong dollar hurting exports and concerns about an escalating trade war with China3.

The net outcome might yet turn out to be positive; the problem is the waters are muddied. That means investors need to build in some leeway into their future earnings assumptions.

With earnings projected to be growing quickly overall, one thing that has improved markedly this year is the valuation of the US stock market. While US stocks could have been assessed as attractive on a number of counts late last year, value wasn’t one of them.

After falling in late January and only having just regained the ground lost, share prices are now lower compared to corporate earnings than they have been for some while.

That doesn’t mean the market is cheap. Based on the earnings US companies are expected to make over the next 12 months, the valuation of the S&P 500 Index – as measured by share price divided by earnings per share – is estimated to be bang in the middle of its five-year average4.

As far as President Trump is concerned, the big stimulus isn’t over. He wants to lower corporate taxes by a further 1% to 20% this autumn5.

Against that is a deteriorating outlook for interest rates. Last month, the US Federal Reserve Bank raised rates again and slipped an extra increase into its outlook for the rest of the year. If the Bank raises interest rates too quickly, future growth may still be at risk.

Then there’s the big unknown of how far a war on international trade could go. A serious diminution of trade between the world’s two largest economies would eat into US export earnings. It could push up inflation too, further encouraging the Fed to raise interest rates.

What might limit these effects in the end is the fact that it would not be in the interests of either China or America to risk precipitating a sharp growth slowdown at this point.

The Trump administration’s reputation rests on a strong economy that filters down to ordinary Americans. China is already in a slower growth phase as it sets about clamping down on overinvestment and risky lending practices.

Fidelity’s Select 50 list contains a number of funds focused on the US as well as others with a large US exposure but also the ability to invest further afield.

Given the array of competing factors driving the US stock market right now and yet more signs of dispersion between earnings growth rates across different business sectors, investors may do well to stick with a highly active management approach.

The JPM US Select Fund fits the brief, currently with its tally of largest holdings dominated by large technology and financial services companies.

The Fidelity American Special Situations Fund is also interesting in that it focuses on companies that have been through troubled periods and are largely off the radars of other investors.

Meanwhile, the “go-anywhere” Rathbone Global Opportunities Fund currently has about 60% of its portfolio invested in America. Again, US technology and financial services companies feature strongly among the Fund’s largest holdings.

Sources:

1 South China Morning Post, 07.07.18

2,4 FactSet, 06.07.18

3 US Department of Commerce, 14.06.18

5 Washington Post, 30.06.18


Important Information

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