A Curve Ball In May

Our Investment Views, Weekly Market Makers

By: Shawn Narancich, CFA Executive Vice President of Research

Held Hostage by Trade
As first quarter reporting season draws to another constructive close, investors’ attention was ripped away from the earnings scorecard and refocused almost exclusively on trade. Today’s imposition of additional tariffs on $200 billion of Chinese imports was on virtually no one’s radar screen a week ago, but the reality is upon us following the latest flurry of presidential tweets and what became largely perfunctory U.S.-Sino trade talks in D.C. that concluded without tangible results. New tariffs and uncertain prospects for ultimate resolution of the trade war with China predictably left equity investors voting with their feet, sending stocks down over 2 percent for their worst weekly performance of the year.

Tariffs to the Rescue?
Except for furniture, most of the products currently subject to Chinese tariffs are not final U.S. consumption expenditures, but rather as the chart below details, tend to be inputs to final products and services, like computers, autos and cell phone service. Sources: Strategas, US ITC, Bloomberg

As tariff taxes get passed through the supply chain, consumers will ultimately pay more, but in a more indirect manner and with a time lag. If ongoing trade negotiations are ultimately unsuccessful, the U.S. economy and its consumer engine will see the impact of additional threatened tariffs more immediately on Chinese imports like toys, apparel, and iPhones.

Investment at Risk
Whether tariffs are ultimately imposed on the remaining $325 billion of Chinese imports remains to be seen, but aside from higher prices that U.S. consumers stand to pay, the impact on business investment is equally noteworthy. Long-tailed capital investment projects rely on cash flow projections far into the future, so when trade wars disrupt supply chains and introduce newly unpredictable variables into demand forecasts, businesses simply stand aside. In other words, they don’t invest. At a point later in the economic cycle, when labor markets are increasingly tight, investment in new technology and equipment are even more important to sustaining economic growth because they enable the existing workforce to do more with less. While tax cuts and accelerated depreciation have helped stimulate additional capital spending, more is needed to feed the productivity machine. Delayed investment ultimately does the U.S. economy a disservice at a time when underlying U.S. economic growth ex-inventory builds and net imports is less robust than the latest 3.2 percent headline GDP growth implies.

Need a Lyft?
Following what has proven to be Lyft’s overpriced IPO, chief competitor Uber followed with its public offering of stock today. Despite pricing at the bottom end of underwriters’ planned range, Uber’s stock failed to gain traction and ended its first day of trading in reverse, down nearly 8 percent. Profits from the ride sharing services may yet materialize for these innovative new companies, but against the week’s jittery backdrop, timing of Uber’s IPO proved difficult.

Rounding Third Base
With 90 percent of the S&P 500 having now reported first quarter results, the last key piece of the puzzle will be retailer earnings. Investors will be keen to judge the evolving impact of e-commerce and tight labor markets on the likes of household names Wal-Mart, Home Depot, and Nordstrom in the weeks to come.

Week in Review and Our Takeaways
• Amid renewed trade tensions, stocks suffered their worst week of the year
• New tariffs and the threat of those yet to be imposed present risks to U.S. economic expansion