Strong Jobs and Earnings Trump Tariffs and Geopolitics

The market landscape of the past couple weeks has been fraught with headline risk that has resulted in several big moves in many asset classes and key stocks that tend to dominate investor sentiment.

I think the most notable event has been the sudden decline in the yield on the U.S. 10-year Treasury moving from 3.11% to 2.82% over the 10 trading sessions. The flight to safety was a result of the spike in yields in the Italian bond market when fears erupted that a snap referendum election would take place to determine if that country would leave the euro currency.

As if that piece of news wasn’t enough to rattle markets, President Trump announced the levying of steel and aluminum tariffs targeting Europe, Canada and Mexico in reaction to foot-dragging on the North American Free Trade Agreement (NAFTA) and fair-trade talks with European Union (EU) officials. Although the size of the tariffs is small in comparison with the $18 trillion U.S. economy, it sends a message that a possible trade war with China might be in the offing if current negotiations don’t progress well. Retaliatory tariffs were immediately announced that negatively impacted some of the consumer staples stocks.

On the flip side, global dealmaking is at a record pace. Announced mergers and acquisitions are on pace to post the biggest year on record. In the first three months of 2018, there were 3,774 deals globally, totaling $890.7 billion and 18% higher than the first quarter of 2017. So far this year, $393.9 billion has been invested in U.S. companies, while domestic deal-making activity in China was also particularly strong.

The biggest deals have been in the health care space, where Cigna (NYSE: CI) is buying Express Scripts (Nasdaq: ESRX) for $54 billion in cash and stock and CVS (NYSE: CVS) is buying Aetna (NYSE: AET) for $69 billion in cash and stock. It appears that this extraordinary surge in mergers and acquisitions (M&A) activity will carry through the year. Add record stock buybacks and dividend increases to the mix and it’s not difficult to see the glass more than half full, despite all the geopolitical noise.

As to the market on a day-to-day basis, there is an undertone of resilience by many leading stocks reflecting what is an undeniably strong domestic economy. All the FAANG stocks, featuring Facebook (Nasdaq: FB), Amazon (Nasdaq: AMZN), Apple (Nasdaq: APPL), Netflix (Nasdaq: NFLX) and Alphabet/Google (Nasdaq: GOOGL) are back up and trading at or near all-time highs, the yield on the 10-year Treasury has backed down and the rally in the dollar has leveled off amid profit-taking in the oil sector, all of which were recent market headwinds.

With investors now getting refocused on the U.S. economy and less on the global issues, the bulls have a shot of taking the S&P above overhead resistance at 2,740 that opens the way for a retest of the 2,800 level or higher. The backdrop is one of good news on the economy and bad news on trade, but the relative impact from the announced tariffs and those that might be slapped on China seem to be getting priced in, along with the Fed set to raise short-term rates by a quarter-point.

The market is coping well with the notion of the U.S. playing hardball on trade because the trade deficit is in fact sky high and there needs to be leveling of the playing field, pure and simple. So, while there may be tariffs announced, they don’t take effect for several months, affording plenty of time to negotiate deals with acceptable terms. Time will tell if Europe, Canada, Mexico and China blink. I think they will because they need the favorable trade with the United States far more than America needs them, and the foot dragging is over after the NAFTA deal got pushed out to the next Congress.

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