SUMMARY
The world’s largest economy seems to be holding up amid the trade war so far. However, peak tariff impact is likely yet to come.
KEY TAKEAWAYS:
With muted tariff impacts on inflation so far, the US economy looks in decent shape
We are watching closely for any signs of tariff-related margin pressure
We are hesitant to take on new risk given that valuations already look stretched
We maintain our strong preference for large-cap equities and secular growth themes
After months of tariff threats, impositions and walk backs, hard evidence of the trade war’s impacts is starting to emerge.
So far, the signs are encouraging. Inflation is only showing subtle hints of rising because of tariffs.
June’s consumer price index (CPI) reading saw a year-over-year advance of 2.7%. That was close to what investors had been expecting, albeit up from May’s 2.4% rate.
Dig below the headline numbers and we see a bit more of what’s happening.
Goods prices were firm and have broken upwards out of their multi-year sideways-to-downward trend.
The sharpest rises were mainly in specialized areas where there aren’t many substitutes, such as window and floor coverings. Their prices jumped 4% over the previous month, one of the largest increases in their history.
Where substitutes were more available, the price increase was gentler. Appliances, for example, rose 2%.
So what’s going on?
Our reading of big, multinational firms’ recent public statements suggests that have many have been able to act nimbly and creatively.
Thanks to their diverse supply chains, they’ve managed to build up their stockpiles and shift suppliers.
Consequently, they have not suffered bigger price increases that needed to be passed on to customers.
Still, the impacts have been uneven across industries.
We believe those with multiple suppliers across multiple territories may continue to control their costs. They should be better able to limit price increases than those with more limited supplier networks.
And it remains too early to gauge the impact on profit margins – and consumer demand – despite the evidence we are getting so far.
For further clues, we are closely monitoring consumer inflation expectations surveys as well as corporate profit margins and capital expenditure.
The US economy looks resilient
Our early takeaway from US earnings season is that the world’s largest economy remains in decent shape.
Aside from the contained overall rate of inflation, earnings from the banking sector also point to robustness.
All 17 financial sector firms that reported results through July 16 beat consensus earnings per share estimates.
Banks are often seen as a good indicator of underlying economic activity, owing to their pivotal role as suppliers of loans and other financial products to businesses and consumers.
Net loans deemed uncollectible – aka charge-offs – came in below expectations.
Meanwhile, major investment banks highlighted growing mergers & acquisitions (M&A) activity.
If financial conditions remain loose with range-bound interest rates and strong equity prices, this may bode well for a continuation of the nascent recovery in M&A. Greater focus upon deregulation – a key element of the Trump administration’s agenda – would also be helpful.
With the economy apparently holding up well, we see little case for the US Federal Reserve to cut interest rates this summer.
That is despite the White House’s messaging that the Fed is already “too late” in easing monetary policy and its urging to lower rates “by a lot.”
In our view, the Fed is likely to keep rates where they are through the third quarter of this year, until either the labor market weakens considerably or disinflationary trends become evident.
The bottom line: Our positioning
Overall, the start of earnings season points to a benign economic environment in the previous quarter.
This has helped support the recent recovery in stocks of lagging sectors and small companies, which are also popular targets for short sellers.
US equity markets are hovering around all-time highs, with many investors already strongly positioned.
We believe this explains the rather muted reaction to the very solid start to second-quarterly earnings season.
With valuations currently stretched, we are hesitant to add broadly to risk. We maintain our preference for large-cap equities and secular growth themes such as artificial intelligence (AI.)
