IT’S NOT THE ECONOMY STUPID!

By David Nelson, CFA

If markets were focused on the U.S. economy, we would have already broken out to new highs. Friday’s employment report along with other economic data confirms the U.S. economy is on solid footing. So much so the Atlanta Fed is boosting GDP for the quarter up to 4.7%. Geo-political headlines dominate the trading action and with this week’s calendar as lite as it is expect more of the same.

Last week we started off staring into the abyss on the heels of political uncertainty in Italy. Their next election is likely to be a referendum on the Euro. Blowouts in sovereign credit default swaps like we saw last week don’t happen unless there’s something rotten at the core. Increasingly there is a rising tide of Euro Skeptics that don’t want to be dictated to by Brussels. Another exit from the zone would be difficult for the EU. I’ll say it one more time. YOU CAN’T SUPPORT A COMMON CURRENCY WITHOUT A COMMON GOV’T.

Back here in the states the economic picture for the moment is healthy. Friday’s report showing we added 233k jobs in May is welcome news this late in the cycle. Not only was unemployment down to lows not seen since well before the financial crisis but Black unemployment hit a record low.  I’m not sure how you can spin a report as good as this one negatively, but house minority leader Nancy Pelosi was sure out their trying on Friday. This shouldn’t be partisan. IMHO good news is good news and should be celebrated by both sides of the aisle even during an election year.

The Fed

Of course, Friday’s good news all but locks in the Fed to a rate hike later this month. The Fed is on a path to normalization, but IMHO will find it difficult raising from these levels if other central banks around the world continue to operate in crisis mode holding down their yields at all cost. It adds pressure to the long end of our curve potentially putting the Fed on hold or worse a policy mistake that inverts the curve.

Trade War?

Trade will likely dominate the news especially with the President arriving in Quebec later this week. Expect stocks to rise on fall off every headline, tweet and soundbite related to tariffs on our allies and adversaries alike.

With the administration playing hardball regarding any negotiations it’s becoming clear the President doesn’t want a NAFTA deal. Given past failures I suspect the President doesn’t want a multi-lateral deal preferring to negotiate with each country separately. No question the rhetoric is chaotic and difficult for investors, negotiators and for that matter world leaders to deal with.

Late last week the administration put steel and aluminum tariffs back in play. Leaders from Toronto to Brussels expressed outrage especially regarding the use of National Security as a pretext. Hitting the tape early Sunday AP – China Warns US No Deal If Tariffs Go Ahead – China has warned any agreements with Washington in their talks on settling a sprawling trade dispute “will not take effect” if threatened U.S. sanctions including tariff hikes go ahead.

Harsh rhetoric and of course the broadcast and print media are running with the headline TRADE WAR. Look, we’ve been in a trade war for the last 3 decades and for the most part, it’s a war we’ve been losing. The theft of intellectual property is just the tip of the iceberg. Make no mistake China is an adversary on every level including trade, geo-politically and militarily. I’m not in the room but for the moment I remain constructive. It’s an election year and even though coming out hard the President lives up to a campaign promise, I suspect we will see some agreements as the summer wears on.

There’s more to the market than just FANG

Meanwhile the best thing stock investors can do is ignore some of the geo-political noise and drill down into what’s actually working. As investors we tend to have a myopic focus on the S&P 500 which is increasingly dominated by a few mega cap tech stocks. I’m not a bear on FANG but there’s more to this market than just the secular growth stories.

Rails and intermodal touch nearly every fabric of our economy and are doing just fine. In some cases, firms like Norfolk Southern (NSC) are raising prices 15% and in some areas of the country some firms can’t meet the demand and won’t take on anymore contracts. That doesn’t sound like an economy that’s rolling over to me.

Despite troubles in the S&P 500 unable to break out, it’s hard for me to get too bearish when the Russell 2000 is at or close to all-time highs.

*At the time of this article some funds managed by David were long NSC