Tariff Tantrum Resembles Taper Tantrum

In 2013, Federal Reserve Chairman Ben Bernanke announced that the Fed would no longer be purchasing bonds, and mass global panic ensued. Bond yields drastically increased and many pundits believed that the stock market would plummet when the Fed announced it would scale down its bond-buying program in 2013. Instead, the stock market rallied after an initial correction and ended the year significantly higher.

Global stocks struggled last week , and it was the worst weekly performance for US equities since January 2016.  Stocks sank after President Trump announced new tariffs on Chinese imports, fueling fears of an impending trade war that investors worry could hurt global economic growth.  It’s possible that such fears, like we witnessed with the Taper Tantrum, may be overblown, as there are reports that the US and China are already beginning the process of negotiating the situation.  The interconnectedness of the global economy will make a trade war expensive for both parties.  A trade war will hurt the Chinese economy more than the US economy.  The Chinese economy is more export-oriented and will be hurt more by losing access to the US market under a full-blown trade war.  We would expect the Chinese officials will look for a win/win scenario that allows President Trump to claim domestic political victory while doing little actual damage to the Chinese economy.  It is likely that trade tension will continue and with the uncertainty will come market volatility, but we do not see this as the catalyst for recession.

Economic Expansion Picks Up Momentum

The US and global economies appear on sound footing, inflation pressures appear contained, the labor market remains strong, corporate earnings are solid and interest rates have been rising only modestly.  The final report on 2017 4th quarter US GDP came in stronger than expected.  Real GDP growth was revised up to a 2.9% growth rate due to upward revisions to both consumer spending and inventories.  The US economy is now growing closer to 3% and we should see additional tailwinds from tax reform and regulatory relief.  Corporate profits should accelerate and the earnings for the S&P 500 this year are expected to be up 18.6%.  We expect that the pattern of coordinated, above-trend global growth we’ve enjoyed for the past few quarters will extend throughout 2018.  We do not believe we are approaching an economic recession or an imminent bear market.  We expect stock prices will again be able to climb the wall of worry, and we would expect stocks to outperform bonds in 2018.

Central Bank Liquidity

Since the Global Financial Crisis in 2008/2009, central banks have injected trillions of dollars into the system to stimulate growth.  With a global economy on the mend, it is time for some of that liquidity to be removed.  Quantitative Tightening (QT) if too restrictive can force an economy into recession.  However, late in economic cycles stocks tend to perform well until monetary policy becomes genuinely restrictive – which is some ways off.  To be clear, the Fed has not yet “taken away the punch bowl,” and we feel the economy can sustain higher interest rates.  The current volatility in the stock market is not a warning of impending recession.  Only when there are fundamental economic problems does volatility signal a recession.