Trade: Deal Making. We may already be getting some relief on one of the major issues that has weighed on the market since early February, when President Donald Trump threatened to impose tariffs on the US’s major trading partners.
Melissa and I argued that his public threats were characteristic of his deal-making style. His goal isn’t to shut off trade with the rest of the world but to make it fairer and more bilateral (rather than multilateral) in nature.
So we are gratified that the trade negotiations already are going our way—i.e., away from a trade war.
Consider the following:
(1) China. On Sunday, Treasury Secretary Steven Mnuchin said that the US and China had made progress as they concluded three days of intense trade negotiations in Washington late last week. The administration has suspended its plan to impose sweeping tariffs on China for now while the talks proceed. “We’re putting the trade war on hold,” he said on Fox News Sunday. The 5/20 issue of The New York Times reported: “On Saturday, both countries released a joint statement that offered little detail about what had been agreed to, other than holding another round of discussions in China. Mr. Mnuchin said on Sunday that the countries had agreed on a ‘framework’ under which China would increase its purchases of American goods, while putting in place ‘structural’ changes to protect American technology and make it easier for American companies to compete in China.”
(2) NAFTA. Also on Sunday, Bloomberg reported that the US is making progress in renegotiating NAFTA with Canada and Mexico. Trump frequently has threatened to quit the current agreement if a good deal can’t be reached. Bloomberg quoted Mnuchin: “‘[W]e are focused on negotiating a good deal and we’re not focused on specific deadlines,’ Mnuchin said on Fox. ‘We’re still far apart but we’re working every day to renegotiate this agreement.’”
Strategy I: Payback or More Buybacks? When stocks plunged 10.2% during the latest correction spanning the 13 days from January 26 to February 8 of this year, there was lots of chatter about liquidity drying up (Fig. 1). That development was widely attributed to the Fed’s quantitative tightening, which started during October of last year (Fig. 2). You might recall that the bears (remember them?) have been predicting that the next bear market in stocks would begin once the Fed started to unwind its QE program.
If they are right about a bear market, it won’t happen because of a shortage of liquidity. As discussed in the next section, Trump’s corporate tax cut at the end of last year significantly boosted corporate earnings and cash flow. Just as importantly, his tax reform package required US corporations to deem earnings that they accumulated abroad repatriated. To ease the pain, a one-time mandatory transition tax will replace the previous 35% statutory tax rate on repatriated earnings; that one-time tax has been set at 15.5% for liquid assets and 8.0% for illiquid assets and is payable over eight years.
The change effectively shifts the US from a worldwide tax system to a territorial one. That means that going forward US multinationals generally will be taxed by the US only on domestic profits and not on dividends from their foreign subsidiaries, as Bloomberg explained in a 1/25 article. The concept of “repatriated earnings” will no longer exist.
Let’s see how much liquidity is parked overseas that might be used to buy back more shares:
(1) Repatriated earnings potential. The Fed’s quarterly Financial Accounts of the United States includes a series called “Foreign Earnings Retained Abroad.” It’s available through Q4-2017 for nonfinancial corporations. Last year, it totaled $213.5 billion, and has been hovering around this four-quarter sum since 2010 (Fig. 3). It’s been running close to 15% of pretax profits plus foreign earnings retained abroad since mid-2012 (Fig. 4). Since 2000, the cumulative total of foreign earnings retained abroad is $2.9 trillion. It’s up $1.7 trillion just since 2010.
(2) Buybacks saying “buy, buy” not “bye-bye.” Joe and I have written that it’s hard to be bearish on stocks when $2 trillion to $3 trillion of cold cash may be coming back to heat up the stock market and the economy. During stocks’ selloff earlier this year, there was also some chatter about a decline in buybacks. Now there is more chatter about how a significant portion of the repatriated earnings could go into buybacks, possibly boosting them to a record high exceeding $600 billion this year for the S&P 500 companies. That’s based on the guidance provided by company managements during their just-completed Q1-2018 earnings reporting season.
Buybacks for the S&P 500 companies totaled $519 billion last year, down from a record high of $589 billion during the four quarters through Q1-2016 (Fig. 5).
(3) Dividends will also continue to fuel the bull market. Joe and I have been observing since 2010 that the current bull market has been driven mostly by buybacks and dividends. We frequently expressed this opinion to counter the bears who claimed that stocks were on a Fed-induced sugar high.
The bears just couldn’t understand who was buying stocks. We said it was obvious: Corporations were buying back their shares and paying out record-high dividends. Lots of the dividends went back into the stock market. Over the past four quarters through Q1-2018, dividends totaled a record $436 billion. If buybacks are on track to exceed $600 billion this year, then total cash distributed to shareholders will easily exceed $1.0 trillion for the first time on record.
Strategy II: Are Earnings Hot or What? Also pumping lots of additional liquidity into the corporate sector is Trump’s corporate tax cut. Joe reports that S&P 500 data are now available for Q1-2018. They show that on a per-share basis revenues jumped 9.5% y/y, reflecting solid global sales for these companies and the rebound in oil prices (Fig. 6 and Fig. 7). Operating earnings per share (based on Thomson Reuters data) soared 24.0% over the same period, reflecting the strength in revenues and the tax cut. Both were at record highs last quarter. The quarterly profit margin of the composite rose to another record high of 12.0%, up from 10.9% during Q4-2017 (Fig. 8). In aggregate, S&P 500 net operating income rose 25.4% y/y to a record $1.2 trillion during Q1 (Fig. 9).
Trump’s tax cut lifted earnings significantly to $38.32 per share during Q1. We were close with our estimate of $37.00. We don’t see any reason to raise our full-year estimate of $155.00. That’s a 17.4% y/y increase. Industry analysts are expecting $161.33, up 22.2%. As Joe and I explained last Wednesday, by year-end the stock market will be discounting the analysts’ consensus estimate for next year, which is currently $176.61. We are sticking with $166.00. In any event, we believe that the earnings outlook is solid enough to drive the S&P 500 to new highs later this year. (See YRI S&P 500 Earnings Forecast.)
US Economy: Hot or Not? The answer to the question just posed is that the economy is lukewarm. The next question is whether it will stay that way or will either cool off or warm up. For now, the outlook is for more of the same: no boom, no bust. Let’s review what’s hot and what’s not:
(1) Leading and coincident indicators. As Debbie reported yesterday, the Index of Leading Economic Indicators continued to hit new record highs in April, advancing for the seventh consecutive month; it hasn’t posted a decline in 24 months (Fig. 10). Our Weekly Leading Index jumped to yet another record high in early May. By the way, it is highly correlated with the S&P 500 stock price index as well as with S&P 500 forward earnings, which is also at a record high (Fig. 11 and Fig. 12). In other words, it remains bullish.
The Index of Coincident Economic Indicators (CEI) also hit another new high in April; it has posted only one decline since January 2014 (Fig. 13). Its y/y growth rate is highly correlated with the comparable growth rate in real GDP. The CEI was up 2.2% y/y through April, continuing to fluctuate around 2.0% as it has since 2010.
(2) Regional business surveys. May data are available for the regional business surveys conducted by the Federal Reserve Banks of New York and Philadelphia. Both posted strong readings. The average of their new orders indexes rose to the highest since July 2004 (Fig. 14).
(3) Economic surprise index. On the other hand, the Citigroup Economic Surprise Index was at 12.3 on May 18, just above the May 16 reading of 11.2, which was the lowest since October 24, 2017 (Fig. 15).
Dr. Ed Yardeni is the President of Yardeni Research, Inc., a provider of independent global investment strategy research.
© 2023 Newsmax Finance. All rights reserved.