JOHN DESSAUER INVESTMENTS, INC. 
8679 Blue Flag Way  Naples, Florida  34109   Phone: 239-597-0880   Fax: 239-254-5096

Weekly Hotline
 

 

      

John Dessauer’s market review and update as of Wednesday October 17, 2018

              We have just seen a mini-stock market panic. The Dow Jones Industrial Average went down 1,300 points in two days. There is no financial crisis looming, not even a mild recession. Third quarter earnings are on track to be up well over 20% compared with a year ago. So why are so many quality stocks down so far from their recent highs?

            While there is a wide range of opinions about why stocks have been sinking, the media pins the plunge on rising interest rates and trade tensions. Those two certainly play a role in explaining the stock plunge. But trade tensions have been bothering investors for a long time and interest rates are not going to soar. Why have stocks suddenly reversed course after gaining in the face of both trade tensions and rising interest rates?

            I think the answer is fear of another devastating financial crisis. It has been ten years since the last one. Banking meltdowns have been a regular feature of market history. The IMF (International Monetary Fund) has counted 124 banking meltdowns between 1970 and 2007. By that score, we should be due for another in the near future. Economists and market pundits have not been good at anticipating financial crises. The financial crisis and recession ten years ago were devastating, not just to stock portfolios but to homeowners, a wide range of financial businesses, and economies around the world. Looking back, I still am appalled that the Bush Administration, after saving Bear Sterns, Countrywide Credit and several other financial institutions, let Lehman Brothers fail.  I know the politics. I remember the media drum beat about “saving” the millionaires and billionaires. And I understand that then President Bush and his advisors thought they should cave in to popular pressure and let a big guy fail, sacrifice a few millionaires to calm the populist political pressures. Lehman Brothers was next in line, they did cave and let Lehman fail, with disastrous consequences that we are still dealing with. After the Lehman Brothers debacle roughly 9 million Americans lost their homes. And eight million Americans lost their jobs. It has taken ten years for the U.S. economy to recover, for unemployment to drop and homeowners to recover. However, ten years is not long enough for the memory of the anguish to fade away. Fear of losing both job and home lingers, in spite of the otherwise good economic news.

            The fear broke the surface after Ford reported the President’s tariffs were costing $1 billion in current profits and that both jobs and manufacturing were suffering. Ford is not the only company that has complained about the costs of the tariffs. But Ford’s announcement had the biggest psychological impact. Fortunately, the mini stock market panic developed as companies were getting ready to report third quarter profits. JP Morgan Chase announced profits that beat Wall Street expectations last week. That was enough to stop the selling. This week other major banks will report third quarter profits and similar results are expected. 

            Analysts are expecting another excellent quarter with third quarter year-over-year profit growth of +21.4%. For all of 2018, the profit growth is expected to be +23.1%, a rate that is not likely to continue in 2019. Profits have been boosted by the tax cuts in 2018. That raises the bar for 2019. In addition, the corporate tax benefit will have run its course. Some think 2019 profit growth will slow to a 10.3% annual rate. The chief reason for the lower growth expectation is concern about rising costs. The dollar is up about 3.7% this year. That tends to have a negative effect on profits for multinational companies. Wages are finally creeping higher. That is a plus for consumer spending, but a negative for corporate costs. Finally, there are the costs associated with the President’s tariffs, with Ford being the poster company for that concern. More than a third of the S&P 500 companies have seen full-year profit margin expectations shrink since June.

            Keep in mind that any growth in corporate profits in 2019 over 2018 will be very good news given the huge profit boost in 2018. After a +23% profit growth year it would not be unusual to have a modest decline the following year. However, American businesses are so strong that profits are likely to absorb the cost hikes from interest rates, tariffs, and wages, and keep growing.

            What if the trade aspect improves? The President has worked out a new trade deal with Mexico and Canada. Some say it is worse than the old deal. Others say it is a good deal. In either case it is positive for corporate profits because it eliminates one major source of tariffs and trade tensions.

The President has now focused squarely on China. He thinks he has the advantage. He may be right. China is vulnerable because it still depends on exports to support growth. The dependence is sharply reduced from ten years ago, but still significant. China also needs significant agricultural imports - soybeans being the most important. Pork is a major source of protein in China. Soybeans are the principal food for the pigs and China cannot supply enough soybeans domestically. After cutting soybean imports from the United States, China turned to Brazil. Soybean farmers in Brazil are delighted. Soybean prices are rising in Brazil. The higher cost poses an issue for China. But the bigger issue is that Brazil is not able to fill the gap. The United States has a much greater capacity to grow and supply soybeans.

Between soybeans and China’s export needs, President Trump’s timing might be just right. Working out a new China trade deal will not be easy, even with the advantage, because saving face is so important in Asia - China in particular. President Trump wants to be seen as a winner. But the Chinese will never accept being seen as a loser.

One thing is clear: a reduction in trade tensions between the US and China would be positive for stocks. 

I will have the next market review and update for you one week from today on Wednesday, October 24, 2018.

            All the best,

John Dessauer    

© October 2018