"I will aim to restore the Japan-U.S. alliance and Japan's strong diplomatic capabilities. Japan can't pursue a strong foreign policy without strengthening its alliance with the United States." -- Shinzo Abe
Agenda-Driven Foreign Policy
You folks happen to notice a new common thread in U.S. foreign policy of late? It's not hard to see. There seems to be a method here, born of a business mindset, and maybe even born of skill (or perhaps just a love of negotiation.) Take the case of China. First, President Trump (prior to the inauguration) accepts a phone call from President Tsai Ing-wen of Taiwan, then indicates a possible consideration of dropping U.S. recognition of the One China policy that had been largely in place since 1979. Suddenly, just before meeting with China's chief rival for regional supremacy, Japanese Prime Minister Shinzo Abe, President Trump speaks with Xi Jingping, and lets the Chinese know that the U.S. will continue to recognize that there is one China. China appears grateful, though the president really promises them nothing new. On to Japan.
Surely it can't be lost on you that president Trump has rattled some Japanese cages over everything from fair trade to currency valuations, some of the very same cages that he's been ratting regarding China. Not only is a bilateral trade agreement becoming likely between the U.S. and Japan, but the two made a joint statement on Friday that made clear that Article 5 of the U.S. -- Japan Defense treaty applies to those islands in dispute between Japan and China. Is this all some kind of play to get Japan in position to pay more of their own freight when it comes to defense? In the same vein, was the One China policy waltz akin to offering China a bone that really holds the U.S. to nothing? North Korea, all the while, probably thinking that they were testing the new U.S. President, but more than likely actually playing into his hand, fired a couple of missiles into the Sea of Japan last week, allowing a joint condemnation of such behavior by the two leaders. That leads me to another cage that this administration has been rattling: that of NATO's.
It's no secret that President Trump has referred to NATO as obsolete. It's no secret that President Trump does not show the kind of fear for Vladimir Putin and Russia that most of the rest of NATO does. Lastly, it's also no secret that 24 of 28 NATO countries do not contribute their fair share toward defense as stipulated by the alliance itself. NATO's stated goal for defense spending is 2% of GDP. Well, this Wednesday, the defense ministers of the NATO alliance will meet in Brussels; U.S. Secretary of Defense James Mattis will be in attendance. The trick here will be to reassure our allies while scaring them enough to get them to contribute what they owe for their own defense. Oh, and did I mention that the euro has also been mentioned by members of the president's team as undervalued?
What do all of these spokes in the policy wheel have in common?
We need to improve our trade position in each and every one of these directions. We also need Japan and the NATO countries to share more of the cost of their own defense. Improving the trade balance and softening the dollar appear to be obviously high priorities for this administration. This administration openly takes insult in areas where the perception that the U.S. has been taken advantage of would not be far-fetched, and is quick to put the other side in a defensive bargaining position. Relying heavily on American military technology, American troop presence, and American treasure has become a way of life around the globe. Forward-looking fiscal policy plans are expected to show increased spending on the military and infrastructure. One place to find money on top of tax revenue would be stop paying everyone's freight.
Investor Focus: Earnings
Fourth-quarter earnings were expected to show improvement over the third quarter -- and indeed they are. As we move into the homestretch, this "earnings season" has provided about a 70% EPS beat rate for the S&P 500. The revenue beat rate remains solid, but badly lags that for earnings per share. That is normal, as that is much harder to engineer. Equity earnings as a whole are running at a growth rate of over 8% on top of the 4.3% increase seen for the third quarter. That is significant. More importantly, just what does this mean to you?
We spoke in this space last week of the market move after the president used the word "phenomenal" to describe his coming tax plan. We've often spoken here about the markets' move on confidence and optimism since election day based on expectations for the new administration's economic agenda. That agenda is reliant upon those already-mentioned lowered taxes, as well as deregulation, repatriation, and ultimately fiscal pending to provide both growth and inflation. Well, perhaps some of that optimism has spilled over into the fundamentals. Mind you, we have not heard from the retailers yet, and those results could be truly awful, but the foundation is being laid to support this rally at some increased level.
That's support that could become necessary should the blooming flower of tax reform come with a couple of thorns attached, such as a border tax, or the elimination of interest expense deductibility. Support that may become necessary should steps toward deregulating the financial and energy sectors get caught up in the courts, and should a repatriation "tax holiday" not attract the kind of revenue that those making fiscal spending plans are hoping for. A loss of that interest-related tax break could make debt payment more interesting to large firms than borrowing in order to repurchase their own shares. Leaving the break in place might make borrowing against foreign-held cash as collateral more interesting than bringing it home and subjecting it to any tax rate, should that tax rate still be higher than what might be paid out as loan interest. Tricky stuff, no doubt.
Regardless; as always, there will be enough to worry about going forward. Agenda-driven rhetoric may drive sector-specific stock prices and overall market trend, but nothing is more important at the end of the day than earnings growth. Think of it as the glue that connects the market that benefitted from monetary policy to the one that "hopefully" benefits from both fiscal and pro-business policies. The only thing more interesting than fourt-quarter earnings will be first-quarter earnings. Probably best at all times to travel with dry socks in your pack, extra rations, and at least two sources of water.
Note: There are no significant domestic macro-economic events.
Sarge's Trading Levels
These are my levels to watch today for where I think that the S&P 500, and the Russell 2000 might either pause or turn.
SPX: 2342, 2328, 2318, 2311, 2299, 2294
RUT: 1405, 1398, 1392, 1387, 1378, 1371
Monday's Earnings Highlights (Consensus EPS Expectations)
At the time of publication, Stephen Guilfoyle had no positions in the stocks mentioned.