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Markets Calm Ahead of Stormy Weather

By John Persinos on June 11, 2018

Sure, it’s disconcerting (if not surreal) to see America at odds with its longtime ally Canada. But the next market swoon might have nothing to do with tariffs. Indeed, I would argue that Wall Street has even bigger concerns, some of which will come to the fore this week.

For today at least, investors shook off G7 rancor and the White House’s ugly spat with Canada. The major stock market averages inched slightly higher Monday, after treading water for most of the session. But the calm won’t last. Let’s start with trade tensions.

For geopolitical predictions that come true, turn not to foreign policy experts but to South Park.

The American adult animated sitcom South Park, infamous for its edgy social satire, has routinely lampooned Canada. Our mild-mannered neighbors to the north are portrayed as secretly sinister and a threat to the U.S. way of life. The show even depicted an American-Canadian shooting war.

Ridiculous, right? Not if you’ve been reading the headlines lately.

President Trump took a wrecking ball to the G7 over the weekend, refusing to sign the summit’s joint statement. Notably, the president accused Canadian Prime Minister Justin Trudeau of being “very dishonest and weak.” Trudeau’s crime: his pledge to retaliate against U.S. steel and aluminum tariffs against Canada.

On Monday, Trump fired off a fresh salvo of tweets expressing more anger at Trudeau. The president also took shots at NATO and the European Union. Trump’s trade advisor Peter Navarro chimed in, claiming that it’s Canada, not Russia, that poses a threat to America.

Investors responded to the G7 circus with surprising nonchalance. They now turn their attention to the summit scheduled for Tuesday in Singapore between Trump and North Korean leader Kim Jong-Un. As a confirmed contrarian, I expect the summit to yield little more than choreographed theater.

On the world stage, as the White House makes friends of enemies and enemies of friends, it’s logical to think that the outbreak of a full-blown trade war is the biggest threat to stocks. But triggers for market declines often emerge from unexpected places. 

The debt bomb…

Let’s examine a brewing crisis that gets scant attention in the media: the corporate debt bomb.

Burgeoning corporate debt is an under-reported trend that could topple the stock market. Rising interest rates only make the problem more urgent.

Seems counter-intuitive, doesn’t it? Profits are rising and massive U.S. tax cuts are funneling cash infusions to corporate coffers.

In the first quarter, S&P 500 firms racked up an average year-over-year earnings growth rate of nearly 25%. The analyst consensus calls for a similar rate of earnings growth in the second quarter. So why worry about corporate debt?

Because the problem has been percolating for years. To streamline their balance-sheets, companies have raised debt and enjoyed the tax-deductibility of interest payments. With the spare proceeds, companies have typically initiated share buyback programs. The protracted period of low interest rates that followed the 2008 financial meltdown provided further incentive to take on more debt.

Now the chickens are coming home to roost, just as central banks in the U.S. and Europe embark on a steady path of interest rate hikes. This week, we’ll get major news on rates that should govern market direction.

According to S&P Global, about 37% of multinational companies are highly indebted, five percentage points higher than the share in 2007. We know what happened a year later in 2008 — global financial collapse, exacerbated by onerous corporate debt.

Clear and present dangers…

The chart below tells the story. Since 1980 on a global basis, the median bond’s rating has steadily declined from A to BBB-. The median bond is now barely above junk bond status.

Even the quality of investment-grade debt has deteriorated. Fund management group PIMCO reports that 48% of such bonds in the U.S. are now rated BBB, up from 25% in the 1990s. The net leverage ratio for BBB issuers was 1.7 in 2000; it’s now 2.9.

Tax cuts are kicking in during the late stage of an economic expansion. Wage growth is picking up. That means inflation poses a threat, which in turn could fuel hawkishness at the Federal Reserve.

We’ll know better about the Fed’s intentions, when its two-day meeting ends on June 13. The announcement of another quarter-point rate hike is widely expected. Also this week, the European Central Bank is set to release a timetable for winding down its monthly bond-buying program.

As an investor, you need to prepare for inflation and higher interest rates. Consider these four common sense moves:

  1. Diversify into precious metals (e.g., gold and silver).
  2. Gain exposure to commodities; agriculture-linked investments are especially promising now.
  3. Avoid medium and long-term bonds.
  4. Allocate a portion of your portfolio to Treasury Inflation-Protected Securities (TIPS).

Stay invested, but don’t leave your portfolio exposed to the stormy weather ahead.

Monday Market Wrap

  • DJIA: +0.02% or +5.78 points to close at 25,322.31
  • S&P 500: +0.11% or +2.94 points to close at 2,781.97
  • Nasdaq: +0.19% or +14.41 points to close at 7,659.93

Monday’s Big Gainers

Regulators approve mortgage insurer’s merger. 

Utility initiates strategic revamp.

Analysts turn bullish on consumer lender. 

Monday’s Big Decliners

Restaurant chain battles sales decline.

Search engine provider faces intensifying competition.

Analysts issue “sell” ratings on fiber-optic equipment maker.

Letters to the Editor

“Will trade conflict weaken China’s dominance of the steel industry?” — Jason F.

China is both the world’s largest producer and the world’s largest consumer of steel. The country accounts for about half of total global production of the alloy.

China’s dominance of both sides of the steel industry has been steadily growing for years and that trend will persist into the foreseeable future. Tariffs won’t change this equation.

Questions about global trade? Drop me a line:

John Persinos is the managing editor at Investing Daily.

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