Some of the world’s most valuable commodities saw price gains this week while financial stocks seem to be lagging. But the question is why? And what gives us confidence for the year ahead? Read on to get all the details!
Commodity Prices Surge – some of the worlds’ most valuable commodities – oil, aluminum, nickel – have seen some solid price gains over the last several days. Crude oil climbed up over $74 for the first time in four years, aluminum has been on a tear with prices reaching the highest levels in the past seven years, and iron ore and nickel have also surged. The recently announced tariffs have arguably helped ‘fuel’ the recent price increases, but it could also be a reflective sign that global economic growth continues apace. In the aluminum space, the recently implemented U.S. sanctions on major Russian producer Rusal also sent buyers scrambling to find cheaper supplies.1 Stocks in energy and mining companies have seen some of the benefits of the commodity surge, but the question is: what will the effect be on consumers?2 In the short-term, the price increases may not necessarily flow through to the consumer, but if aluminum and the other metals prices remain elevated, companies may eventually look to pass along those added costs.
Why are Financial Stocks Lagging? Generally speaking, banks in the Trump era should benefit from a strong profit formula consisting of lower taxes, rising interest rates, robust economic growth, and deregulation. Yet, financial stocks have struggled to keep up with the broader S&P 500 during recent up-days.3 One possible explanation is that many analysts are realizing that without the tax cuts, bank earnings for many of the largest players would have been flat, slightly negative, or only slightly positive. In other words, on their own banks are not necessarily increasing earnings and profits. The yield curve could be the culprit – when the yield curve flattens, bank net interest margins tend to tighten, since banks borrow on the short end of the curve and lend at rates on the longer end of the curve. Just this week, the yield curve from five to 30 years shrunk to as little as 29 basis points, the narrowest spread since 2007, while the spread between the 2-year and the 10-year yield hit 41 basis points, the smallest spread since before the financial crisis.4
Are Tariff Threats Working? This week, China announced that it is removing a two-decade restriction on foreign automakers, which must currently enter joint ventures with Chinese automakers for any business done in China. Foreign automakers are only allowed 50% share of any local venture. Some existing players have indicated that the rule change may not actually affect their standing much, as unwinding the existing arrangements would prove too difficult. But newer automakers like Tesla could benefit, as they seek to make new entry into the Chinese market.5 Meanwhile in China, GDP grew 6.8% in Q1, despite widespread concerns about financial and debt risks amid a government-led economic restructuring.6
Retailpocalpyse! In a continuation of a wave that’s been happening for a few years now, retailers are closing big box and brick and mortar locations at a near record pace. According to commercial real estate firm, CoStar, some 90 million square feet of retail space is already set to close in 2018, which is easily on track to surpass the record 105 million square feet of space closed in 2017. We’ve seen big headlines from retailers like Toys ‘R Us, Sam’s Club, Sears, and Bon-Ton shuttering stores, and it seems poised to continue as the year progresses on. Here in Chicago where Zacks Investment Management is based, Sears will close its last department store, which follows its shedding of 50,000 jobs in 2017. The end of an era. As far as use of the retail space in the future, we would expect innovative solutions versus a graveyard-like outcome. Think residential spaces, offices, entertainment venues, churches, or medical centers.7
Confidence for the Year Ahead! An additional story that is still evolving is Corporate earnings. Corporate earnings have been tallied for the first quarter, and it is fair to say they did not disappoint. Corporate America, in two words, is strong and healthy.
What’s more, looking beyond the strong results from Q1, we found an even more compelling story that inspires confidence for the year ahead: rising earnings estimates.
If the earnings story invites optimism for the year ahead, the headwind that potentially stands in the way is the fear of a brewing trade war. The market has not responded well to announced tariffs, and there appears to be some anxiety about the extent of damage a trade war could cause. The end result is a tug-of-war between positive drivers (earnings) and headwinds (tariffs), we examine in this month’s Market Strategy Report.
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Disclosure