Originally posted on ExecSpec.net
President Trump campaigned in 2016 on making the US dollar weak again to reduce the endless wave of record trade deficits with China. Clearly, he delivered on that pledge throughout 2017 as the dollar index fell 12 percent and devalued almost 11 percent against the Chinese renminbi (yuan).
While Trump delivered on the dollar, the result thus far has been rising deficits with China and the world in 2017 and 2018. Our merchandise trade deficit with China hit a record $375 billion in 2017 and appears certain to surpass $400 billion for 2018.
The Yuan has been appreciating against the dollar for the past couple of months, which should theoretically reduce China’s surplus as the Yuan appreciates. However, it’s unlikely we will witness a dramatic turn around in our balance of trade unless we enter a recession where nominal US imports fall much faster than exports.
During most of 2018, the yuan actually fell sharply on the prospects of a trade war with the U.S. and accelerating U.S. growth. The recent rally in the yuan vs. the dollar reflects slower U.S. growth and the increasingly positive sentiment that the U.S. and China will negotiate a deal in early 2019.
Our U.S. stock market enjoyed the falling dollar in 2017 when strong U.S. and European growth accelerated, improving corporate earnings. Stocks rallied again in the second and third quarter of 2018 despite a stronger US dollar with tax cut tailwinds and U.S. GDP growth that far outpaced Europe.
The good news is most of the bad news has now been discounted. In the fourth quarter of 2018, it became apparent that U.S. economic data and earnings would not be as strong as consensus had expected, sending our major stock indices down over 20 percent to more realistic multiples.
Earnings consensus forecasts have fallen from over 10 percent growth as of last October to six percent today. So far in January, 75 percent of companies are reporting lower earnings guidance. A slower U.S. economy in 2019 along with better-looking tea leaves from China on wanting a trade deal with the U.S. led to a three percent drop in our dollar and a nice 12 percent pop in our stock market from the extreme panic low at Christmas.
The Fed robo rate hikes are no longer a major market concern until the economy reaccelerates and the other major anxiety surrounding a trade war is subsiding. These are all signs that the downside risk for stocks is shrinking, allowing a more sustained rally by the end of the first quarter.
Short term we expect a January peak in stocks to be followed by an important higher low in February where another round of investing can begin. Eventually, our stock market will need a stronger yuan and weaker dollar before it can sustain a rally back to its October 2018 peak.