Now that tariffs are starting to bite, the September Eye on the Market takes a close look at the latest from the front lines of the Trade War.

FEMALE VOICE:  This podcast has been prepared exclusively for institutional wholesale professional clients and qualified investors only as defined by local laws and regulations. Please read other important information which can be found on the link at the end of the podcast episode.


MR. MICHAEL CEMBALEST: Welcome back, everybody. This is Michael Cembalest with the Labor Day Eye on the Market Podcast. It must have been a long, hot summer at the Heritage Foundation and the American Enterprise Institute. Imagine how excited they must have been a couple of years ago. Finally a president that would restore the pillars of Reagan-ism, pro-business policies and court appointments, corporate tax cuts, personal tax cuts, lots of deregulation. And for Heritage and AEI, this couldn't come soon enough after the Obama years; there was a surge in government regulation and the ease of starting a new business in the U.S. actually fell relative to the rest of the world. So the early payoff for equity investors, as we all know, is pretty substantial. And there were actually signs that Trump had revived some dynamism in U.S. manufacturing. But since January of 2018, when this tariff war started, the S&P has basically traded in a volatile and sideways fashion. And I have no reason to think that this is going to change before the elections, so it makes sense to range trade the equities around the highs and lows that we've seen since January of 2018, which would be on the S&P a range of, let's call it, 2,700 to 3,000 for the S&P 500.


So let me start with the good news, because there's not enough attention being paid to that. So the Fed is probably going to prolong the business cycle and a revert of a recession in 2020 with lower policy rates. We're seeing a spike in mortgage refinancing in home purchases. Retail sales look pretty good. Credit statistics of U.S. households look very good with respect to mortgage and credit card delinquencies. The inverted yield curve I don't think is a reliable signal at all when 70 to 100% of European and Japanese government bonds trade at negative yields, driving up demand for long-duration U.S. assets. So that's something that we didn't have in the past, though I think this is distorting that yield curve signal. There are some multinationals that are adjusting to the trade war by moving some of their production to Vietnam and other countries. There's more easing ahead coming from certain central banks. And as we've written about quite a few times, a very weak primary and secondary equity issuance combined with lots of M&A and stock buybacks has resulted in very weak and actually falling net global equity supply. So on the margin, that creates pretty favorable supply and demand dynamics for stocks, particularly after you get some kind of selloff. So that's the good news that we should probably keep in mind.


Now, here's the bad news. There's a lot of data now showing that Trump's trade war is starting to bite. So you've got the highest tariff levels in 40 years. Global trade volumes are starting to weaken. The pain is very acute in Germany where it looks like production's actually declining. Global manufacturing and employment surveys are really taking a hit. Europe is more trade-reliant and is suffering more than other regions. U.S. manufacturing hours are declining on a year-on-year basis. And what's amazing, in the U.S., even the sectors that have, quote-unquote, benefitted from tariffs have seen decline to employment rather than increases. So the tariffs are arguably not even achieving what they're supposed to achieve. And all of this is hitting corporate profits, which are now growing at maybe 2 to 3% and in the absence of stocks buybacks, organic S&P 500 earnings growth during the first half of the year, probably would have been close to zero.


So it doesn't sound like a big hit when you see that the trade war is hitting profits by, let's say, 3 to 5%, but that's enough to offset almost the entire Trump tax cut for the corporate sector if they absorb it through profit margins. And what if they pass it through to households? Well, that would offset most of the benefits of the household tax cut, since it would affect 50 to 80% of computer and smartphone purchases. So there's plenty of evidence that the trade war is now having a material economic impact.


Remember as well that, even though we don't have a recession outlook—I think growth will be in the kind of 2% range for the rest of the year—the U.S. equity market is a lot more reliant on global trade and production and things like that than the U.S. economy. So the U.S. economy, of course, is 70% reliant on consumption, but the U.S. equity market is very reliant on global trade. Profit margins around the world are pretty heavily tied to the increase in globalization. So if we're going to unwind globalization at this point, that's going to have a hit on profit margins. And we've got some charts on this month's Eye on the Market showing that the U.S. is more sensitive to de-globalization than simple import/export the GDP measures would suggest.


So from our perspective, it might take a substantial unwinding of this trade war to propel equity markets to much higher levels and break out of the trading range that we've seen since January, 2018. And it's not clear to me at all that either Trump or his potential Democratic successors are interested in a substantial unwinding of this trade war. Democrats might conduct this war differently, but it's totally unclear to me, and I haven't heard any of them suggest that they would be unwinding many of the measures that have been put in place. And so, if that's the case, this Trump-ism trading range that we've seen since 2018 is likely to remain in place.


I haven't really seen anything from either Heritage or AEI strongly denouncing what the administration is doing, perhaps out of fear of what might come from the Democratic party if Trump loses. And we have an exhibit in this months' Eye on the Market that talks about the various ways that different Democratic candidates would choose to fund Medicare for all, free college tuition, student debt forgiveness, a trillion dollars in infrastructure spending, 500-billion for affordable housing, universal pre-K, trillion dollars in federal agree New Deal procurement costs, et cetera, et cetera. And I would say as well that the Iowa electronic futures markets that look at who will control the Senate in 2020, the chances of a Democratic sweep are rising. And the price is now for futures contracts for Republican and Democratic control of the Senate are almost the same, which is a pretty big change from a few months ago when there was a much greater certainty of Republicans being seen as controlling the Senate.


So therefore, we have to start looking at the potential consequences of a Democratic sweep. And so we summarize here issues related to higher taxes on income and capital gains, the eliminations of a step up in basis, doubling the capital gains rate, taxing in accrued capital gains even if they haven't been realized yet, treating capital gains and dividends as ordinary income and then taxing them at the same rates. You've heard a lot of those things. And then as well, Elizabeth Warren's idea for a surtax that would function as a wealth tax, since it would be dependent on wealth levels as well as on income levels. Higher corporate tax rates, curbs and penalties on stock buybacks, bank taxes and financial transactions taxes, as well as limitations on private equity companies to pay themselves dividends and monitoring fees, Accountable Capitalization Act, et cetera, et cetera. You've heard us write about many of these things before. So the stakes are rising for fairly substantial change in 2020 in the tax code, which I think may also serve as another upper bound to this Trump-ism trading range that we've seen since January, 2018.


So to summarize, we would be pretty aggressive buyers of equities if they tested the bottom of the trading range that we've seen. And the day after Christmas last year, we sent out an Eye on the Market highlighting just how attractive the valuations were. But at this point, Trump's trade war is really starting to bite. And as we get closer to the high end of the trading range, it makes sense to me to fade a little bit of market enthusiasm and divest investment aggressiveness.


So that's it for this month. Take a look at the Eye on Market piece itself. There's 25 great charts in there. I hope you all had a great summer. I did catch 27 tarpon over a two-day span in July, so that was exciting. And I look forward to seeing many of you this fall as I go on some roadshows to see clients. Thanks again. Talk to you soon. 


FEMALE VOICE:  Michael Cembalest's Eye on the Market offers a unique perspective on the economy, current events, markets and investment portfolios, and is a production of J.P. Morgan Asset and Wealth Management. Michael Cembalest is the chairman of Market and Investment Strategy for J.P. Morgan Asset Management and is one of our most renowned and provocative speakers. For more information, please subscribe to the Eye on the Market by contacting your J.P. Morgan representative. If you'd like to hear more, please explore episodes on iTunes or on our website. This podcast is intended for informational purposes only and is a communication on behalf of J.P. Morgan Institutional Investments, Incorporated. Views may not be suitable for all investors and are not intended as personal investment advice or a solicitation or recommendation. Outlooks and past performance are never guarantees of future results. This is not investment research. Please read other important information which can be found at

Click above to hear J.P. Morgan Eye on the Market's "So long yellow brick road" podcast episode and subscribe via Apple Podcasts or Google Play.

Imagine the excitement at the Heritage Foundation and the American Enterprise Institute after Trump’s election. Finally, a President to restore the pillars of Reaganism: pro-business policies and court appointments, corporate tax cuts and deregulation1. For Heritage and AEI, this couldn’t come soon enough: after all, during the Obama years, the ease of starting a new business in the US fell relative to the rest of the world. The early payoff for equity investors was substantial (see yellow brick road, below), and there were signs of renewed dynamism in US manufacturing jobs. Ever since Trumpism showed its true colors on economic and trade policy, the S&P 500 index has traded in a volatile/sideways fashion and manufacturing dynamism has stalled I have no reason to think this will change before the election; if so, it makes sense to range-trade equities around highs and lows seen since January 20182.

One line displaying the S&P 500 Index level since January 2015. The “yellow brick road” time period begins in November 2016 with Trump’s election and ends on January 22, 2018 when the trade war with China begins. Source: Moody's. Q4 2018.
One line displaying the S&P 500 Index level since January 2015. The “yellow brick road” time period begins in November 2016 with Trump’s election and ends on January 22, 2018 when the trade war with China begins.

1 Heritage/AEI on benefits of lower taxes and deregulation: “Tax Reform for Investment and Jobs” (August 2017, Heritage); “A Guide to Tax Reform in the 115th Congress” (February 2017, Heritage); “Overregulation drags down business” (February 2017, Heritage); and “How much can tax reform affect economic growth” (AEI, November 2017). 

2 The recent 3-month annualized volatility of the stock market has been around 14%, which is almost exactly equal to average volatility since 1958; lower equity market volatilities in 2003-2006 and 2016-2018 were aberrations.