Financial theory says that stocks adjust to reflect all available information. So what new information have investors learned in the last week?
Trump’s tariffs are slamming the brakes on growth.
Since peaking on September 21 at 2929, the S&P 500 has fallen 5% to 2786 as of October 10. Meanwhile, NASDAQ — which peaked August 29 at 8110 has lost 8% as of Wednesday.
Are rising interest rates to blame? Donald Trump is seeking to blame the Fed for the market break — saying it’s ‘going loco.’
But rising interest rates can’t be a surprise to investors since the Fed has been advertising interest rate hike plans consistently.
What’s more, investors with a basic knowledge of macroeconomics would know that tight labor markets and rising oil prices will create inflation and the Fed will raise rates to fight it off.
The problem is not rising interest rates, it’s the growth crushing impact of Trump’s tariffs. According to the Wall Street Journal, the U.S. has imposed tariffs on $250 billion of Chinese goods and intends to impose additional import taxes on $257 billion of products.
Consider the case of IPG Photonics, a Massachusetts-based maker of fiber lasers. Its shares were as high as about $261 this June. But on July 31, IPG lowered its guidance 2018 revenue growth outlook from 10% to 15% to 7% to 9%.
Then on October 5 — over three weeks before it is due to report its next quarterly results, IPG announced that the lowered revenue guidance was too high — but did not specify how much.
On October 10, IPG shares closed at about $132 — a near 50% wipeout.
In both cases, founder and CEO Valentin Gapontsev fingered “the current global macroeconomic trade and geopolitical environment” for the declining revenue growth forecast. As he said October 5, “Tariff and trade-related headwinds were the primary driver of weaker than expected performance for our business in China and Europe.”
And as I wrote in my 2017 book, Disciplined Growth Strategies, stocks move on “beat-and-raise.” This means if a company exceeds investor expectations for revenue and EPS growth each quarter and raises its guidance above those expectations, the company’s shares will rise.
If a company misses its revenue growth and EPS targets or lowers its guidance, the stock plunges. If a company lowers its guidance between regular earnings reports — without specifying how much lower, you know that there is an unusually large amount of uncertainty in the company’s future.
IPG is not alone. Consider Ford — which said last month that tariffs will cost it $1 billion in profits due to higher steel prices, according to Reuters. On October 10, Ford announced it would cut $11 billion in costs and 70,000 jobs, according to Business Insider.
Growth in earnings for 2019 is expected to drop sharply. While I/B/E/S forecasts suggest 21.4% EPS growth in the recently completed third quarter and 23.1% for all of 2018, 2019 growth is expected to be a mere to 10.3%.
A one-two punch of tariffs boosting corporate input costs and rising wages are squeezing margins. As Kristina Hooper, chief global market strategist at Invesco in New York, told Reuters
What we’re going to see is more of a focus on costs given that we’ve heard a lot rumblings. As tariffs proliferate, this becomes a bigger issue. It’s cost of goods. Second, it’s wage costs. We’re not seeing it really borne out in the jobs data yet, but from my perspective, there have to be industries that are feeling and experiencing an increase in wage costs.
A case in point: in September, FedEx Corp cited employee compensation and other expenses when it disappointed Wall Street, noted Reuters.
In short, if markets are efficient — meaning that prices adjust rapidly to new information — then stocks are tanking not due to rising interest rates but due to the growth-impeding effect of tariffs.
With corporate costs rising and global competition remaining intense, companies are unlikely to be able to sustain revenue growth if they try to raise prices to maintain their profit margins.
This means that companies will need to hold the line on prices and cut costs. Ford is likely the tip of the spear when it comes to layoffs. And as more people lose their jobs, consumer spending will decline. That could lead to a cycle of slowing revenue growth and layoffs.
The problem could be fixed quickly were the president to eliminate all the tariffs.
Since that won’t happen, investors should buckle up for a bumpy ride.