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WALL STREET INSIGHT

Dow Jones breaks through 20,000 level, but trouble seen ahead

Wax of speculation may melt by getting too close to sun of economic reality, some say
Monday, January 30, 2017 - 05:50

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Stock-market bulls say the trade and immigration issues will soon be forgotten in light of more nakedly pro-growth policies. This week, the flight to the sun is likely to continue, especially if companies such as social network Facebook and oil driller Exxon Mobil can produce stellar earnings.

US stocks rose last week and the Dow Jones Industrial Average finally broke through the 20,000 level but economic, earnings and White House reports hinted there could be trouble ahead.

Several companies, including manufacturing giants 3M and United Technologies, commented on the deleterious effects of the rising dollar on the outlook for the year. With a few exceptions, corporate executives did not foresee the acceleration in economic growth that the stock rally was predicated on. While some big firms, including Boeing, surpassed Wall Street targets, others, such as Google parent Alphabet and steelmaker AK Steel, produced disappointments.

Meanwhile, President Donald Trump spent his first week in power pushing some of the most politically and economically poisonous elements of his campaign platform. The new president picked a fight with Mexico, vowing that the southern neighbour of the US would pay in some fashion for a wall that he has already ordered along the border. President Pena Nieto of Mexico affronted by the threat, cancelled a diplomatic visit to the US, setting up the worst diplomatic impasse between the trading partners since the signature of the North American Free Trade Agreement increased economic cooperation between the two nations - and Canada - in 1988.

Most worryingly for the future of liberal democracy, Mr Trump widened the parameters for deportation of undocumented immigrants and suspended acceptance of refugees from seven primarily Muslim countries. Those orders threatened to break up families and strand thousands of Syrian refugees who had escaped the violence there and were issued visas by the Obama administration. With sinister talk prioritising Christian refugees over Muslims, Mr Trump's orders recalled those of 1930s totalitarian leaders.

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Morality aside, Mr Trump's trade and immigration policies have little basis in economic logic.

Most economists say these policies are little more than "red meat" for his supporters in "Rust Belt" states. The "border tax", or tariff, that the Trump administration is set to impose on goods produced in Mexico and elsewhere overseas may encourage some factory operators to move into the US. The public shaming and private pressure that Mr Trump is exerting on corporate giants could even force them to meet quotas of American workers. These corporations are not going to shake off the rust in the belt of depressed cities as Mr Trump is promising.

According to most sober analyses, the unemployed in car-producing states in Michigan and Indiana are not losing their jobs to Mexican or even Chinese workers. Machines, not immigrants, are their enemy.

"Sell humans, buy robots," wrote analysts at brokerage Jefferies, in a recent research note, summing up the most important. Among the companies that Jefferies analysts say is set to benefit from a shift to a robotic factory crew is Rockwell Automation.

Last week, executives at Rockwell Automation were among the many quizzed by analysts on how they would react to Mr Trump's threat to impose a "border tax". The Rockwell executives answered frankly they would likely relocate a factory in Mexico to the US. They also noted that they were set to benefit from the "reshoring" of manufacturers because of how it will drive up the demand for automated factory lines.

As Mr Trump himself has proved repeatedly in his career, US corporations are adept at squeezing through loopholes in government mandates.

Stock-market bulls say the trade and immigration issues will soon be forgotten in light of more nakedly pro-growth policies.

"The Trump administration is promising a strongly pro-business environment for many industries," said Tim Shirata, executive vice-president of money manager Guild Investments. "They argue that their proposed corporate and individual tax cuts, business-friendly administration, and decreased regulation will counterbalance their "buy American and produce in America' policies".  

The administration's apparent determination to repeal Barack Obama's signature Affordable Care Act, is another double-edged sword. Insurers such as UnitedHealthCare may benefit from a return to unfettered competition insurance, but hospital chains such as HCA, reporting earnings this week, could see more negative effects.

Consumer sentiment hit the highest level in decades in January, according to a University of Michigan poll. But rising mortgage rates are hurting home sales, which could be a sign that sentiment is peaking and the loss of insurance for millions of consumers in the event of an Obamacare repeal could be a further blow.

Analysts at brokerage Bank of America Merrill Lynch Global Research are advocating an "Icarus trade," betting that the soaring US stock markets will continue to fly higher until such time that the wax of speculation melts by getting too close to the sun of economic reality.

At that point, presumably, US stocks will follow the path of Icarus and Daedalus after their wings of wax came apart and come crashing back to earth.

This week, the flight to the sun is likely to continue, especially if companies such as social network Facebook and oil driller Exxon Mobil can produce stellar earnings.

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