Trading Day: Trade tension turns to tentative hope

Trading in early June began cautiously, influenced by U.S.-China trade tensions and geopolitical concerns, though a revised Atlanta Fed GDPNow estimate of 4.6% and the possibility of upcoming talks between Presidents Trump and Xi Jinping spurred a late Wall Street rally; the S\&P 500 rose 0.4% and the Nasdaq gained 0.7%. Despite a 2.9% drop in pre-tax corporate profits in Q1, corporate America remains in a strong position with profits as a share of national output near record highs, although headwinds from tariffs and potential weakening consumer demand pose future challenges.

Analysis

The early June trading landscape was characterized by initial caution stemming from U.S.-China trade frictions and global geopolitical unease, yet markets saw a late-day uplift with the S&P 500 and Nasdaq gaining 0.4% and 0.7% respectively, partly fueled by an optimistic revision of the Atlanta Fed's Q2 GDPNow estimate to 4.6% and prospects of U.S.-China presidential dialogue. This positive equity movement, which saw energy, Meta, and AMD lead, occurred alongside a 0.6% depreciation of the U.S. dollar to a six-week low, a surge in U.S. crude oil prices by up to 4% (WTI near $64/bbl, Brent over $65/bbl) as OPEC+ maintained output, and a rise in U.S. Treasury yields, notably a 7 bps increase at the long end steepening the curve. Gold prices also jumped 2.8% to $3,380/oz. While Q1 2024 U.S. pre-tax corporate profits declined 2.9% sequentially (after-tax down 3.6%), this followed a substantial 5.4% Q4 2023 surge, and year-over-year profits still grew by over 5%, underscoring corporate America's resilient financial footing with profit shares of GDP (e.g., 13.0% pre-tax with IVA/CCAdj, 12.0% after-tax) remaining near historic highs, significantly above the 75-year average of less than 7.5%. Nevertheless, challenges are emerging, reflected in reduced S&P 500 earnings growth forecasts for Q2 2024 (to 5.5% from 10.2% two months prior) and calendar year 2025 (to 8.3% from 14.0% at year start), and a significant structural shift towards domestic profit generation, which rose to 87.5% of total U.S. corporate profits in Q1 2024 from 75% in Q4 2019.

Key Decisions for Investors

• Investors should closely monitor upcoming U.S.-China trade developments and key economic data releases, including inflation figures and U.S. JOLTS job openings, as market sentiment remains highly reactive to these inputs.
• While corporate balance sheets appear strong with near-record profit-to-GDP ratios, the notable downward revisions in S&P 500 earnings growth forecasts for Q2 (to 5.5%) and 2025 (to 8.3%) suggest exercising caution regarding forward-looking equity valuations.
• Consider portfolio adjustments in light of current trends: potential continued outperformance in the energy sector given OPEC+ stance, the impact of sustained dollar weakness and rising long-term Treasury yields (20- and 30-year nearing 5.00%) on fixed income, and gold's (near $3,380/oz) enduring appeal as a geopolitical and inflation hedge.
• Re-evaluate exposure to companies with significant international revenue streams, given the observed trend of U.S. corporate profits becoming increasingly domestically sourced (87.5% in Q1 2024 versus 75% pre-pandemic), which may indicate heightened risks for globally-focused firms amidst protectionist trends.