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Trade war headlines could get much worse before they get better

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“Next week is a very big week. Lighthizer is clearly a hawk,” said Tom Block, Washington strategist at Fundstrat. He said it will be important to see a positive tone after the meeting, as none of the other sessions have been downbeat. “They gave a good cop, bad cop team going over there. It will be very important how that communique comes out after the meeting.”

Economists believe the U.S. and China will ultimately come together because the trade war is hurting both countries.

November trade data showed the U.S. trade deficit narrowed sharply. Both imports and exports declined but the drop-off in imports was larger.

“That showed a sharp drop in imports of 3.6 percent month on month. That’s a big drop. We also got trade data for Asian exports to the U.S. for December. Asian exports to the U.S. in December were down 10 percent,” said Carpenter. “I do think trade matters … when you start to affect the U.S. and China, you’re by definition talking about a global phenomena. The U.S. economy is big. The Chinese economy is big. Put them together, and it has to register on a global scale.”

Source: UBS

Block said there’s a fog of trade issues currently, and even though he expects a deal, the outcome with China is still uncertain. He also notes that the reworked trade agreement with Canada and Mexico is not adopted yet, with both Republicans and Democrats in Congress seeking changes.

“There’s bilateral negotiations going on with Japan. … There’s negotiations going on with the EU. There’s a lot of moving pieces on trade, and [Trump] set up, with his bluster, a lot of key points coming up, and I don’t think anyone knows where they’re going. There’s a lot of murkiness with the whole trade picture,” said Block.

Strategists expect if the Commerce Department does move on auto tariffs, the administration would wait to respond until after it has a deal with China.

“We think China has shown some willingness to make some concessions,” said Citigroup economist Cesar Rojas. “For example, on IP protection, in a different forum, the government has pledged more strict protection. … There has also been some news suggesting they will push for legislation on core technology theft.”

Rojas said the sticking point will be in the details and whether China follows through and whether the U.S. can be satisfied with enforcement.

“If there is a positive tone, then our expectation is there could be a roll over of the deadline in recognition of progress in the negotiations, and therefore the trade representative would move forward. If the tone is not positive then that would hint at the potential escalation, but still we are about two more weeks ahead of that deadline,” Rojas said.

If the Commerce Department proposes tariffs on European autos, it would not be a surprise, given Trump’s criticism of German luxury vehicles in the U.S. despite the fact that BMW and Daimler are also U.S. manufacturers.

“We expect the report will recommend tariffs,” said Rojas. “The administration is likely to push for trade talks. … What we’re seeing are signs of a slowdown in the European economy … to come up with this threat of additional tariffs when they were relatively weak gives the U.S. additional leverage.”



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Booming rally in small-cap stocks reaches historic proportions

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Traders and financial professionals work ahead of the opening bell on the floor of the New York Stock Exchange (NYSE), January 14, 2019 in New York City.

Drew Angerer | Getty Images

Traders and financial professionals work ahead of the opening bell on the floor of the New York Stock Exchange (NYSE), January 14, 2019 in New York City.

Small caps’ snapback is flashing an ominous signal.

The Russell 2000 has rallied 16.5 percent in 2019, the third best start to a year since the index’s inception. However, small caps’ future is bound to be bleaker if history is any guide. According to Jefferies, in the previous five best starts to a year, small caps suffered weaker-than-average performance in the following three months and squeezed out only a 1.2 percent gain for the rest of the year.

“Can’t draw up a better start to new year than this, however we need a pullback,” Steven DeSanctis, a Jefferies strategist, said in a note on Sunday. “We’d like the market to take a breather.”

He added that earnings have shown strong double-digit growth, but small caps still trail large company earnings, and the outlook for first and second quarter is “in the red.”

Small-cap stocks dipped into bear market territory when recession fears triggered a massive sell-off in December. Now, the group is up 24 percent since Christmas Eve, but the strong comeback might be overlooking the poor earnings outlook. Wall Street is now foreseeing a 2.9 percent decline in small-cap earnings in the first quarter, according to FactSet. In addition, the China trade uncertainty is clouding the road ahead.

“If the U.S. does not get a trade deal done with China over the next few weeks, a recovery in earnings growth is unlikely, as companies put off capex until 2020,” DeSanctis said. “This is one of the biggest risks for the market and explains why we have not raised our Russell 2000 year-end target of 1550.” The index is currently trading at around 1,569.

Growth stocks are seen beating value stocks in the small-cap world given the earnings growth, DeSanctis pointed out.

“The next two quarters should be weak and even down year-over-year for Small and Large caps. We think this supports our Growth over Value theme. [Growth stocks] do look better with the price to book and price to sales ratios double digits below average,” he said.

The strong rally coupled with downward earnings revisions have also made small caps expensive again in a short period of time. The Russell 2000 is trading at 19.8 times forward earnings.



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Papa John’s to struggle despite activist, analyst downgrades to sell

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A customer enters a Papa John's restaurant in Louisville, Ky.

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A customer enters a Papa John’s restaurant in Louisville, Ky.

Papa John’s investors will be disappointed in the near term as sales struggle, according to one Wall Street analyst.

Stifel’s Chris O’Cull downgraded the stock to sell from hold on Monday and wrote that the company’s recent promotions suggest the embattled pizza maker is struggling to compete for customers in the face of low-price deals at rivals Dominos, Pizza Hut and Little Caesars’. But for the restaurant chain to bolster sales, the analyst believes it will need to commit to subsidizing franchisees, a direct threat to earnings over the next few years.

“In order for Papa John’s to drive transactions we believe it will need to commit to an everyday low price menu that will probably hurt franchisees’ profits until consumer perception of its value changes,” O’Cull wrote in his note. “These offers are clearly designed to drive transactions, but to be successful they must increase transactions enough to offset the dollar impact of the discount, otherwise the results lower store margin percentage and dollars.”

Stifel reduced its 2019 earnings per share estimate to 80 cents from $1.20 (well below the Wall Street consensus estimate of $1.19) and cut its price target to $35. The new price target represents 22 percent downside from Friday’s close of $45.26.

The downgrade comes about two weeks after the company announced a $200 million investment by activist hedge fund Starboard Value. Papa John’s said Starboard CEO Jeffrey Smith will become its chairman following the fund’s investment in the form of a convertible stock purchase of 11 to 15 percent.

Activist investors typically accumulate stakes in companies they believe are undervalued and encourage executives to adopt changes they think will boost returns for shareholders. Such demands can range from board seats and CEO replacement to an entire sale of the business.

Papa John’s stock was unchanged in premarket trading Tuesday morning.



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UAE announces IDEX weapons deals as Middle East arms spending climbs

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Attendees walk the floor at IDEX, the International Defence Exhibition and Conference, in Abu Dhabi in 2015.

Markus Matzel | ullstein bild | Getty Images

Attendees walk the floor at IDEX, the International Defence Exhibition and Conference, in Abu Dhabi in 2015.

The United Arab Emirates announced about $1.35 billion in defense deals with local and international companies on the opening day of IDEX 2019, the International Defence Exhibition and Conference, in Abu Dhabi on Sunday.

Of the 33 deals announced Sunday, 18 were domestic and 15 were with foreign firms, the latter accounting for just under $1.1 billion of the total, an IDEX spokesperson said during a news conference.

American companies took the greatest share of foreign sales, at about $490 million. Led by Raytheon, Lockheed Martin and Hesco, the deals will provide missiles, new radar systems capabilities and defensive shelters for the UAE military, respectively. Others notching sales to the country included France’s Thales, Australian firm EOS Defense and Germany’s Rheinmetall Electronics.

The deals with 18 domestic firms highlight the small Gulf country’s investment in developing its own defense manufacturing industry as part of a drive to diversify its economy away from oil.



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