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Weekly Investment Commentary: Equities falter on continued U.S./China trade concerns
Highlights
- Global equities fell again last week, and the S&P 500 posted its third straight weekly decline.
- Fears of a protracted U.S./China trade war and softer U.S. and global data weighed on investor sentiment.
- If trade talks resume, but without signs of a resolution, an extended period of churning could develop.
Equities around the world were lower again last week. The S&P 500 fell 1.1%, posting its third consecutive weekly loss.1 Equities are under pressure due to expectations for a protracted U.S./China trade war that has been especially damaging to the technology sector. Softer U.S. and global economic data also depressed sentiment. In addition, an oil sell off and a sidelined Fed are also weighing on investor outlook. Energy stocks were the worst performers for the week, while trade concerns hit technology and retail earnings weighed on consumer discretionary stocks.1
Weekly top themes
- The U.S. manufacturing PMI reached new cycle low in May, falling two points to 50.6. Manufacturing new orders sank into contraction territory.2
- Summer tariff increases are likely to keep consumer spending sluggish. We believe declining spending would result in near-term weakness for the consumer, but not a bear market. U.S. consumers are relatively healthy, with a high savings rate and an encouraging level of jobs and wage rate increases.
- The Fed minutes released last week did not contain any significant surprises. The Fed is clearly on hold, and any rate cuts in the absence of a recession threat are still a tall order.
- Bond investors seem convinced that a rate cut is coming by December, with Fed funds futures pricing the odds of a cut at close to 100%. However, we’re not as sure. We might change our minds if we returned to 1.5% growth and wage growth of 2.5%, which are currently well above 2% and 3%, respectively. We believe that the threshold for a rate cut remains high.
- The probability of NAFTA 2.0 being ratified has increased slightly. Tariffs on steel and aluminum were lifted two weeks ago, and we saw a productive meeting between House Speaker Nancy Pelosi and U.S. Trade Representative Robert Lighthizer. Progress is being made, but more work needs to be done.
- Congress may be able to reach a deal to raise the debt ceiling to fund the government, as neither Republicans or Democrats see political benefit to shutting it down. As always, the President’s rhetoric and action remain the wildcards.
- Stocks with negative gross cash flow have beaten the market by 9% this year. This has resulted in a very unusual market anomaly, as these types of stocks would typically be underperforming by a similar amount.3
Market uncertainty is likely to persist as U.S./China negations stall
There have been several risk-off phases this decade, triggered by economic threats due to politically induced setbacks. However, the current sluggish global economy and weak trade, coupled with escalating trade tariffs and non-tariff barriers, is a worrisome combination. This is especially true because once protectionism has gained momentum, it may prove difficult to stop or reverse. While many risk asset prices are only off modestly from April highs, there’s an ominous undercurrent in global financial markets.
We have assumed that the pro-growth bias of both the U.S. and China would lead to a trade truce. That premise looks increasingly questionable, although a deal is always possible. Given that financial markets have not reacted more significantly, investors are still generally expecting the global economic expansion to persist.
Despite the longer-term power struggle, the constructive case for a trade deal between the U. S. and China was predicated on President Trump focusing on the short-term win, while the Chinese look to the longer-term. This difference in political time horizons made a deal possible. Now, the focus for both parties has shifted to long-term strategic objectives, resulting in a stalemate. A financial market downturn may be needed to break the impasse. An extended period of churning could develop if trade talks resume, but without signs of a resolution.
The current market weakness differs from prior periods of economic uncertainty during this decade. There has always been a path to a positive outcome for growth and risk assets, primarily via additional policy stimulus. However, the economic and market outcome this time has become more uncertain, and time will not work towards a positive outcome unless trade negotiations improve. Business sentiment will erode if mounting trade roadblocks and uncertainty do not diminish. Protectionism tops the list of recession catalysts, and a permanent deterioration in U.S./China trade relations could have adverse long-term revenue ramifications for global trade and growth.
"A permanent deterioration in U.S./China trade relations could have adverse longterm revenue ramifications."
1 Source: FactSet, Morningstar Direct and Bloomberg
2 Source: Markit
3 Source: Empirical Research Partners
The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy. The Dow Jones Industrial Average is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange and the Nasdaq. The Nasdaq Composite is a stock market index of the common stocks and similar securities listed on the NASDAQ stock market. The Russell 2000 Index measures the performance approximately 2,000 small cap companies in the Russell 3000 Index, which is made up of 3,000 of the biggest U.S. stocks. Euro Stoxx 50 is an index of 50 of the largest and most liquid stocks of companies in the eurozone. FTSE 100 Index is a capitalization-weighted index of the 100 most highly capitalized companies traded on the London Stock Exchange. Deutsche Borse AG German Stock Index (DAX Index) is a total return index of 30 selected German blue chip stocks traded on the Frankfurt Stock Exchange. Nikkei 225 Index is a price-weighted average of 225 top-rated Japanese companies listed in the First Section of the Tokyo Stock Exchange. Hong Kong Hang Seng Index is a free-float capitalization-weighted index of selection of companies from the Stock Exchange of Hong Kong. Shanghai Stock Exchange Composite is a capitalization-weighted index that tracks the daily price performance of all A-shares and B-shares listed on the Shanghai Stock Exchange. MSCI EAFE Index is a free float-adjusted market capitalization weighted index designed to measure developed market equity performance, excluding the U.S. and Canada. The MSCI Emerging Markets Index is a free float-adjusted market capitalization index that is designed to measure equity market performance of emerging markets. Bloomberg Barclays U.S. Aggregate Bond Index covers the U.S. investment grade fixed rate bond market. The BofA Merrill Lynch 3-Month U.S. Treasury Bill Index is an unmanaged market index of U.S. Treasury securities maturing in 90 days that assumes reinvestment of all income.
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