Let’s start keeping track:
HIGHLIGHTS
MARKET RECAP
US stocks advanced by 0.59% despite the trade war being ramped up another notch. International stocks jumped, +2.63%, helped by a falling dollar, which declined by 0.55%. Interest rates were up across the board, and the spread between the 10 and 2-year treasury increased by 5 basis points to 26. The 10-year note broke through the 3% barrier and is yielding 3.07%.
TRADE WAR
Trump upped the ante in the trade war battle by implementing the tariffs on $200 billion of Chinese products that he had previously threatened. The tariffs start at 10% and then go up to 25% by year-end. China responded with $60 billion. Trump then said he would hit back with another $267 billion. When economists talk about how trade wars start and turn from something small into something big, this is the playbook. And Trump and his Chinese counterpart are playing their parts perfectly. Should Trump go all the way with the tariffs as described, Oxford Economics is forecasting a 1% hit to GDP. Expected growth next year per the Federal Reserve is about 2.4% (before the trade war).
The US is right in that China does not trade fair regarding technology transfer and intellectual property. Trump’s obsession with China’s trade surplus is wrong. The administration also has not laid out exactly what they want, leading some to believe that Trump really does not want a deal, and the tariffs are more about hurting China than trying to build a better economy.
Chinese company Alibaba said they would not add a million US jobs they had promised at an earlier point.
Trump’s hardline approach may or may not ultimately work, but in the meantime, as the tariffs eventually work their way through the economy, businesses and employees will suffer, inflation will increase, and growth will either slow or decline.
CORPORATE DEBT
Randall Forsyth writes in his weekly “Up & Down Wall Street” column in Barron’s that Stephanie Pomboy of MacroMavens has been warning about corporate debt. Corporate interest expense is at a record, even while interest rates are still relatively low. But given the excessive debt burden, companies will be cutting back borrowing by 14.6%, compared to the prior year, an indication that slowly increasing interest rates are causing pain. Pomboy argues that equities have been rising with global central bank stimulus for years now, and when that ends early next year, interest rates will rise further, cutting into corporate profits, and the fuel that has driven this long rally will be spent.
SCOREBOARD
HIGHLIGHTS
MARKET RECAP
US stocks ended up 1.14% on good economic reports. Equities were also helped by emerging markets, which were up by 0.70%, calming fears, at least for now, of a never-ending fall that would drag down US stocks. International stocks increased by 1.52%. Technology had a good week, up 1.8%. Apple released its new line up of products and shares increased by 1.1%.
ECONOMY
It was a week of strong economic reports. Industrial production was up 0.4% in August and July was revised up to 0.4% from 0.1%. Year over year, industrial production is up by 4.9%, the highest number since December of 2010.
Retail sales were up by 0.1% in August, showing some recent moderation in growth. But year over year, sales are up by 6.5%, the most since December of 2011.
The University of Michigan Consumer Sentiment Index reported its second-highest reading since January of 2004, at 100.8.
DEFICIT
Barron’s cover story this week was on U.S. debt. We have written and spoken about this many times in the past. The deficit is one of those things that is not a problem until it becomes a problem. And when that happens, it is not going to be pretty. At some future point, investors are not going to want to finance U.S. debt. And then interest rates will skyrocket, or the Fed will have to print dollars, and the dollar will depreciate.
America currently owes $15.7 trillion, which is 78% of the gross domestic product (GDP). The Congressional Budget Office (CBO) estimates that in a decade debt will be $28.7 trillion, or 96% of GDP. And that assumes no catch up in infrastructure, no financial crisis, and no wars. It is one thing if debt increases in line with GDP growth. But that is not the projection. The CBO estimates nominal GDP growth at 4% and debt to rise at 4.9% over the next 10-years.
Neither political party has any interest in addressing this serious issue.
BUYBACKS
For the first half of the year, stock buybacks made up the largest percentage of cash spending by companies in the S&P 500. Buybacks were up by 48% and totaled $384 billion during that period. Capital spending increased by 19% to $341 billion.
TARIFFS / TRADE WAR
For all the talk of tariffs and a trade war, so far to date, they have yet to be implemented in mass. Currently, tariffs on imports effect about $113 billion in goods. That is 4% of all US exports. About $70 billion has been implemented on US exports or about 3% of the total. Trump has threatened tariffs on another $700 billion of imports.
SCOREBOARD
HIGHLIGHTS
MARKET RECAP
Markets around the world fell. US stocks were down by 1% and international stocks fell by 3%. Emerging markets equities entered a bear market (see below) and there is fear of contagion. Bonds fell by 0.35% on a rise in interest rates. The US economy continues to show strength.
The NASDAQ, composed primarily of technology stocks, dropped 2.6%, its worst performance since March. Social media stocks were under the spotlight as they returned to testify in front of Congress about foreign influence on elections. The Department of Justice said it would look into the “stifling” of voices on social media. Semiconductor stocks dropped on lower earnings expectations. Stocks were hurt further on Friday when Trump said that an additional $267 billion in tariffs on China, on top of what was previously announced, is now on the table. Tesla dropped by 6% to $263 when Elon Musk was shown smoking marijuana in an interview.
ECONOMY
Nonfarm payrolls increased by 201,000 in August and private-sector wages increased by 2.9% year over year. The unemployment rate remained unchanged at 3.9%. The 2.9% increase in the wage rate was the highest of this expansion. While that is good for workers, it could cut into corporate profit margins and give the Fed more leeway to increase interest rates.
The ISM Manufacturing Index jumped higher in August to 61.3, up from 58.1. That is the highest level since May of 2004 and indicates strong growth ahead. However, according to the ISM report, “Respondents are again overwhelmingly concerned about tariff-related activity, including how reciprocal tariffs will impact company revenue and current manufacturing locations.”
The Global Manufacturing PMI fell by 0.3 points in August to 52.5. It was the seventh drop in eight months. But the index still remains in expansionary mode (greater than 50) for the 30th consecutive month. Developed markets, led by Europe turned in better numbers than the emerging markets.
The Philly Fed State Leading Indexes project growth in 49 states over the next six months, however, growth rates are expected to moderate.
BEAR MARKET INDICATOR
The Goldman-Sachs Bull-Bear Indicator, which relies on five market factors, is flashing its strongest warning signal since the 1970s. High stock market valuations and a tight labor market are two of these key factors. However, Goldman is not anticipating a deep bear market, but they are forecasting lower returns ahead. Moderating factors include a low-interest rate environment, subdued inflation, and an accommodative monetary policy around the world.
EMERGING MARKETS
Emerging markets dipped into bear market territory on Thursday. The MSCI Emerging Markets index is now off just more than 20%. A fall of 20% or more is considered a bear market. A rising dollar, trade tensions, and falling commodity prices shoulder most of the blame. The rising dollar makes it more difficult for countries with debt denominated in the US currency to repay their loans. Rising trade tensions could put a damper on global trade that some emerging market countries count on, as well as lead to an economic slowdown. Raw-material prices are down about 10% since the May peak. Emerging market countries like Brazil, Chile, and Indonesia are major commodity exporters.
MORE DRAMA IN DC
Bob Woodward’s new book, “Fear”, was published and paints a portrait of a dysfunctional White House. And the NY Time published an op-ed by an anonymous author who is supposedly a senior official in the White House. The piece says that there is a group operating to control the worst instincts of Trump and to basically act as the adults in the room.
SCOREBOARD
MARKET RECAP
Stocks were up for the week but down on Friday on worries that Trump was planning to go forward with more tariffs on Chinese imports and on reports that the US and Canada were not able to reach a trade deal as hoped for.
For the week, US stocks were up 0.93% and international stocks fell by 0.11%. Bonds dropped by 0.30%. August was another good month for US stocks, +3.43%, while international stocks fell by 2.4%. Bonds were up 0.81% for the month. The NASDAQ had its best August performance in 18 years, +5.7%, powered by Apple (+20%), Amazon (+13%) and Netflix (+9%).
A strong economy coupled with strong profits has been the main driver behind this market. The GDPNow model from the Atlanta Fed is projecting Q3 growth at 4.1%, Macroeconomic Advisors is at 3.1% and the NY Fed’s Nowcast is at 1.98%. Meanwhile, corporate profit projections continue to improve for 2018, 2019 and 2020. They are up by 0.67%, 1.29% and 0.69% from 13 weeks ago (one-quarter of the year). However, the rate of change has been falling in recent weeks.
US / MEXICO
The US and Mexico came to terms on an updated NAFTA agreement. The agreement would lessen dispute resolution measures and would require higher paying jobs in auto-factories. The focus then turned to wrap up a deal with Canada by Friday but that did not happen.
VIX and STOCK MARKET RISE
Something of interest, which might be nothing, is that the volatility index (VIX), often called the fear index, rose this week in tandem with stocks. Normally, there is a negative correlation. When stocks go up, the VIX normally goes down, and the opposite. But recently there has been a positive correlation. The last time that happened was right before the correction we had earlier this year. This correlation has sometimes occurred before previous sell-offs as well as shown below.
YIELD CURVE
New research based on the yield curve from the San Francisco Fed shows that the risk of a recession is rising but a downturn is far from certain. As the difference between short and long-term Treasury’s narrows, there is growing likelihood that the curve will invert, meaning that short-term rates will yield more than long-term rates. While the two and ten-year Treasury’s are most commonly discussed when determining yield curves, the San Francisco Fed says that the difference between the 10-year and the three-month bill is the more useful indicator. While the 2-10 spread is tight at 24 basis points, the difference between the three-month and ten-year is much wider, at 75 basis points.
SCOREBOARD
HIGHLIGHTS
MARKET RECAP
The S&P 500 closed at an all-time high, finishing at 2,874.60 on Friday. That beat out the previous high on January 26 of 2,872.87. Overall, US markets were up 1.03% and international stocks jumped 1.69%.
BAD POLITICAL NEWS
Markets advanced despite a swirl of bad political news, even by the standards of the Trump administration. Trump’s so-called “fixer” and former lawyer pled guilty to bank and tax fraud, campaign finance violations and said that Trump had directed him to pay money to two women to keep quiet on past relationships. Then former campaign chairman Paul Manafort was convicted on 8 different charges. It was reported that David Pecker, CEO of American Media (National Enquirer) and Allen Weisselberg, CFO of the Trump Organization, had received immunity from prosecution.
Pepsi said it would buy SodaStream International for $3.2 billion.
US / MEXICO
It is reported that the U.S. and Mexico are close to finalizing a NAFTA deal as soon as Monday. Breakthroughs in automobiles and energy and helping accelerate the talks. Canada would next need to get on board after the US and Mexico reach an agreement.
SCOREBOARD
HIGHLIGHTS
MARKET RECAP
US equities were up by 0.63% for the week but that hid some wild swings. Stocks fell hard on Wednesday, worries about Turkey and falling commodity prices spooked markets, at the low point equities, were down by 1.37%, but they rallied into the close and finished off by 0.79%. A Thursday rally made up for most of the loss, stocks increased by 0.78%. The Dow had its biggest increase in four months, up by 1.58%. The rally was spurred by word that there would be a resumption of trade talks between the US and China later in the month. Solid retail earnings reports (see below) also helped.
As it stands now, the S&P 500 is just 0.80% off its all-time high. International stocks fell again, down 0.97% on the week and they are now down almost 5% for the year. Emerging market stocks have fallen even more, down about 10%. The Vanguard Emerging Markets Index Fund (VWO) sells at a forward price to earnings ratio of 12.5 and there are value-oriented emerging markets funds that now sell at a forward ratio of less than eight.
LEVERAGED LOANS
Leveraged loans might be the fault line that cracks in the next recession. The popularity of the loans has increased in recent years given their ability to protect investors in a rising rate environment. But the loans, which investors effectively invest in through popular ETFs and mutual funds, present a potential mismatch if investors begin to sell their positions faster than the loans can be liquidated. Selling a loan is not the same as selling a stock or a treasury bond. Another problem is the loans being marketed now do not have as many covenants as in past years. That means that in the event of bankruptcy, the loans are protected by fewer assets than was traditional in the past.
Moody’s estimates future recoveries at 32% versus 40% in the past.
For the time being, the economy remains strong, but leveraged loans could become a problem down the road.
RETAILERS REPORT GOOD RESULTS
Solid results by Walmart, Nordstrom and other retailers indicate the economy remains strong. A combination of tax cuts and rising wages have helped sales rise at Walmart, Nordstrom, Home Depot and Coach. Walmart’s sales in the last quarter increased by the most in over a decade. Walmart’s e-commerce sales were up by 40%. But not all is perfect, sales at Macy’s were up just 0.5% and they were down at JC Penny.
JOBLESS CLAIMS
New unemployment claims fell by 2,000 to 212,000 indicating a continued strong labor market.
SCOREBOARD
MARKET RECAP
Turkey’s currency, the lira, dropped by more than 14% on Friday as their President instructed citizens to sell the dollar and gold and buy the lira. President Recep Tayyip Erdogan said that “This will be in response to those who have declared an economic war.” He blamed the “interest rate lobby” that wants Turkey to raise interest rates.
Trump later tweeted “I have just authorized a doubling of Tariffs on Steel and Aluminum with respect to Turkey as their currency…slides rapidly downward.” Combined, the dual Presidents comments led to a sell-off around the world.
In recent years Turkey appeared to have a strong economy. But that was a disguise, as the economy was boosted by taking on heavy debt denominated in foreign currencies. Now the bill is due and as the lira falls, the pain increases.
US stocks did not suffer much, finishing just about even for the week. The damage was overseas where international equities dropped by 2% and emerging markets were down 2.3%.
BULLISH BETS START TO PILE UP
As US stocks were close to records on Thursday, traders were wagering big on a continued bull run. Bullish call options, which cash in on higher prices, have increased in volume on the S&P 500. At the same time, bets on low volatility have hit the highest level since November, according to the Commodity Futures Trading Commission, indicating that traders expect the market to move slowly higher.
SCOREBOARD
HIGHLIGHTS
MARKET PERFORMANCE
US and international markets split ways again, with the US up by about 0.72% and international markets down by 0.81%. There was the normal back and forth on tariff threats with China, but the market does not seem so concerned. A solid payroll report showed that the labor market continues to be tight. The only kink in the armor of the strong US economy was a fall in the ISM Manufacturing Index to a 3-month low. But the reading of 58.1 is still extremely strong. Apple won the race to the $1 trillion valuation, hitting the mark on Thursday.
PAYROLL
Nonfarm payrolls increased by 157,000 and the two preceding months were revised up by a total of 59,000. So far, the tariffs do not seem to have impacted hiring. Average hourly earnings were up 2.7% compared to last year. One factor holding down bigger increases in average earnings is that employers have been hiring less educated, lower paid workers to fill job positions. A related factor is an increase in jobs for the 25 to 34-year old’s, they are replacing older, higher paid employees as they begin to retire. The unemployment rate dropped to 3.9%. Overall, the labor market continues to be strong.
ISM
The ISM Manufacturing Index fell by 2.1 points in July, the most in almost two years, to 58.1. The reading was a three-month low and indicates some moderation in factory activity. Despite the decline, the overall level of 58.1 is still a very strong number and indicates continued growth for Q3 although probably weaker than Q2.
The report stated that “respondents are again overwhelmingly concerned about how tariff-related activity, including reciprocal tariffs, will continue to affect their business.”
TRADE
The back and forth that trade wars are known for continued this week. The White House threatened to increase tariffs to 25% on $200 billion of Chinese goods from the previously announced amount of 10%. China responded on Friday saying that it would increase tariffs up to 25% on $60 billion of US products. These tariffs are supposed to go into effect in September. The Chinese yuan is down 7% versus the dollar over the last two months. That will help the Chinese deal with the higher tariffs.
If Chinese exports are hurt by the trade war, the government might be inclined to stimulate the economy by taking on more debt. The problem is that China is close to being maxed out on debt. Pushing China over the edge into a full-blown debt crisis would likely lead to problems throughout the global economic system.
VALUATION
There are lots of metrics out there showing that the market is overvalued, and some showing it is fairly valued, but here is one that indicates the market is way overvalued. Price to sales on the S&P 500 is at about 2.2, near the highest level since 2000.
APPLE
On Thursday Apple became the first company to reach a valuation of $1 trillion. Apple trades just under the S&P 500 index multiple, selling at 15.8 forward earnings.
SCOREBOARD
HIGHLIGHTS
MARKET RECAP
There was a hint of good news on the trade front this week. European Commission president Jean-Claude Juncker met with Trump and they agreed to work on an agreement with no tariffs and no subsidies (read more below). That, and generally favorable earnings, along with a solid 4.1% estimated increase in Q2 GDP, advanced stocks by 1.07% in the US and 1.08% outside the US. Bonds fell by 0.18%, as yields were up across the curve by about 7 basis points.
TRADE
Prior to his meeting with European Commission President Jean-Claude Juncker, Trump tweeted “I have an idea for them. Both the U.S. and the E.U. drop all Tariffs, Barriers, and Subsidies! That would finally be called Free Market and Fair Trade! Hope they do it, we are ready – but they won’t.”
The White House team went into the meeting looking to negotiate, chief economic advisor Larry Kudlow said before the meeting, “I just say, keep an open mind—you might be surprised by the outcome of this meeting.”
Surprised we were, the parties agreed to work towards zero tariffs and the removal of all trade barriers for non-auto industrial goods. The EU would increase its purchases of soybeans (very soon) and would import large quantities of natural gas. The two parties would work together to reform the World Trade Organization and to end the theft of intellectual property, forced technology transfers, government subsidies and the selling of products below cost. If all this happens we give Trump and his team major credit. A world with free, or freer trade, will improve economic outcomes across the globe.
The jump to work a deal with the Europeans might have been pushed along by increasing political heat here in the US. The initial impact of the tariffs is starting to be felt. Earlier in the week, the Trump administration said it would provide $12 billion in support to farmers impacted by the trade war. The costs of tariffs are also showing up on some company conference calls, as executives worry about higher costs and lower sales.
HOME SALES
Existing home sales fell for the third consecutive month and are now down 2.2% year over year. Higher costs are holding back prospective buyers. Prices of existing homes are up 5.2%, and mortgage rates on a 30-year fixed, while still historically low, have increased to 4.54% from 3.92% a year ago. New home sales were down 5.3% in June.
FACEBOOK/TWITTER
Facebook shares fell by 19%, losing $120 billion in market value, as the company projected slower revenue growth going forward. Twitter dropped by 21% after reporting a drop in users. However, most of the drop in users were “fake” or “fraudulent” accounts, apparently, investors would rather Twitter have kept those fake accounts!
SCOREBOARD
