Economic Update 7-02-2018

• Economic data for the week featured a slight downtick in first quarter GDP, a drop in durable goods orders, pending home sales and consumer confidence, while new home sales and jobless claims remained strong.
• U.S. and foreign stocks all lost ground during the week, with trade tensions dominating.  By contrast, bonds gained globally as interest rates ticked lower, aside from higher-risk high yield and emerging market debt where the result was negative.  Commodities continued to gain ground, with a sharp spike in crude oil prices again last week.

U.S. stocks lost ground during the week, including the worst one-day performance all quarter on Monday, and an attempt at a rally by Friday, which ended poorly with comments from the administration alluding to a possible dramatic withdrawal from the World Trade Organization (WTO).  From a sector perspective, utilities and telecom led the way, with positive returns, while tech, financials and consumer stocks trailed with the largest declines.

Worries over global trade continued to dominate the headlines, with potential prohibitions on Chinese firms investing in U.S. tech companies and controls on U.S. technology exports to China.  As both a component of and side issue apart from other headline trade discussions, technology intellectual property remains a key U.S. issue of concern in these negotiations, with speculation that the U.S. could implement the International Emergency Economic Powers Act from the 1970s, to apply a higher level of scrutiny to areas where U.S. security interests are perceived to be threatened (technology being the key target area noted).  However, in other speeches during the week, trade rhetoric was toned down somewhat, although the inconsistency of policy tone and objectives from week to week has certainly raised investor sensitivities.  It’s important to note that trade amounts that would be affected by potential tariffs in their current form remain relatively minor (as a percentage of GDP).  Worries that have been keeping many on edge lie in the threat of these spiraling into an escalating, nasty tit-for-tat that throws a negative shock into global growth—even if a trade war is not that detrimental to the U.S. directly at first.  With the U.S. economy performing relatively strongly as of late, and Chinese growth decelerating somewhat compared to the past decade, the timing of such rhetoric is likely not lost on the participants.

Foreign stocks lost ground as well, with most regions declining on net to a similar magnitude as U.S. equities.  Emerging markets fared slightly worse due to a stronger dollar relative to EM.  The exceptions were Latin America and Russia, which fared well with the gains in oil prices during the week.  Mexico gained as it appeared a left-wing presidential front-runner, initially thought a threat to pull back on an increasingly market-friendly environment (which has occurred in other Latin American nations), provided reassurances to the contrary.

More than any area, the export-heavy European region has perhaps the most to lose by the threat of a global trade war—particularly Germany.  Continued wrangling over the immigration debate also represents an important sentiment overhang since the political environment, and, in particular, populist leanings, could play a much more serious role in European affairs, as this debate has reached the heart of the debate over decision-making autonomy of individual member-states vs. the eurozone as a whole.  When the debate goes south, states such as Italy hint at an EU exit.  Much like the recent debate over trade in the U.S., investors appear to be having a difficult time handicapping the odds of these more extreme events amidst all the dramatic rhetoric—this may continue until some type of resolutions are reached.  European growth momentum has slowed a bit sporadically, which, should this continue, could pressure markets as well.  An earthquake rattle Osaka, Japan last week, and while there did not appear major damage, GDP could be affected due to factory shutdowns and closures.

U.S. bonds gained a fraction of a percent, with government and corporates largely rising in unison.  High yield, on the other hand, suffered negative results as spreads widened, as did bank loans to a lesser degree.  Foreign debt in developed markets also ticked slightly higher, on par with domestic bonds, while emerging market bonds continued to suffer due to higher U.S. rates acting as a force in boosting the dollar (eroding fundamentals somewhat in many EM nations), as well as continued impacts of trade uncertainty.  Emerging market bonds were one of the hardest hit areas of the quarter, with local currency bonds down upwards of -10%.

Real estate in the U.S. fared decently as interest rates ticked downward, while foreign real estate fell back in keeping with broader equities.  This continues a string of improvement in REIT performance in recent weeks as interest rates have tempered a bit.

Commodities rose by several percent again, continuing their strong run over the past year.  Higher oil prices again dominated, with West Texas Intermediate Crude Oil rising by +8% to four-year highs—ending over $74/barrel.  The U.S. has been pushing for a halt of all Iranian oil exports, thereby cutting production potentially offsetting production increases from OPEC last week; supply disruptions in Libya and lower U.S. inventories also appeared to play a role.  Other groups generally declined in unison, including precious and industrial metals, as well as agriculture in keeping with the stronger dollar.

Sources:  LSA Portfolio Analytics, American Association for Individual Investors (AAII), Associated Press, Barclays Capital, Bloomberg, Deutsche Bank, FactSet, Financial Times, Goldman Sachs, JPMorgan Asset Management, Kiplinger’s, Marketfield Asset Management, Minyanville, Morgan Stanley, MSCI, Morningstar, Northern Trust, Oppenheimer Funds, Payden & Rygel, PIMCO, Rafferty Capital Markets, LLC, Schroder’s, Standard & Poor’s, The Conference Board, Thomson Reuters, U.S. Bureau of Economic Analysis, U.S. Federal Reserve, Wells Capital Management, Yahoo!, Zacks Investment Research.  Index performance is shown as total return, which includes dividends, with the exception of MSCI-EM, which is quoted as price return/excluding dividends.  Performance for the MSCI-EAFE and MSCI-EM indexes is quoted in U.S. Dollar investor terms.                                                                               

The information above has been obtained from sources considered reliable, but no representation is made as to its completeness, accuracy or timeliness.  All information and opinions expressed are subject to change without notice.  Information provided in this report is not intended to be, and should not be construed as, investment, legal or tax advice; and does not constitute an offer, or a solicitation of any offer, to buy or sell any security, investment or other product.