Economic Update 6-03-2019

• During a shortened week, economic data consisted of a downwardly-revised but still-strong Q1 GDP report, continued low jobless claims, and mixed consumer confidence. Housing data was again mixed to a bit weaker.
• Equity markets around the world lost significant ground on the week, as existing (China) and new (Mexico) trade issues drove sentiment in developed nations, while emerging markets gained ground. Bonds again rallied with U.S. treasury rates falling to their lowest levels in several years. Commodities also were hit, due to a recent sharp decline in crude oil prices, which offset higher prices for grains.

U.S. stocks suffered through another difficult week, due to ongoing rhetoric from the stalled trade negotiations with China, coupled with the surprise announcement of potential tariffs on Mexican imports. Every sector ended up with losses, led by energy and consumer staples, while materials, interestingly, held up best with only a -2% decline.

China announced that it was ‘considering’ an export restriction of rare earth metals to the U.S., in another escalation of the ongoing trade war. While a lower likelihood than other trade tools, due to effects on its own supply chains and labor, this has occurred before, in a behind-the-scenes Chinese trade spat with Japan in 2010. China produces roughly 70% of the world’s rare earths, used extensively in computer and mobile phone hardware, due to their unique properties and specialized uses in certain components, such as screens and batteries.

Some relief was felt later in the week, when Fed Vice Chair Clarida hinted that a more ‘accommodative’ policy could be in order if downside risks intensified. A variety of market strategists and economists have also shifted forecasts further into the ‘easing’ camp, due to the possibility of a trade deal taking far longer than expected (even moving into next year).

This points to a very real conundrum of the current U.S.-China trade negotiations: while the tariffs and uncertainty of short- and long-term policy bring a large degree of open-ended outcomes, including possible inflation and lack of business investment, a sustained economic downturn or recession could be politically problematic. In fact, as much as a strong economy has served as a tailwind for incumbent Presidents in re-election bids, a weakening economy has quickly derailed such hopes, and favors challengers—as much as any other factor in elections of recent decades. This small amount of positive sentiment was reversed again Friday as the President announced tariffs in stages to be levied against Mexico, in increments of 5% per month to a maximum of 25% until the ‘illegal immigration problem is remedied.’ This has ramifications on the political negotiations behind the likelihood of passage of the USMCA (NAFTA’s replacement), although the trade situation as obviously become very fluid and difficult to predict in recent weeks. Mexico, along with Canada, is the U.S.’ largest trade partner, with $350 bil. in imports last year, a quarter of which are autos and auto-related parts.

Foreign stocks in Europe and the U.K. fared similarly to the U.S., while emerging markets fared far better, earning positive returns for the week. Investors absorbed EU parliament election results, which included a slip in the power for the more conventional pro-EU centrist coalition parties, while populist fringe parties on both the right and left gained significant ground. Emerging market gains, oddly bucking the trend of negative global growth sentiment, were led by gains in Brazil, the Far East (including China), as well as Turkey. The latter was due to improved relations with the U.S., including the release of a held U.S. scientist as a sign of goodwill.

U.S. bonds continued their strong run as equities struggled. Treasury interest rates fell to their lowest levels in two years, with the 10-year reaching near 2.1%. The inversion watch continues, with the 10y-3m spread inverted, while the 10y-2y remains positively sloped. During the week, treasuries outperformed credit, with high yield bonds performing especially poorly, along with equities. With the dollar up slightly, foreign developed market bonds fared positively, albeit to a lesser degree than in the U.S., as did emerging markets to a limited degree.

Commodities generally lost ground, with gains of nearly 5% in agricultural contracts corn and soybeans being more than offset by sharp declines in energy. While the price of natural gas also fell by -5%, the price of crude oil declined by nearly -9% in the week to $53.50/barrel—vying for the lowest level this year. Crude is now again in bear market territory, having fallen -20% since highs of $66 in April, due to the double-whammy of fears of a global slowdown affecting demand and supply levels remaining solid due to U.S. production.

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.