Stocks close lower as geopolitical concerns take center stage

I haven’t the faintest idea as to whether stocks will be higher or lower a month – or a year – from now. What is likely, however, is that the market will move higher, perhaps substantially so, well before either sentiment or the economy turns up. So if you wait for the robins, spring will be over. – Warren Buffett

For the second consecutive week, both the Dow Jones Industrial Average and the S&P 500 Index closed lower as a number of political events in Washington caused investors to lose confidence in the current administration. After the presidential election back in November, the stock market rose on the belief that Trump’s pro-growth agenda would be enacted and help boost the economy. However, nine months into his presidency, there have no changes to the Affordable Care Act, no tax reform or tax cuts and no legislation to increase infrastructure spending. Backlash over President Trump’s remarks on the events in Charlottesville, Virginia was the tipping point as they led to the elimination of two advisory councils to the president and the ouster of White House chief strategist Steve Bannon. There was also concern that chief economic advisor Gary Cohn would leave, prompting fears that there might be a mass exodus of other Trump appointees and advisors. All of this turmoil came a week after tensions between North Korea and the U.S. reached a boiling point, although the heated rhetoric was toned down last week as the U.S. said it would continue to pursue a diplomatic resolution. A terrorist attack in Spain only added to the nervousness among investors while minutes from the last Federal Reserve meeting showed that its members were equally divided over the path of future interest rate hikes. One side thought that caution should be exercised in a low-inflation environment while the other side worried about the possible adverse effects of postponing a rate hike with the labor market at full employment. Both sides were in agreement, though, on the Fed’s plan to reduce the $4.5 trillion in securities on its balance sheet and much less optimistic about the probability of any fiscal policy moves in the near-term. If there was any good news last week, it was that second quarter earnings continued to be strong and economic data was mostly positive. And in the final analysis, it is these fundamentals that ultimately determine the direction of stock prices.

Last Week

Retail sales in July rose by more than expected and were at the highest level since December on strong demand for new automobiles and Amazon’s Prime Day shopping specials. Homebuilder sentiment soared on rising demand from home buyers due to low mortgage rates and increased consumer confidence. But housing starts and permits did not benefit as both were weaker than expected in July as there was a shortage of skilled labor and a short supply of buildable lots. Import prices in July edged slightly higher and confirmed that inflation remains benign and industrial production was also up slightly but trailed expectations. Weekly jobless claims fell 12,000 to 232,000 as the labor market remains tight with few layoffs.

For the week, the Dow Jones Industrial Average fell 0.8% to close at 21,674 while the S&P 500 Index declined 0.6% to close at 2,425. The Nasdaq Composite Index dropped 0.6% to close at 6,216.

This Week

It will be a light week for economic reports as July new home sales and existing home sales are expected to increase over the previous week and July durable goods orders, which can be volatile from one month to the next, are forecast to fall by about the same amount as they rose in June. Weekly jobless claims are expected to rise modestly but remain at levels consistent with a tight labor market.

Both Federal Reserve Chair Janet Yellen and European Central Bank President Mario Draghi are scheduled to speak at the Economic Policy Symposium in Jackson Hole, Wyoming.

Companies in the S&P 500 Index have seen their earnings increase 11% in the second quarter, marking the first time since 2011 that the index has posted consecutive quarters of double-digit earnings gains. The most notable companies on the earnings calendar this week are Medtronic, HP, Broadcom, Autodesk, Lowe’s, Dollar Tree, Toll Brothers, JM Smucker and Hormel Foods.

Portfolio Strategy

With only a few economic reports scheduled for release this week and second quarter earnings season over, the focus for the markets will be on the Economic Policy Symposium on Friday. Expectations for another interest rate hike this year by the Federal Reserve are fading as inflation remains below the Fed’s target of 2%. The core personal consumption expenditures (PCE) index, the Fed’s preferred inflation gauge, recently showed an annualized gain of just 1.5%. Even though the labor market is tight and the economy is at full employment, wage growth has only been modest. For these reasons, Fed Chair Janet Yellen will likely strike a dovish tone in her remarks. Fed officials acknowledge that balance sheet reduction will begin soon and contend that their plan should not disrupt financial markets. However, unwinding $4.5 trillion in securities has not been attempted before and this process could put upward pressure on interest rates. While fundamentals are still strong, lack of economic data and earnings reports to trade on this week will mean that geopolitical events could once again be the center of attention. With seasonal trading volume low, the market might be vulnerable to headline risk that leads to increased volatility. The months of August and September have historically been the weakest ones for the stock market and there has not been so much as a 5% correction in over nine months. If the Trump administration can get back on message with its pro-growth agenda, then that would go a long way toward calming investors’ nerves. Recessions are what end bull markets and there is no recession in sight as GDP growth in the third quarter is expected to be even stronger than in the second quarter.