To be an investor you must be a believer in a better tomorrow. – Benjamin Graham
The stock market seems to be climbing a wall of worry and last week it suffered a mild setback as all of the major stock averages fell at least 1%. The Dow Jones Industrial Average was the biggest loser as it dropped 389 points or 1.5% as a number of news events contributed to nervousness among investors. The most troubling concern involves retaliation by other countries in the form of tariffs on U.S. goods and the possible outbreak of trade wars. In addition to the 25% tariff on imported steel and the 10% tariff imposed on aluminum, there have been reports that the Trump administration has considered slapping $60 billion in tariffs on Chinese goods. The administration also wants to target intellectual property theft by the Chinese government, which has been rampant and has occurred for far too long. The revolving door, otherwise known as the White House, was also on full display last week as President Trump fired Secretary of State Rex Tillerson and replaced him with Mike Pompeo, the former head of the Central Intelligence Agency (CIA). Trump also named Lawrence Kudlow to replace Gary Cohn as his chief economic advisor, a move that may soften Trump’s stance on tariffs. The never-ending investigation into whether or not the Trump campaign colluded with Russia in the 2016 presidential election also took a new turn as special counsel Robert Mueller subpoenaed the Trump organization and related businesses. Although all of the inflation data released last week was relatively benign, retail sales in February fell slightly and have now fallen three consecutive months for the first time in nearly six years. This result was a bit surprising as it was thought that the recently passed tax cuts would lead to increased consumer spending, especially with consumer sentiment data at all-time highs. In fact, the Atlanta Federal Reserve now forecasts that first quarter gross domestic product (GDP) will only be about 1.9% compared to its original forecast of 5.4%. JP Morgan Chase also lowered its forecast for 1st quarter GDP to 2%. Worries have now turned to economic growth that might be too weak rather than too strong, resulting in corporate profits that also might be less than expected.
What a difference a month makes. Unlike January inflation data that was much stronger than expected, data in February was generally mild by comparison and in line with expectations. The consumer price index (CPI) rose slightly and alleviated concerns that inflation will accelerate and the producer price index (PPI) also posted only a modest increase. Core CPI, which excludes food and energy, has risen 1.8% on an annualized basis through February. February U.S. industrial production posted its biggest increase in four months as favorable weather led to a rebound in construction but housing starts fell more than expected in February as construction of multi-family housing units plunged. The preliminary University of Michigan consumer sentiment index rose to its highest level since 2004. Weekly jobless claims fell 4,000 to 226,000, less than expected, and near a 50-year low.
For the week, the Dow Jones Industrial Average dropped 1.5% to close at 24,946 while the S&P 500 Index declined 1.2% to close at 2,752. The Nasdaq Composite Index fell 1.0% to close at 7,481.
February existing home sales and new home sales are forecast to be higher than those reported in January and consistent with a stable housing market. February durable goods orders are expected to rebound with a healthy increase after declining last month while leading economic indicators for February are expected to be up modestly but at less than half the increase in January.
The Federal Reserve meets on Wednesday and it is widely expected that the federal funds rate will be raised by a quarter of one percent. New Fed Chairman Jerome Powell will hold his first news conference after the meeting. Depending on the strength of the economy and inflation, it could be the first of four interest rate hikes this year.
Among the most prominent companies on the earnings agenda this week are Oracle, Micron Technology, Accenture, FedEx, General Mills, Darden Restaurants, ConAgra Brands, Nike, Carnival and Cintas.
Since the Trump administration announced a 25% tariff on imported steel and a 10% tariff on imported aluminum on March 1st, there have been lingering fears that a trade war might develop and the stock market has been volatile with little or no gain. Both Canada and Mexico were granted an exemption from the tariffs until the North American Free Trade Agreement (NAFTA) could be renegotiated and President Trump emphasized that he would be flexible in either removing or modifying tariffs for each country. The effect on broad-based, diversified exchange-traded funds (ETFs) and actively managed equity mutual funds has been relatively small as steel and aluminum stocks have done well while companies that use steel and aluminum in their production process have tended to underperform. By and large, the market has shrugged off the news but remains wary that tariffs on steel and aluminum could lead to an escalation of tariffs around the globe as countries attempt to protect their own industries. If the tariffs are confined to just steel and aluminum and are used as a negotiating tool to bring countries together to discuss fairer trade practices, then the stock market should not be affected adversely. However, if trade wars develop, there is the possibility of higher prices and inflation, which could lead to higher interest rates, negatively impacting stocks and bonds. For bond investors, it would be wise to shorten the duration of fixed income portfolios to minimize the amount of principal erosion caused by higher rates.