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S&P 500 Index plunges 6% as trade war fears with China escalate

The key to investing is not assessing how much an industry is going to affect society, or how much it will grow, but rather determining the competitive advantage of any given company and, above all, the durability of that advantage. – Warren Buffett

The Dow Jones Industrial Average suffered its largest decline since January 2016 last week while the S&P 500 Index and the Nasdaq Composite Index also posted losses of at least 6%. A number of reasons could be cited for the drop in stock prices, the first of which occurred on Monday when reports surfaced that Facebook had failed to protect its customer data. Political analytics firm Cambridge Analytica was able to collect data on 50 million profiles of people without their consent, causing shares of Facebook to plunge and weighing on the entire technology sector. Fears rose that the government might impose regulations not only Facebook but other companies in the technology sector as well. The Federal Reserve also met last week and, as expected, raised the federal funds rate by a quarter of one percent and predicted two more similar rate hikes for the year. While this rate increase and forecast were widely expected, comments by Fed Chair Jerome Powell might have caused some uneasiness among investors. He said that tariffs on trade are a “new risk” to the Fed’s economic outlook and warned that some asset prices are “elevated”, including stocks.  He also warned that the impact on the economy from fiscal policy remains “very uncertain”. On a positive note, he remarked that the economic outlook has strengthened and that the probability of a recession remains low. But probably the biggest reason for the plunge in stock prices was the announcement by President Trump that up to $60 billion in tariffs would be imposed on Chinese technology companies to penalize China for intellectual property theft. On the heels of tariffs already imposed on imported steel and aluminum, this news caused equity investors to sell and ask questions later as fears of a potential trade war with China escalated. The Trump administration will provide a list of targeted products in 15 days and there will be a 30-day period for public comment before the tariffs are actually imposed. By then it is hoped that an agreement can be reached between China and the U.S. that would avoid the imposition of tariffs. In this case, the bark from implementing tariffs might be worse than the bite.

Last Week

Existing home sales in February were much better than expected but a shortage of homes for sale still persists, resulting in higher prices for homes. New home sales in February, however, fell for the third straight month and were below expectations as the same shortages pushed prices higher. Durable goods orders in February were double the expected increase due to strong demand for commercial aircraft. Orders for non-defense capital goods excluding aircraft were also strong, signaling that business spending remains robust. Leading economic indicators for February also beat estimates and recorded the fourth straight month of gains, a positive sign for the economy going forward. Weekly jobless claims confirmed that the labor market remains strong, so much so that the Federal Reserve forecasts a 3.8% unemployment rate by year-end.

The government avoided a shutdown as Congress passed a $1.3 trillion budget bill that President Trump reluctantly signed after threatening to veto it over objections to unnecessary and wasteful domestic spending.

For the week, the Dow Jones Industrial Average dropped 5.7% to close at 23,533 while the S&P 500 Index tumbled 6% to close at 2,588. The Nasdaq Composite Index lost 6.5% to close at 6,992.

This Week

There will be very few economic reports this week. The final reading of fourth quarter 2017 gross domestic product (GDP) is expected to be 2.5%, the same as the previous estimate. Both the March consumer confidence index and the March University of Michigan consumer sentiment index are forecast to remain high and exceed levels in February as consumers remain sanguine about the economy and the job outlook.

It will be a particularly light week for quarterly corporate earnings reports as the most notable companies on the list include Walgreens Boots Alliance, Constellation Brands, McCormick and Paychex.

Portfolio Strategy

While economic growth for the first quarter is expected to be much weaker than originally expected, the good news is that growth forecasts for the balance of the year are strong. Bank of America is the latest money center bank to lower its forecast for first quarter GDP to less than 2% while, at the same time, maintaining its forecast for full-year growth of just under 3%. This follows the Atlanta Federal Reserve’s forecast last week that growth would slow to 1.9% and JP Morgan’s prediction of 2% GDP growth in the first quarter. Heading into the new year, hopes had been high for above-average growth as manufacturing data was particularly strong. But recent economic reports on automobile sales, retail sales and housing suggest weakness in the economy, prompting many economists to lower their forecasts for first quarter growth. In its meeting last week, the Federal Reserve dismissed any current weakness and was optimistic about the economy, raising its outlook for full-year growth to 2.7%. The slowdown in the first quarter should only be temporary as consumer and business spending will improve as the year goes on. The strong durable goods orders reported for February could portend further gains as business confidence remains high, borrowing costs remain low, global economic growth is improving and the dollar is weakening. The recent cut in the corporate tax rate from 35% to 21% will also help and should allow business investment to continue to expand at a healthy rate for the rest of the year.

Because I will be out of the office on vacation next week and won’t return until the following week, the next Weekly Market Commentary will be on April 9th.