Tech stocks power market higher, but trade issues remain unresolved

People hear a tip on a bus on some stock. They’ll put half their life savings in it before sunset and wonder why they lose money in the market. – Peter Lynch

All three of the major stock averages posted solid gains last week but the results could have been even better were it not for President Trump’s tariff threats against China and the inability to strike a trade deal with Canada. Through the close of business on Wednesday, both the S&P 500 Index and the Nasdaq Composite Index were perched at all-time highs after the U.S. and Mexico reached a bilateral trade agreement that replaced the North American Free Trade Agreement (NAFTA). If approved by Congress, the deal will last for 16 years. Investors breathed a sigh of relief and bid stock prices higher on the belief that other trade disputes would also be resolved. But that optimism was quickly dashed when President Trump announced on Thursday that he was in favor of placing tariffs on $200 billion of Chinese goods. More bad news hit the market on Friday when talks between the U.S. and Canada broke down and no trade agreement was reached by the deadline. Although talks between the two countries are likely to resume, it appears that trade tensions and uncertainties will continue to be a drag on the market for awhile longer. Despite the disappointment over the trade issues, the Nasdaq Composite Index was up over 2% last week and finished the month of August with a gain of 5.7% as technology stocks continued their strong performance. The S&P 500 Index was up 3% for the month while the Dow Jones Industrial Average gained 2.2%, making it the best August performance for stocks in over four years. Now that second quarter earnings season is in the rear view mirror, the focus for investors will likely be on economic data, which will probably be favorable, and trade and tariffs, which seem like the biggest obstacles right now to further gains in the market.

Last Week

Second quarter gross domestic product (GDP) was revised higher to 4.2% from 4.1% and most economists predict that GDP will increase by at least 3% in the third quarter. Consumer spending rose in July in line with expectations while the core personal consumption expenditures (PCE) index, the Federal Reserve’s preferred measure of inflation, rose slightly and was 2% on a year over year basis, matching the Fed’s target rate. Pending home sales fell for the seventh straight month in July as a shortage of homes for sale was driving up home prices and making them unaffordable for prospective buyers. Consumer confidence rose in August to the highest level since October 2000 and the final monthly reading of the University of Michigan consumer sentiment index was better than expected but at its lowest level since January. Weekly jobless claims rose 3,000 to 213,000, slightly higher than expected, but layoffs still remain at the lowest levels in nearly 50 years.

For the week, the Dow Jones Industrial Average added 0.7% to close at 25,964 and the S&P 500 Index gained 0.9% to close at 2,901. The Nasdaq Composite Index climbed 2.1% to close at 8,109.

This Week

The most important piece of economic data this week will be the August employment report, which is expected to show that about 187,000 new jobs were created and that the unemployment rate dipped to 3.8% from 3.9%. Average hourly earnings are expected to rise less than 3% year over year, helping confirm the view that inflation remains under control.  July construction spending is forecast to increase modestly while July factory orders are forecast to fall slightly. Both the Institute for Supply Management (ISM) manufacturing index and non-manufacturing index or services sector index are expected to remain solidly in expansion territory.

Among the most notable companies scheduled to report earnings this week are Barnes & Noble, Gamestop, Casey’s General Stores, Vera Bradley, Broadcom and Dell Technologies.

Portfolio Strategy

If there ever was an opportune time to invest in overseas markets, now may be the time. The U.S. stock market just completed its best August performance in years with the S&P 500 gaining 3% and the Nasdaq Composite Index climbing nearly 6%. The news cannot get much better, either, as second quarter GDP growth was revised higher, corporate earnings have been stellar, the labor market is strong and inflation remains under control. But the calendar has just turned to September and this month has been the worst month of the year for the Dow and the S&P 500 with average declines of about 1% since 1950. History has not been kind to the Nasdaq, either, as it has suffered losses as well. While corporate earnings should continue to grow for the balance of the year, the growth will not exceed the level posted in the second quarter. Valuations of U.S. stocks are also stretched as the S&P 500 currently trades at 17 times projected earnings for 2018, higher than its historical average. Interest rates are probably headed higher as it is a near-certainty that the Federal Reserve will raise the federal funds rate in September and again in December. On the other hand, interest rates are near-zero in Europe and Japan and recent economic data has been improving along with better earnings growth. Stock valuations are much lower, too, as the MSCI EAFE Index trades at about 14 times estimated forward earnings, a sizable discount to the U.S. market. Although U.S. stocks should continue to offer decent returns, a better case can be made for developed market international equities at this point in the U.S. cycle and taking into account their relative underperformance on a year-to-date basis.