During the Gold Rush, most would-be miners lost money, but people who sold them picks, shovels, tents and blue-jeans (Levi Strauss) made a nice profit. – Peter Lynch
A combination of a Federal Reserve interest rate hike and implementation of tariffs between the U.S. and China were enough to send stocks lower for the week. Both the Dow Jones Industrial Average and the S&P 500 Index posted modest losses while the Nasdaq Composite Index bucked the trend to close slightly higher. Despite the loss for the week, the S&P 500 managed to record its sixth straight monthly gain. The bad news began on Monday as the new tariffs between the U.S. and China took effect and got worse when both countries cancelled further trade talks for now. Negotiations between the U.S. and Canada were also at a standstill and looked unlikely to be resolved by a September 30th deadline. The lack of progress on trade was followed by the announcement by the Federal Reserve that the federal funds rate would be raised by a quarter of one percent to a range of between 2% and 2.25%, a move that was widely expected. What wasn’t expected was removal of the language by Fed officials that monetary policy was still “accommodative”. Their goal all along has been to normalize monetary policy by raising interest rates to a “neutral” level. The Fed feels justified in doing so since second quarter GDP was strong at 4.2%, core inflation is at its 2% targeted rate and the labor market continues to tighten. For these reasons, another rate hike of the same amount seems likely in December. On a positive note, though, Fed Chairman Jerome Powell does not see inflation surprising to the upside, which could limit the pace and number of future interest rate hikes beyond this year. At the same time, increased tariffs and the outbreak of a full-blown trade war could lead to higher prices, increased inflation and more aggressive tightening by the Federal Reserve, none of which would be favorable for the economy or the financial markets.
U.S. durable goods orders in August were much better than expected and consumer spending increased in line with estimates. Consumer confidence in September reached its highest level in about 18 years while the University of Michigan consumer sentiment index was above 100 in its final reading, only the third time since January 2004 that the index has topped 100. Both indices measure sentiment on current economic conditions and prospects for the next six months. New home sales rebounded in August and were better than expected and home prices rose in July but at the slowest pace of growth since last summer. The core personal consumption expenditures (PCE) index, the Fed’s preferred inflation measure, was unchanged in August and has risen 2% on a year-over-year basis.
The price of oil rose above $80 a barrel as the Organization of Petroleum Exporting Countries (OPEC) decided not to increase production at this time.
For the week, the Dow Jones Industrial Average declined 1.1% to close at 26,458 and the S&P 500 Index lost 0.5% to close at 2,913. The Nasdaq Composite Index added 0.7% to close at 8,046.
The most important piece of economic data to be released this week is the September employment report, which is expected to show that about 185,000 new jobs were created and that the unemployment rate edged lower to 3.8% from 3.9%. August construction spending and factory orders are both expected to rebound strongly from the previous month. Both the ISM manufacturing index and the ISM non-manufacturing or services sector index are forecast to still be comfortably in expansion territory.
The most prominent companies that are scheduled to report quarterly earnings this week are PepsiCo, Costco Wholesale, Constellation Brands, Lennar and Wageworks.
At its meeting last week, the Federal Reserve also issued its forecast for economic growth and interest rate policy over the next few years. After a final reading of 4.2% for second quarter GDP to go along with first quarter GDP growth of 2.2%, Fed officials are forecasting 3.1% growth for the full year, 2.5% in 2019 and only 1.8% in 2020 and 2021. Its projection for interest rate hikes calls for three increases of 25 basis points each (a basis point is one hundredth of one percent) in 2019 and one more such increase in 2020, which would bring the federal funds rate range to between 3% and 3.25%. In addition to tightening monetary policy, the Federal Reserve has also been reducing securities that it had purchased during its quantitative easing program on a monthly basis. Both the European Central Bank (ECB) and the Bank of Japan (BOJ) have signaled their intention to end their bond-buying programs, although they plan to keep interest rates low for the foreseeable future. While the economy is in no imminent danger of falling into a recession, one needs to be mindful of the fact that the majority of interest rate hike cycles have ended in a recession. The corporate tax cuts helped boost profits this year by almost twice the rate in 2017 but will make earnings comparisons much more difficult next year. The Federal Reserve must be careful not to raise interest rates too fast or it could run the risk of plunging the U.S. economy into a recession.