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S&P 500 closes lower on trade concerns, Fed policy worries

Based on my own personal experience – both as an investor in recent years and an expert witness in years past – rarely do more than three or four variables really count. Everything else is noise. – Martin Whitman, American investment adviser who founded Third Avenue Funds

The stock market’s two-week winning streak came to an abrupt halt last week as both the Dow Jones Industrial Average and the Nasdaq Composite Index fell more than 2%. The S&P 500 Index fared a little better but also closed lower on concerns about global trade and tariffs, Federal Reserve interest rate hikes and the prospect of slowing worldwide economic growth. While the Trump administration’s top priority has become reaching a trade deal with China, worries persist that an agreement may not be reached at the G-20 summit meeting at the end of the month. The conflict between the two countries goes beyond trade to technology, intellectual property and market access, all of which have weighed heavily on investor sentiment. There were reports last week that China delivered a written response to U.S. trade demands and that any new tariffs were on hold. This news was a positive development but not enough to lift stocks out of the red for the week. Also on investors’ minds is the Federal Reserve and the direction of monetary policy. Dovish comments by Fed Chair Jerome Powell last week were well-received, but an interest rate hike in December is still all but certain. A policy mistake by the Federal Reserve could result in a recession and the flattening yield curve (the difference between short-term interest rates and long-term interest rates) bears watching. Treasury yields fell last week and the difference between the 2-year and the 10-year is only 27 basis points. (A basis point is one hundredth of one percent). The bear market in oil is also worrisome. The drop in the price of oil, which plunged over 6% last week, has been caused by increased supply from U.S. shale fracking as well as weaker demand. This price decline may be signaling that the global economy is slowing. Recent economic data out of Germany, Japan and China have not been encouraging, either, and the concern is that slower economic growth eventually reaches our shores.

Last Week

As expected, the consumer price index (CPI) in October rose moderately but the core CPI, which excludes food and energy, posted only a modest increase and has risen only 2.1% in the last 12 months. U.S. import prices in October were higher than expected, but they actually declined slightly when food and energy were excluded. U.S. retail sales rebounded sharply in October and were better than expected, helped by a strong labor market, higher wage growth and elevated consumer confidence levels. Weekly jobless claims rose by only 2,000 to 216,000, higher than forecast, but still consistent with a strong labor market with very few layoffs.

For the week, the Dow Jones Industrial Average lost 2.2% to close at 25,413 and the S&P 500 Index dropped 1.6% to close at 2,736. The Nasdaq Composite Index declined 2.1% to close at 7,247.

This Week

October housing starts and existing home sales are expected to be in line with the numbers reported in September as the housing market remains on solid footing. October durable goods orders, which can be volatile from month to month, are expected to drop slightly while leading economic indicators in October are forecast to increase slightly.  The final November University of Michigan consumer sentiment index should show that consumer confidence remains very high.

U.S. markets are closed for Thanksgiving on Thursday November 22nd and will close early on Friday.

For the second straight week, retailers will dominate the earnings calendar as the Gap, TJX Cos., Lowe’s, Kohl’s, Best Buy, Target and Barnes & Noble are scheduled to report. Other prominent companies on the list include Deere & Co., Medtronic, Agilent Technologies, Analog Devices, Autodesk and Campbell Soup.

Portfolio Strategy

Although third quarter earnings have been strong and recent economic data has been mostly favorable, the stock market has fallen due to concerns over global trade and Federal Reserve monetary policy and their potential negative effects on the economy. The Federal Open Market Committee (FOMC) has increased the short-term federal funds rate three times this year to its current range of between 2% and 2.25% and is widely expected to raise this rate by 25 basis points in December. Next year’s forecast calls for an additional three rate hikes as Fed Chairman Jerome Powell recently remarked that interest rates are a long way from neutral. Defining what the term neutral means is critical, but many believe that 3% is probably a reasonable target in this current environment. With economic growth projected to slow next year and with inflation under control, Powell would be justified in taking a less aggressive approach to tighter monetary policy, as he intimated in a speech last week. The other obstacle facing the stock market has been the lack of a trade agreement between the U.S. and China and the imposition of tariffs with the prospect of even more tariffs. Serious discussion between President Trump and Chinese President Xi Jinping about trade and a resolution of their differences at the G-20 summit meeting would eliminate this uncertainty that has been plaguing the stock market. China’s economy may be slowing but government stimulus could make it stronger and even though the U.S. economy is expected to soften, no recession is expected in the foreseeable future. Under this scenario, a more dovish Fed coupled with a U.S. and China trade agreement could ignite a rally in stocks.