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Stocks close lower as trade tensions with China continue

As in roulette, same is true of the stock trader, who will find that the expense of trading weights the dice heavily against him. – Benjamin Graham

The Dow Jones Industrial Average fell for the fifth consecutive week as the market continues to be held hostage by ongoing trade tensions between the U.S. and China. Since May 5th when President Trump escalated the trade war with China, the S&P 500 Index has declined 4.1%. During this time, investors have become more pessimistic that a trade agreement will be reached anytime soon as China seems in no hurry to get back to the table to resume talks. Whereas previously investors were confident that a deal would be struck in a timely manner, now there are fears that the trade war could get worse before it gets better. Last week there were reasons for both optimism and pessimism. The Commerce Department eased restrictions on Huawei, the giant Chinese telecommunications company, by allowing it to buy American-made products to maintain its existing networks, which should minimize disruption. President Trump also said that the ongoing trade war could be over quickly but declined to give any specific time frame or provide any reason for his outlook. But a Chinese trade representative fired back and said that trade talks can only continue if the U.S. adjusts its “wrong actions”. Tariffs clearly seemed to have a negative effect on retail earnings as Home Depot, Lowe’s and Nordstrom all reported lower than expected quarterly earnings. Target and Best Buy bucked the trend and beat analysts’ estimates but Best Buy also lowered its outlook for the year. While trade negotiators will probably reach a deal at some point, it now appears it will take much longer than first thought. Although economic fundamentals remain favorable, the stock market is unlikely to move appreciably higher unless there is resolution on trade.

Last Week

Sales of existing homes in April fell more than expected but the outlook for housing remains bright based on favorable market conditions, low mortgage rates and higher wage growth. April durable goods orders also declined more than expected due to a slowdown in exports and a buildup in inventories. Core capital goods, a reliable measure of business investment, dropped more than expected as manufacturing activity was hurt by the escalation of the trade war between the U.S. and China.

Minutes from the Federal Open Market Committee (FOMC) meeting in May showed that its members felt a patient approach was appropriate in determining the target range for the federal funds rate. They also felt that inflation would remain near its 2% target, accompanied by modest growth and a continued strong jobs market.

For the week, the Dow Jones Industrial Average dropped 0.7% to close at 25,585 and the S&P 500 Index  declined 1.2% to close at 2,826. The Nasdaq Composite Index fell 2.3% to close at 7,637.

This Week

The second estimate for first quarter gross domestic product (GDP) is expected to be revised lower from 3.2% to 3.1%. Both the May University of Michigan consumer sentiment index and the May consumer confidence index should remain at high levels. The Chicago Purchasing Manager’s Index (PMI) for May is expected to be solidly in expansion territory while the personal consumption expenditures (PCE) index in April, the Federal Reserve’s preferred inflation measure, is forecast to be less than 2%, the Fed’s inflation target.

Retailers will again headline this week’s earnings reports as Dick’s Sporting Goods, Abercrombie & Fitch, Dollar Tree, Dollar General, Gap and Costco Wholesale are scheduled to report.

Portfolio Strategy

With little in the way of economic data this week and with first quarter earnings season largely behind us, the focus will again be on trade tensions with China and their effect on growth. First quarter GDP growth is expected to be revised slightly lower and many economists have reduced their estimates for growth in the second quarter. JP Morgan now expects growth in the current quarter to be only 1%, down from its earlier forecast of 2.25%. Their economists cite weak manufacturing data and believe that the trade war with China is hurting business sentiment. Fears that tariffs are already having a negative effect on global growth have surfaced in the bond market. Last week yields on Treasuries fell to their lowest levels since 2017 as the 10-year yield ended the week at 2.32% and the 2-year yield declined to 2.16%. (Bond prices move inversely to yields). To reflect reduced growth expectations, the 3-month Treasury Bill yield of 2.35% exceeded the 10-year Treasury yield, an inversion that could portend a recession. The most important piece of economic data this week will be the personal consumption expenditures (PCE) index, the Fed’s preferred measure of inflation. Expectations are for a year-over-year gain of only 1.6% in April, well below the Federal Reserve’s target of 2%. With weaker than expected growth and lower than forecast inflation, investors are already talking about the possibility of the Fed lowering interest rates in order to revive the economy and prevent a recession. In fact, the futures market has begun to price in three Federal Reserve rate cuts by the end of 2020.