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Dow falls for 6th straight week on trade war fears

Today people who hold cash equivalents feel comfortable. They shouldn’t. They have opted for a terrible long-term asset, one that pays virtually nothing and is certain to depreciate in value. – Warren Buffett

Trade tensions continued to take their toll on the stock market last week as all three major averages closed lower. For the Dow Jones Industrial Average, it was the sixth consecutive weekly loss, making it the longest losing streak since 2011. The market has gone from thinking that there would definitely be a trade deal with China to now thinking that there won’t be one. To retaliate against the U.S., it was reported that China was considering restricting the export of its vast supply of rare-earth minerals used in the production of devices such as mobile phones, computer memory chips and rechargeable batteries. If an escalating trade war with China wasn’t bad enough, news on Friday that President Trump threatened to impose tariffs on Mexico until illegal immigration across the southern border is stopped came as a total surprise to the markets. Mexico is one of the largest U.S. trade partners and it is hoped that this latest threat does not become a reality. All of this uncertainty on trade and tariffs is causing investors to question global growth. The bond market is sending a signal that the economy is slowing which, in turn, is sending stocks lower. (Bond yields move inversely to prices.) Last week the yield on the 10-year Treasury fell to 2.14%, the lowest yield since September 2017 while the yield on the 2-year Treasury fell below 2% to 1.95%. The relationship between the two yields is still positive and upward-sloping, suggesting that a recession is not likely. But the 3-month Treasury Bill yield of 2.35% is higher than the 10-year Treasury yield, denoting an inversion of the yield curve which historically has preceded a recession. All of this uncertainty is negatively affecting stock prices and causing bond prices to increase and bond yields to decline as investors seek safety in the form of fixed income investments. The sooner trade issues are resolved, the better off both markets will be.

Last Week

High consumer confidence and a strong labor market suggest that the yield curve is sending a false signal and last week’s data provide evidence of that. Consumer confidence in May rose to a 6-month high as a strong labor market will likely support higher consumer spending and keep the economy expanding. Weekly jobless claims were in line with estimates and the rate of layoffs remains near a 50-year low. First quarter GDP growth was revised slightly lower from 3.2% to 3.1% and pending home sales in April fell slightly and were lower than expected.

For the week, the Dow Jones Industrial Average dropped 3% to close at 24,815 and the S&P 500 Index  declined 2.6% to close at 2,752. The Nasdaq Composite Index fell 2.4% to close at 7,453.

This Week

The employment report for May is expected to show that about 185,000 new jobs were created and that the unemployment rate remained at 3.6%. The ISM Purchasing Manager’s Index (PMI) for May is expected to be solidly in expansion territory, marking 10 years and 1 month of consecutive economic expansion in the manufacturing sector, according to this index. April construction spending is forecast to rebound modestly after falling in March while April factory orders are forecast to drop after posting a big increase last month.

It will be a very light week for quarterly earnings reports and the most notable companies on the agenda include Tiffany, American Eagle Outfitters, Gamestop, Vera Bradley, Ciena, Campbell Soup and JM Smucker.

Portfolio Strategy

Lost in the trade war with China and the looming conflict with Mexico could be the employment data that will be released on Friday. Normally this report takes center stage and is closely monitored since it provides important clues about the strength of the U.S. economy. Estimates call for another solid jobs number of about 185,000 and for the unemployment rate to remain at 3.6%, a 50-year low. As significant as this piece of economic data usually is, it will likely take a back seat this week to the latest tariff threat against Mexico and the ongoing trade tensions with China, which show little sign of ending anytime soon. China and Mexico are two of the largest trading partners of the U.S. and countless U.S. jobs are tied either directly or indirectly to trade with Mexico. Higher tariffs could increase the cost of numerous products for consumers and businesses, leading to higher inflation and slower economic growth, which ultimately would affect corporate profits. If the tariffs are imposed on Mexico, they would not be implemented until June 10th, which gives Mexico time to respond and take appropriate action. Either way, this latest threat against Mexico coupled with the standoff with China only adds to the uncertainty about global growth and could harm consumer confidence and discourage businesses from investing. The strong labor market has been one of the pillars of the longest expansion in U.S. history, but that could end if these trade wars continue through the summer.

Since I will be out of the office on vacation for the next two weeks, the next Weekly Market Commentary will be sent on Monday June 24th.