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S&P 500 falls as trade war uncertainty trumps Fed rate cut

The best thing that happens to us is when a great company gets into temporary trouble…We want to buy them when they’re on the operating table. – Warren Buffett

Once again it was trade-related tensions with China that ultimately determined whether or not the stock market was positive or negative last week. Through the close of business on Thursday, stocks were basically flat despite an attack on Saudi Arabia’s oil production facilities and a widely-expected interest rate cut by the Federal Reserve. Lower level trade negotiations between the U.S. and China resumed last week that were intended to lay the groundwork for high-level negotiations next month. But on Friday, Chinese trade officials abruptly cancelled a planned visit to a Montana farm, fueling speculation that trade talks did not go well. The S&P 500 fell about a half of one percent, which was the loss suffered by this benchmark for the entire week. After drone strikes took out about half of Saudi Arabia’s oil production on September 15th, the price of oil rose more than 10% and stocks fell as investors feared that higher oil prices could slow the economy further. Later in the week, though, stocks recovered after Saudi Arabia’s energy minister said that the country’s oil supply would be back online by the end of the month. The Federal Reserve also didn’t disappoint investors as it cut the federal funds rate by a quarter of one percent to a range of between 1.75% and 2.00%. The Fed cited “implications of global developments for the economic outlook as well as muted inflation pressures” as rationale for the cut but gave no clear signal for further interest rate cuts. Fed members were about equally divided among three different choices: keeping rates unchanged with no rate cut, cutting rates by 25 basis points but agreeing to no further cuts this year and cutting rates now with at least one more cut this year. But Federal Reserve Chairman Jerome Powell and the other members seemed to be in complete agreement that the Fed would not resort to negative interest rates even during a crisis. The only other thing that seemed certain was that uncertainty created by the trade war would continue to affect the economy and the stock market over the near-term.

Last Week

Leading economic indicators were unchanged in August after a big increase in July as strong housing permits offset weakness in the manufacturing sector. The data suggests that the economy should continue to grow modestly, boosted by strong consumer spending and healthy job growth. Housing starts surged in August and were better than expected while existing home sales rose to their highest level in 17 months, helped by lower mortgage rates, low unemployment, rising wages and slower home price inflation. Weekly jobless claims rose only slightly as layoffs remain low.

Negotiations between General Motors and the United Automobile Workers broke down as workers went on strike over issues involving pay, job security, pension contributions and GM’s plant closure policy.

For the week, the Dow Jones Industrial Average declined 1% to close at 26,935 and the S&P 500 Index fell 0.5% to close at 2,992. The Nasdaq Composite Index dropped 0.7% to close at 8,117.

This Week

August new home sales are expected to be higher than those in July while durable goods orders in August are forecast to decline slightly after a modest increase in the previous month. Consumer confidence data for September should remain elevated and the final reading of second quarter GDP should remain at 2.0%. The personal consumption expenditures (PCE) index, the Fed’s preferred inflation gauge, is expected to rise 1.4% year-over-year in August.

The most notable companies slated to report quarterly earnings this week include Nike, ConAgra Brands, CarMax, AutoZone, Cintas, KB Home, Accenture and Micron Technology.

Portfolio Strategy

Last week the Federal Reserve followed the European Central Bank (ECB) and the Bank of Japan (BOJ) in a race to the bottom after it lowered its benchmark interest rate by 25 basis points to a range of between 1.75% and 2.00%. But unlike Europe and Japan, which currently have negative benchmark interest rates, the U.S. still has a positive federal funds rate after the second rate cut this quarter. In his press conference after the meeting, Fed Chairman Powell could not see a reason why the Fed would use negative interest rates as a monetary policy tool. Federal Reserve members were optimistic about the future despite the rate cut, forecasting GDP growth of 2.2% for this year and inflation running at 1.8%, slightly below the Fed’s target. While the Fed acknowledged the trade uncertainty and the recent weakness in Europe and China, it was sanguine about the U.S. economic outlook due to strong consumer spending, a healthy housing sector, a robust jobs market and high consumer and business confidence. Chairman Powell also dismissed the recent yield curve inversion that sparked recession fears as being caused primarily by strong global demand for U.S. Treasuries and market sentiment. With over $17 trillion in negative-yielding bonds around the world, it’s no surprise that investors would flock to the U.S. Treasury market with its much higher yields. After plunging to about 1.50% recently, the yield on the 10-year Treasury has risen to 1.75% and the yield curve (the difference between the 2-year and the 10-year) has again become positive, albeit by only 6 basis points. (A basis point is one hundredth of one percent). Further rate cuts are not a sure thing and Chairman Powell and the Federal Reserve will take a wait and see approach with regard to future economic data before making any monetary policy decisions.