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Stocks close lower in volatile week on trade war fears

An investment operation is one which, upon thorough analysis, promises safety of principal and an adequate return. Operations not meeting these requirements are speculative. – Benjamin Graham

In a wild week on Wall Street that saw the S&P 500 Index plunge 3% on Monday, the stock market managed to claw its way back and end the week only modestly lower. The focus again last week was the ongoing trade war with China as second quarter earnings and economic data were merely an afterthought. Monday’s losses were triggered after Chinese authorities let their currency, the yuan, weaken below its lowest level against the dollar in more than ten years. The move was designed to help China offset the negative effects of tariffs imposed by the U.S. As a result of their action, the Treasury Department designated China as a currency manipulator and claimed that China was using its currency as a weapon in the trade war. The war of words also heated up as China said that it would no longer purchase U.S. agricultural products and the U.S. retaliated by saying that government agencies would no longer buy equipment from Huawei, the giant Chinese technology company. Cooler heads prevailed as the week wore on, though, as China set its currency at a higher level versus the dollar, easing trade tensions. There also was positive trade data out of China as their exports rose over 3% year-over-year, which was much better than expected. Despite the harsh rhetoric by both sides, trade negotiations are still scheduled to resume next month even though the Trump administration has threatened to impose 10% tariffs beginning on September 1st on $300 billion of Chinese goods that are currently not subject to tariffs. But increasing trade tensions dimmed the outlook for global economic growth and bond yields across the world fell. The yield on the 10-year Treasury dropped below 1.6% during the week and the spread between the 10-year yield and the 2-year yield narrowed to the lowest level since 2007.  While the 10-year yield recovered and finished the week at 1.74%, slowing global growth caused by trade uncertainties may prompt the Federal Reserve to lower interest rates when it meets again in September.

Last Week

The ISM non-manufacturing or services sector index fell in July and posted the slowest pace of expansion in three years. The producer price index (PPI) in July edged slightly higher and through the 12 months ending in July, it has increased 1.7%. The core PPI, which excludes food and energy, actually declined slightly. Weekly jobless claims fell by 8,000 to 209,000 as the labor market continues to be strong.

For the week, the Dow Jones Industrial Average declined 0.7% to close at 26,287 and the S&P 500 Index dropped 0.5% to close at 2,918. The Nasdaq Composite Index fell 0.6% to close at 7,959.

This Week

The July consumer price index (CPI) is expected to increase modestly and be higher than in June while July import prices are expected to be flat. Retail sales in July are also forecast to show a modest gain as are housing starts for the month. The August preliminary University of Michigan consumer sentiment index is expected to remain high consistent with the level in July.

Among the most prominent companies scheduled to report quarterly earnings this week are Sysco, Macy’s, Walmart, JC Penney, Advance Auto Parts, Briggs & Stratton, Deere & Co., Nvidia, Agilent Technologies, Applied Materials, Cisco Systems and Barrick Gold.

Portfolio Strategy

Although the yield on the 10-year U.S. Treasury sank to only 1.74% last week, it is still much higher than the 10-year bond yield of other major countries. Japan, Germany and France have negative 10-year bond yields while the United Kingdom has a 10-year bond yield of just 0.48%. As global bond yields have plunged, real estate investment trusts or REITs have benefited by rising more than 20% this year. The Vanguard REIT ETF (VNQ), which tracks the MSCI U.S. REIT Index, has posted a year-to-date total return through August 9th of 23.9%, handily outperforming the S&P 500 Index return of 17.8%. This ETF invests in companies that purchase properties such as office buildings, hotels, apartment buildings, shopping centers, storage facilities and health care facilities. One of the requirements for REITs is that they pay out at least 90% of their taxable income in dividends to shareholders. For this reason, their primary objective is to offer shareholders an attractive level of income as the average current yield for REITs is about 4%. By comparison, the current dividend yield of the S&P 500 Index is only about 2%. While this year’s strong performance is the exception rather than the rule, many REITs have excellent cash flow that they can use to increase dividends. REITs also tend to behave differently than equities and provide diversification that reduces the risk of owning stocks and bonds in a portfolio.

Since I will be on vacation the week of August 19th, the next newsletter will not be sent until Monday August 26th. Have a great week!