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Stocks close lower as China trade war tensions escalate

Outperforming the majority of investors requires doing what they are not doing. Buying when others have despaired, not selling when they are full of hope, takes fortitude. – John Templeton

What looked like solid gains for the major stock averages through Thursday last week turned into losses of at least 1% as President Trump took to Twitter on Friday. Although he criticized Federal Reserve Chairman Jerome Powell again for not cutting interest rates more, he also escalated the trade tensions with China by ordering that U.S. companies find alternatives for their operations in China.  This tweet came after China announced on Friday morning that it would implement new tariffs on another $75 billion worth of U.S. goods that will range between 5% and 10% and be imposed in two stages on September 1st and December 15th. Trump retaliated in this tit for tat trade war by raising tariffs by another five percentage points on Chinese goods. All of this was not lost on the Fed as Jerome Powell said in a speech that the Federal Reserve will take the necessary monetary steps to sustain the economic expansion. While he emphasized that there is no rule book for the current U.S.-China trade war, the Fed is prepared to cut interest rates at its meeting in September to maintain growth and bolster the economy. But there were fears last week that lowering interest rates may not have the desired effect of reigniting the economy. The Treasury yield curve, or the difference between short-term interest rates and longer-term  rates, briefly inverted again last week and ended the week on Friday with the 2-year Treasury yielding 1.51% and the 10-year Treasury yielding 1.52%, a difference of only one basis point. (A basis point is one hundredth of one percent). The flat yield curve suggests that the economy is slowing and the low bond yields are indicative of a near-certain interest rate cut by the Federal Reserve at their meeting in September. Consumer spending, which accounts for nearly 70% of total economic activity, continues to be strong, though, as Home Depot, Lowe’s and Target all reported better than expected quarterly earnings last week. The trade war with China is uppermost in investors’ minds, however, and this uncertainty is likely to weigh on sentiment and create volatility in the markets over the near-term.

Last Week

July existing home sales were better than expected due to lower mortgage rates and a strong labor market while July new home sales fell by nearly 13%. The pace of new home sales in June was increased to a 12-year high, though, and homebuilders were more optimistic about future sales. U.S. leading economic indicators rose in July after two straight monthly declines, pointing to moderate growth in the second half of the year.

Minutes from last month’s Federal Reserve meeting showed that the most recent Fed interest rate cut was not part of a “pre-set course” for future cuts but a “recalibration” in response to changing economic conditions. The Fed also acknowledged that tariffs were seen as a “persistent headwind” to economic growth.

For the week, the Dow Jones Industrial Average declined 1.0% to close at 25,628 and the S&P 500 Index dropped 1.4% to close at 2,847. The Nasdaq Composite Index lost 1.8% to close at 7,751.

This Week

The personal consumption expenditures (PCE) index, the Fed’s preferred measure of inflation, is expected to rise by 1.4% year-over-year in July. Durable goods orders in July are expected to increase modestly but be less than June’s increase while the revised second quarter GDP estimate should be 2.1%, the same as the original estimate. Consumer confidence in August is expected to remain near its highs for the year as consumers remain upbeat about the economy and their job prospects.

Among the most notable companies scheduled to report quarterly earnings this week are Eaton Vance, Autodesk, Hewlett Packard Enterprise, Dell Technologies, Tiffany, Williams-Sonoma, Dollar Tree, Dollar General, Abercrombie & Fitch, JM Smucker, Campbell Soup, H&R Block and Best Buy.

Portfolio Strategy

With bond yields at historic lows and volatility increasing in the stock market, exchange-traded funds (ETFs) that emphasize stocks of companies that pay above-average dividend yields or have consistently increased their dividend offer investors a way to generate income with less risk. While these funds typically trail the S&P 500 Index in up markets, they tend to outperform this benchmark when volatility increases and markets fall. Three of these so-called dividend ETFs that have excellent track records include the iShares Core High Dividend ETF (HDV), the SPDR S&P Dividend ETF (SDY) and the ProShares S&P 500 Dividend Aristocrats ETF (NOBL). HDV tracks an index of high quality dividend-paying domestic stocks and has a dual investment objective of capital appreciation and income. It currently has 75 holdings and a dividend yield of 3.5%. For consistent dividend growers, the ProShares S&P 500 Dividend Aristocrats ETF (NOBL) tracks an index with the same name and invests in blue chips that have paid dividends and grown them for at least 25 consecutive years. These companies have stable earnings, solid fundamentals and strong histories of profits and growth. This ETF has captured most of the upside of stock market gains in rising markets and fewer losses in falling markets. The current yield of this ETF is about 2.1%. Finally, the SPDR S&P Dividend ETF (SDY) invests in both high-dividend paying stocks as well as in companies that have consistently increased their dividends for 20 straight years. The current yield of this fund is about 2.5%. For investors looking to maximize their total return without taking on too much additional risk, dividend-oriented ETFs provide a low cost, tax efficient way to accomplish this.