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Trade and interest rates bring volatility, but economic momentum remains key


August 2, 2019

Capital market volatility returned from its brief summer holiday, following an escalation in trade policy tension between the United States and China. On Thursday, President Donald Trump announced an additional 10 percent tariff on $300 billion worth of Chinese imports beginning September 1, marking an end to the trade war “truce” achieved between the United States and China at the Group of 20 (G-20) meeting in Osaka, Japan late last month. China responded to the surprise announcement with a vow to “take necessary countermeasures,” without indicating what specific policy action would be taken. The President later said the new taxes on imports could exceed 25 percent, which are expected to include popular consumer items such as mobile phones, laptop computers and children’s clothing. Investors are concerned that the breadth, depth and duration of these new potential tariffs threaten future economic growth and corporate earnings. This resulted in broad selling pressure across traditionally riskier parts of global assets.

The Federal Reserve (Fed) Open Market Committee, (FOMC) interest rate decision represents the other major policy event this week. The FOMC meeting concluded with the Fed cutting interest rates for the first time in 10 years. However, investors came away from the meeting and subsequent press conference with few assurances of further rate cuts, with Chairman Jerome Powell describing the cut as insurance against a global slowdown and trade-related issues, rather than the first in a longer cycle of easing. Further, two members of the voting committee dissented with the decision to cut rates at this time, indicating an increasing level of disagreement among committee members. This seems to make consensus for future policy potentially more difficult.

After ending last week at an all-time closing high of 3,026, stocks of large U.S. companies, as measured by the S&P 500, declined five consecutive days this week. Stocks fell 3.1 percent — the largest weekly loss in 2019. Over the same week and at the time of this writing, emerging market equities have fallen by 5.0 percent, foreign developed equities were down 2.8 percent, commodities fell 1.9 percent and high yield bonds moved lower by a modest 0.6 percent. However, other components of a diversified portfolio were positive this week: investment-grade bonds are up 0.9 percent, municipal bonds rose 0.5 percent, and real estate investment trusts (REITs) increased 0.4 percent.

Looking ahead

How do this week’s developments impact our views on the forward investment landscape? We have communicated extensively about our view that policy is the key driver of asset prices in the current environment. Given uncertainty surrounding how long the current United States/China trade impasse may last and uncertainty of the forward path of interest rates, the capital market reaction this week is understandable, although it could quickly become overdone. Sectors that have become flashpoints between the United States and China — Information Technology and Consumer Discretionary — were the worst performers this week. Meanwhile, Healthcare fell modestly, and the interest-rate sensitive Utilities sector rose during the week, with the U.S. 10-year Treasury yield falling to 1.85 percent, the lowest level in three years. This action suggests to us that investors who were used to the trade war truce and were anticipating a clear path to aggressive rate cuts were roused from their summer slumber.

Our chief concern, however, continues to look beyond this week’s capital market action and toward weakening economic momentum that appeared prior to unravelling trade negotiations. Our systematic data checks, which span more than 700 economic variables, have registered a slowdown, both outside the United States as well as within, albeit from a strong base. Recall that in 2017 and early 2018 the prevailing capital market narrative was one of “synchronized global growth.” However, in early 2018, China began to weaken, as did Europe and Japan, and eventually North America followed suit. Now, central banks around the world are responding to a global slowdown and trade-related policy frictions with a “synchronized global easing” of interest rates.

Should the trade war continue to escalate, CEOs, CFOs and consumers may slow down expansion and consumption decisions. This could exacerbate what we still forecast as a gradual slowdown. That behavior has not happened yet, and we are carefully monitoring indicators to assess whether the growth picture could weaken from here. In the United States, second quarter sales and earnings are coming in modestly above expectations, with approximately 75 percent of S&P 500 companies having reported. This indicates that we have to respect an adverse outcome, but we have not yet seen it in the corporate fundamental data. Moreover, the jobs market, including the July report released August 2, is supportive of consumers, key drivers of the U.S. economy.

As we have communicated in the past, we characterize the trade war as an “edgeless” phenomenon, meaning it is very difficult to forecast or handicap its outcome, including terms and timing. No matter how many people appear in the press as policy experts, these negotiations could end at any time or they could go on longer than anyone anticipates. Further, market volatility such as we’ve experienced this week can create many opportunities, which we constantly evaluate. Our job is to improve the odds of your success, and we think remaining diversified and disciplined within your financial plan is the best path for you. Please do not hesitate if we can answer any questions and we thank you for your trust.

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This information represents the opinion of U.S. Bank Wealth Management. The views are subject to change at any time based on market or other conditions and are current as of the date indicated on the materials. This is not intended to be a forecast of future events or guarantee of future results. It is not intended to provide specific advice or to be construed as an offering of securities or recommendation to invest. Not for use as a primary basis of investment decisions. Not to be construed to meet the needs of any particular investor. Not a representation or solicitation or an offer to sell/buy any security. Investors should consult with their investment professional for advice concerning their particular situation. The factual information provided has been obtained from sources believed to be reliable, but is not guaranteed as to accuracy or completeness. U.S. Bank is not affiliated or associated with any organizations mentioned.

Based on our strategic approach to creating diversified portfolios, guidelines are in place concerning the construction of portfolios and how investments should be allocated to specific asset classes based on client goals, objectives and tolerance for risk. Not all recommended asset classes will be suitable for every portfolio. Diversification and asset allocation do not guarantee returns or protect against losses.

Past performance is no guarantee of future results. All performance data, while obtained from sources deemed to be reliable, are not guaranteed for accuracy. Indexes shown are unmanaged and are not available for direct investment. The S&P 500 Index consists of 500 widely traded stocks that are considered to represent the performance of the U.S. stock market in general.

Equity securities are subject to stock market fluctuations that occur in response to economic and business developments. International investing involves special risks, including foreign taxation, currency risks, risks associated with possible differences in financial standards and other risks associated with future political and economic developments. Investing in emerging markets may involve greater risks than investing in more developed countries. In addition, concentration of investments in a single region may result in greater volatility. Investing in fixed income securities are subject to various risks, including changes in interest rates, credit quality, market valuations, liquidity, prepayments, early redemption, corporate events, tax ramifications and other factors. Investment in debt securities typically decrease in value when interest rates rise. This risk is usually greater for longer-term debt securities. Investments in lower-rated and non-rated securities present a greater risk of loss to principal and interest than higher-rated securities. Investments in high yield bonds offer the potential for high current income and attractive total return, but involve certain risks. Changes in economic conditions or other circumstances may adversely affect a bond issuer's ability to make principal and interest payments. The municipal bond market is volatile and can be significantly affected by adverse tax, legislative or political changes and the financial condition of the issues of municipal securities. Interest rate increases can cause the price of a bond to decrease. Income on municipal bonds is free from federal taxes, but may be subject to the federal alternative minimum tax (AMT), state and local taxes. There are special risks associated with investments in real assets such as commodities and real estate securities. For commodities, risks may include market price fluctuations, regulatory changes, interest rate changes, credit risk, economic changes and the impact of adverse political or financial factors. Investments in real estate securities can be subject to fluctuations in the value of the underlying properties, the effect of economic conditions on real estate values, changes in interest rates and risks related to renting properties (such as rental defaults).

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