A New World of Volatility

Domestic stocks recorded solid gains last week and reversed the previous week’s losses. Markets remained volatile, however, as traders appeared to remain focused on the turbulent political environment rather than the upcoming release of first-quarter corporate earnings reports. The tech-heavy Nasdaq performed best, helped by a rally in Facebook shares as traders seemed to react favorably to Facebook CEO Mark Zuckerberg’s testimony before Congress on Tuesday and Wednesday. While tech shares performed well, energy stocks led the gains in the S&P 500, helped by a rally in crude prices to their highest level since late 2014. For the first time in many years a small geopolitical risk premium seems imbedded in oil prices. Real estate and utilities shares lagged as longer-term bond yields increased, making their relatively high dividends less appealing in comparison.

Concerns over growing trade tensions with China continued to weigh on sentiment, although traders appeared to grow more optimistic that a full-scale trade war involving the world’s two largest economies would be averted as the week progressed. Stocks rose at the start of trading on Monday, helped by President Donald Trump’s somewhat softer stance on trade issues over the weekend. Chinese President Xi Jinping provided another boost to sentiment later in the week after he repeated a vow to ease access to sectors ranging from banking to auto manufacturing and to protect intellectual property in a “new phase of opening up.”

Even as the trade backdrop brightened a bit, new geopolitical clouds darkened the horizon. Stocks fell sharply in early trading Tuesday, following a tweet from President Trump threatening a missile strike on Syria in response to the Assad regime’s apparent chemical attack on dissident areas the previous weekend. Traders also appeared to be unsettled by tweets from the President attacking the Mueller investigation following the FBI’s seizure of documents from his personal attorney and “fixer,” Michael Cohen. Stocks rallied on Thursday after the President appeared to calm tensions on both fronts, tweeting that a Syria strike might not be imminent and that he would have already fired Mueller if he were planning to do so. Reports also surfaced on Thursday that the President was considering having the U.S. re-enter the Trans-Pacific Partnership, a multilateral trade agreement that could offer lower trade barriers to U.S. exporters, despite having recently withdrawn from it, which was seen as very good news.

Friday brought the release of the first major first-quarter earnings reports, with JPMorgan Chase, Wells Fargo, and Citigroup all declining in early trading despite topping analysts’ estimates. Due in part to recent corporate tax cuts, expectations for first-quarter profit growth are high, with analysts polled by FactSet anticipating that earnings for the S&P 500 as a whole will rise more than 17 percent on a year-over-year basis. If realized, this would be the strongest earnings performance since 2011, also per FactSet. Note, however, that the impact of the tax cuts on year-over-year earnings comparisons will inevitably be temporary.

Early Saturday brought the expected but discounted air strikes on Syria by American, British and French forces. This may now be a key driver of market action going forward, especially if more strikes are forthcoming. Early futures trading after the strikes on Saturday were sharply negative, but it of course remains to be seen how price action develops when full-on trading returns on Monday.

Longer-term bond yields increased last week, with much of the move coming on Thursday, after the release of data showing a drop in weekly jobless claims. Last week’s claims came in under 300,000 for a record 162nd consecutive week, the longest such stretch on record dating back to 1967. Given that streak, some are perplexed that wage gains remain muted. One possible reason for the lack of wage pressure is the labor participation rate of 62.9 percent, considerably lower than the 35-year average of 65.5 percent, which peaked in January 2000 at 67.3 percent.

The minutes from the latest Federal Reserve policy meeting did not seem to have a significant impact on markets despite confirming that Fed officials were contemplating a slightly faster pace of rate hikes as they grew increasingly confident that the inflation rate was moving up toward their 2 percent target. Most analysts continue to believe that the Fed will raise rates at least two more times in 2018, with a third hike possible.

With geopolitical tensions in focus, European stock markets also ended last week higher as the start of earnings season and positive economic news countered some investor reluctance about the relative attractiveness of equity markets. Still, trading volumes were generally low, as traders seemed more comfortable sitting on the sidelines. As in the U.S., concerns about the prospects of a trade war or the ramifications of a military confrontation centered on Syria ebbed as the week progressed.

The pan-European STOXX 600 Index advanced around 1 percent for the week. Germany’s exporter-heavy DAX 30 also rose for the week, despite news that the country’s exports plunged in February, largely due to a strengthening euro. German markets were supported by news that consumer price inflation accelerated in March, and they were also lifted by a report that China’s imports increased in the latest period. The UK blue-chip benchmark, the FTSE 100 Index, also rose about 1 percent, but the index has been underperforming its European counterparts largely due to the strong pound, which weighs on the companies that convert non-UK profits back into the sterling. Benchmark indexes in Spain, France, and Italy also ended the week higher.

In Asia, Chinese stocks advanced last week as the easing of trade-related tensions between the U.S. and China was good news there too, even as both sides struggled to reach a resolution. As noted above, China’s President Xi Jinping pledged to increase market access for foreign financial services companies and to relax foreign investment restrictions in other sectors. In Japan, large-cap stocks posted gains, but small-caps were little changed for the week.

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Volatility See-Saw

Rising interest rates, concerns over inflation, a rout in tech stocks, a less than great jobs number, and (especially} fears of a trade war with China have dragged U.S. equity markets lower and spurred one of the most sustained bouts of market turbulence in years. The volatility marked a sharp reversal from the prolonged period of calm that had kept Wall Street’s “fear gauge,” the CBOE Volatility Index, or VIX, near record lows. The VIX is up more than 70 percent since the start of the year. Traders have been buying futures contracts pegged to the VIX in the past two weeks, betting on continuing volatility.

The major domestic equity benchmarks ended last week lower after another week of significant volatility. Consumer discretionary and energy stocks fared less poorly, while health care, industrials, financials and tech shares lagged. President Donald Trump continued his Twitter attacks on Amazon, but Amazon’s stock recouped a portion of its recent losses at midweek before falling again in Friday’s broader sell-off. The week was also notable for the initial public offering of streaming music company Spotify.

Heightened trade tensions between China and the U.S. continued to dominate sentiment during the week. Stocks sold off sharply on Monday, following China’s announcement that it would retaliate on U.S. aluminum and steel tariffs with $3 billion in new tariffs of its own, targeting roughly 130 U.S. products and concentrated on agricultural exports. On Tuesday, the U.S. further upped the ante, outlining a list of $50 billion in proposed tariffs on 1,300 Chinese products, and China responded on Wednesday with its own $50 billion list of tariffs on U.S. soybeans, cars, and aircraft.

Throughout the middle of the week, traders took the tit-for-tat trade announcements in stride, as Commerce Secretary Wilbur Ross and President Trump’s new chief economic advisor, Larry Kudlow, sought to downplay the economic impact of the tariffs and suggested that further negotiations with China lie ahead. Traders were also encouraged by a Bloomberg report that President Trump might announce a tentative deal on a renegotiated North American Free Trade Agreement (NAFTA) at the Summit of the Americas in mid-April.

Market patience reached a breaking point on Thursday evening, however, after President Trump raised the stakes even further by ordering the consideration of an additional $100 billion in tariffs on Chinese goods. Stocks futures fell in response, and on Friday morning, Chinese officials struck back, which was a notable departure from their delayed and guarded response to earlier U.S. tariff announcements. Commerce Ministry spokesman Gao Feng threatened a “fierce counter strike” and stated that negotiations were unlikely in the current environment. U.S. stocks fell further in response.

With the announcement yesterday that he’s considering $100 billion more tariffs on Chinese goods (about which Republican Sen. Ben Sasse of Nebraska said, “He’s threatening to light American agriculture on fire. … This is the dumbest possible way to do this”), President Trump created confusion within his administration and abroad because of a negotiating style he has used his entire adult life and outlined in his book, The Art of the Deal. You might call it “governing by bluff.” For example, he threatened to veto a spending bill that conservatives hate, then signed it. He announced stiff tariffs on imports of steel and aluminum, then the administration started negotiating big carve-outs. He publicly talks of war with North Korea, then agrees to meet with Kim Jong-un. He muses openly of replacing top aides, including White House Chief of Staff John Kelly, then lets them stay.

Unlike most politicians, the President sees the “announcement” not as the rollout of a policy, but as the starting point for negotiations. A word Mr. Trump uses all the time privately, and sometimes publicly, is “flexible.” Everything is up for negotiation. Everything is zero sum. And he always wants a scorecard, to know minute-by-minute who is “winning.” With foreign countries like China, his scorecard is the trade deficit. Aides like former chief economic advisor Gary Cohn spent 14 months trying to explain to Mr. Trump why economists and market experts don’t see trade deficits as a win-loss ratio, but they failed to change his mind. So the bluff is really just his extreme, gambler’s negotiating style: Make a maximalist ask, frame the debate around that, and go from there, improvising all the way.

This approach had a mixed record in his business career, with some obvious successes. Its most spectacular failure was in Atlantic City, where his casinos went belly-up and he temporarily gave his life over to his creditors. It’s too early in his presidency to tell definitively whether his negotiating tactics will work in international relations, of course. As Eurasia Group’s Ian Bremmer points out, Mr. Trump has already gotten some concessions out of the Chinese and South Koreans, so the approach has worked, at least to a point.

That said, a bluff can only work when one has a history of following through. Mr. Trump has followed through on his threats enough that it’s impossible to determine what he’s really thinking, which seems to be his point. The president tossing his papers in the air during an appearance Thursday in West Virginia — saying it was the “boring” speech he was supposed to give on tax cuts — was a remarkably apt metaphor. Mr. Trump’s carefully crafted unpredictability may give the President leverage and keep people guessing, but it also stirs wild uncertainty and market volatility pretty much every single day.

For Mr. Trump, however, the tiff with Amazon isn’t just business—it’s personal. Fueling his ire is not so much Amazon itself, but Jeff Bezos, the company’s CEO, who also owns The Washington Post, whose coverage the president dislikes, people close to the White House say. It also almost certainly matters that Bezos is a lot richer – more than 35 times richer – than the President.

Friday also brought the monthly jobs report. The unemployment rate held steady at a 17-year low of 4.1 percent. However, the U.S. gained just 103,000 new jobs in March, less than the 170,000 consensus estimate, to mark the smallest increase since last fall, but also the tightest labor market in nearly two decades. Job openings are at a record high and big and small firms alike say they plan to add more workers. Although the number of new jobs created slowed sharply from February’s revised 326,000 increase, the U.S. still added an average of 202,000 jobs a month in the first quarter of 2018. That’s still faster than the average gains in 2017 and 2016.

The yield on the benchmark 10-year U.S. Treasury note rose following the employment report, although it fell back later on Friday amid the heightened trade rhetoric and ended the week modestly higher. Expectations for Fed tightening fell slightly during the week but at least two more rate hikes are generally expected in 2018.

European and Japanese stocks also weathered a volatile week as trade hostilities between the U.S. and China were the big news there too. The pan-European STOXX 600 Index ended the week higher due to a rally on Thursday that produced the biggest one-day percentage gain in nearly two years, according to FactSet data. Germany’s export-heavy index DAX 30 and France’s CAC 40 ended the week higher, fueled by their biggest one-day gains since April 2017. Chinese stocks, however, fell roughly in proportion to domestic U.S. losses. A trade war may be good politics, but it is bad for everyone economically and more markets.

If you are curious about what the U.S. economy looks like at full tilt,you might check out Elkhart, Indiana. The self-proclaimed RV capital of the world, which nine years ago had the country’s worst unemployment rate, offers up an intriguing view of what is possible: Area high-school students skip college for factory jobs that offer great pay and benefits. For-hire signs sprout like roadside weeds. And workers are so flush that car dealers can’t keep new pickups on the lot. However, strains are showing. Employers can’t hang on to their employees, and house prices are soaring. The worker shortage prompted a local KFC restaurant to offer $150 signing bonuses. A McDonald’s failed to open for lunch because managers couldn’t corral enough hands at $8 an hour to serve the lines waiting at the door. No place in the U.S. has seen a labor-market turnaround like this metropolitan region of 110,000 workers, a mix of blue-collar whites, Mexican immigrants and Amish. “It’s like 1955. If you show up and have minimal literacy skills, you can find a job here,” said Michael Hicks, an economist at Ball State University.

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Tech Concerns Remain

Domestic stocks recovered some of the previous week’s steep losses last week and recorded solid gains. The week was most notable for a sell-off in high-valuation tech companies, however, which caused the Nasdaq to lag the other benchmarks. A steep drop in Amazon shares caused the consumer discretionary sector to join tech and energy stocks among the week’s laggards in the S&P 500. Typically defensive consumer staples stocks performed well, on the other hand, as did real estate and utilities, whose heavy dividends became more attractive as long-term bond yields decreased.

Last week got off to a very strong start as the trade war fears that led to much of the previous week’s volatility appeared to fade somewhat. Traders were encouraged by China’s decision — for the time being, at least — not to establish retaliatory tariffs on its imports of U.S. soybeans and commercial aircraft. Reports of talks between Chinese and U.S. officials on opening the Chinese market to U.S. goods and protecting U.S. firms’ intellectual property rights were also encouraging. Monday saw the S&P 500 notch its best daily gain since August 2015, even though trading volumes were disappointing, perhaps reflecting a lack of broad conviction in the rally.

The market gave back a good portion of its gains on Tuesday with a late-day sell-off in tech. The primary culprit appeared to be a report that the Trump administration was considering a crackdown in Chinese investments in U.S. firms with tech deemed necessary to national security. Speculation has grown that the administration is pushing back against the Chinese government’s plans to dominate emerging tech and industrials, such as artificial intelligence.

Other factors also contributed to volatility in tech-related shares throughout last week. Worries about the safety of self-driving cars following a fatal pedestrian accident the previous week caused semiconductor maker Nvidia to announce that it was suspending its own experiments with the technology, leading to a sharp drop in the shares of one of 2017’s top market performers. Tesla shares also sank as investors reacted to a fatal crash in one its cars, although it remained unclear whether the vehicle’s self-driving mode had been engaged at the time.

Meanwhile, controversy over the use of customer data continued to weigh on Facebook shares, particularly after the announcement of a Federal Trade Commission investigation into the issue — a contagion that seemed to spread to Twitter. Amazon shares suffered from worries about antitrust or other regulatory action against the company following a report on Wednesday that President Trump was “obsessed” with the company. Tech shares got some relief on Thursday, as Microsoft stock rose following reports of a coming reorganization at the company. However, this confluence of problems has fed a media narrative that the tech industry is headed for a sea-change moment where investor cash dries up and consumer interest cools. This week, Andrew Ross Sorkin of The New York Times asked if we are “witnessing the end of a tech boom.”

Volatility in stocks last week seemed to cause investors to seek a haven in the U.S. Treasury market, even though The U.S. GDP grew at a 2.9 percent annual rate in the last quarter of 2017, 0.2 more than expected and up from the 2.5 percent annual growth reported in the third quarter. The yield on the benchmark 10-year U.S. Treasury note reached its lowest level since early February.

The leading European stock indexes regained some ground last week but finished the month and the first quarter under water. The UK blue chip FTSE 100 index led the way, picking up just over 2 percent, while the pan-European STOXX 600, German DAX, and French CAC 40 each added more than 1 percent. As in the U.S., a reduction in concerns about a global trade war helped fuel the recovery.

In Asia, the trade-related concerns between the U.S. and China were top of mind. The announced U.S. measures led China promptly to announce (but not yet implement) retaliatory tariffs of its own. Despite the war of words, the risk of a full-blown U.S.-China trade war is remote, according to many analysts, and Chinese stocks rallied as a consequence. Japanese stocks also rallied last week, recovering some of their losses from the previous week. However, all of the major Japanese market indexes remain substantially in the red YTD.

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Trade War Fears Fuel Ugly Market Action

Stocks suffered steep losses last week against a remarkably turbulent geopolitical backdrop. The large-cap S&P 500 eclipsed its sharp drop in early February and recorded its worst weekly loss since the start of 2016. The tech-heavy Nasdaq performed even worse, weighed down in part by a steep drop in Facebook shares following revelations about undisclosed use of customer data. In related news, tech stocks fared especially poorly, along with financials and healthcare stocks. Conversely, energy stocks managed to escape the week’s downdraft, thanks to a rally in oil prices to seven-week highs following reports of a drawdown in crude inventories. All 30 Dow stocks suffered losses amidst Thursday’s 700 point decline before the index lost another 400 points on Friday. Meanwhile, the VIX shot up roughly 25 percent last week to a level approaching 25, well above its long-tern average of 20. Last week’s declines took most of the major indexes back into negative territory YTD.

There was plenty of news to weigh on sentiment last week, but the prospect of escalating trade tensions was clearly chief among them. On Thursday, President Trump announced that he’s planning new tariffs against China that could total $60 billion as well as new restrictions on technology transfers and acquisitions of U.S. firms by Chinese competitors. China is virtually certain to retaliate in kind and says that it will “fight to the end to defend its own legitimate interests with all necessary measures… China is not afraid of and will not recoil from a trade war.” On Friday, China announced plans for tariffs on $3 billion in U.S. goods, including fruit, pork and pipes, which it said were in response to earlier-announced U.S. tariffs on steel and aluminum and which took effect last week.

Persuading China to conform to trading norms will likely require more than scattershot tariffs. It will likely demand patient, sophisticated American leadership to rally other nations to join the effort — much like the Trans-Pacific Partnership that was abandoned by the Trump Administration. In the meantime, both American and Chinese consumers will likely suffer in both the short and longer-term as prices rise, orders fall, projects are postponed, and the bigger issues of market access and intellectual property security are set aside.

Facebook’s troubles last week included upset lawmakers and regulators in multiple countries as well as angry users. A rising number claim to be abandoning the social-media giant, prompting some analysts to warn that its growth could sputter. There were also increased calls for increased regulation of the tech sector, an idea that Facebook President Mark Zuckerberg went out of his way not to reject.

Other White House developments also unnerved market players. On Thursday, news broke of the resignation of John Dowd, President Trump’s chief attorney in the Mueller probe. After the close of trading, news also came of the replacement of National Security Advisor H. R. McMaster with former U.N. Ambassador John Bolton, widely perceived as likely to take a much harder line against North Korea and Iran. Finally, stocks wavered again on Friday morning, following a tweet from the president threatening a veto of a $1.3 trillion spending bill that passed through Congress on Thursday. A veto would have prompted a government shutdown at midnight Friday, but President Trump eventually signed the bill a few hours later, warning that he would “never sign another bill like this again.”

Almost lost in Thursday’s turmoil was last week’s Fed action. Following a unanimous vote to raise the benchmark federal-funds rate by 25bp on Wednesday, Federal Reserve officials signaled that after next year they could pick up the pace of increases to cool economic growth. They said they expect to raise rates two or three more times this year and three times next year from the current range of 1.5 to 1.75 percent. But with the new Fed outlook projecting faster growth, higher inflation, and lower unemployment in the coming years, officials indicated that by 2020 rates could be at a level marking a deliberately restrictive policy for the first time in more than a decade.

New Fed Chair Jerome Powell noted the need to strike a balance between raising rates too much, which would hold inflation below the Fed’s 2 percent target and thereby damage its credibility, and raising rates too slowly, which would let the economy overheat and force them to move so quickly it triggers a recession. In theory, keeping inflation from exceeding the target will require a 0.9 percent increase in the unemployment rate; since records began being kept in 1948, an increase of that magnitude has only been accomplished via recession.

Last week’s economic data provided mixed messages as to whether growth was accelerating and would push the Fed to be more aggressive. A gauge of U.S. manufacturing activity came in stronger than expected, while growth in the much larger services sector came in slower than anticipated. February durable goods orders, released Friday, reversed recent declines and indicated a modest expansion in business capital spending. The yield on the benchmark 10-year U.S. Treasury note moved back to multiyear highs on Wednesday but declined sharply on Thursday as traders sought perceived safe havens in response to trade worries.

European stocks dipped to lows not seen since early 2017 last week. While the U.S. temporarily exempted EU nations from looming steel and aluminum tariffs, it apparently was not enough to quell concerns from traders about a potential trade war between the world’s two biggest economies. Stocks in Europe plummeted for three consecutive days at the end of week due to lackluster economic data as well as the announcement of U.S. import tariffs. The pan-European index STOXX 600, Germany’s export-heavy index DAX 30, the UK blue chip FTSE 100, and France’s CAC 40 all gave up between one and four percent for the week. Basic resource, technology, and bank stocks were some of the weakest segments.

In Asia, stocks also plunged last week and all the major Japanese market indexes are now substantially in the red YTD. Most of the weekly losses occurred on the tariff news. The Trump administration also removed earlier steel and aluminum tariffs from many countries in Europe (as noted above) as well as for South Korea but left them in place for Japan. China’s benchmark stock indexes recorded their worst weekly performance in six weeks. The steep declines prompted intervention by China’s government-backed investment funds, which habitually step in to prop up domestic stock markets on days of big losses.

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Subdued and Down

Domestic stocks fell modestly last week after a Friday rally broke a four-day losing streak for the S&P 500 and partially compensated for earlier losses. Small- and mid-caps outperformed larger shares. The tech-heavy Nasdaq performed the best of the major indexes, but still traded off about one percent for the week. Within the S&P 500, utilities and real estate stocks fared best, helped by a decline in longer-term U.S. Treasury yields, which make their dividend payments more attractive by comparison. Conversely, the much larger financials sector, which sees lending margins squeezed by lower interest rates, was among the market’s weaker segments.

Fears of heightened global trade tensions appeared to be the main factor weighing on sentiment early last week. Traders continued to worry about retaliation following the previous week’s announcement of new U.S. tariffs on steel and aluminum imports, but major trading partners in Asia and Europe appeared to be taking a wait-and-see approach before responding in kind. Markets were also unsettled by President Trump’s dismissal of Secretary of State Rex Tillerson, widely viewed as a free trade advocate within the administration. Also worrisome were reports that the president had requested the preparation of a package of tariffs targeting China. Finally, although not a trade issue, news that Special Counsel Robert Mueller had subpoenaed President Trump’s business organization appeared to drain the energy from an early rally on Thursday.

The week’s economic data may have also dampened sentiment. The Commerce Department reported that retail sales declined 0.1 percent in February, well below the 0.3 percent rise many expected. February consumer prices rose modestly and in line with expectations, but the absence of an upside surprise seemed to add to worries of a potential slowdown in global growth. Indeed, the retail sales number and other data caused the Atlanta Federal Reserve’s GDPNow model, a running estimate of current-quarter economic growth, to fall to 1.8 percent by the end of the week, a slowdown from late 2017 and well below recent consensus expectations. The subdued growth and inflation data led to a modest decrease in the yield on the benchmark 10-year U.S. Treasury note, which bottomed on Wednesday morning before rising again later in the week. Bond trading was generally subdued ahead of next week’s FOMC meeting, at which the consensus expects a 25bp interest rate hike.

European equities ended last week mixed amid relatively light trading volumes, disappointing inflation numbers for the eurozone, and political uncertainty about the prospects of a trade war and other geopolitical tensions. At the start of the week, the pan-European benchmark STOXX 600 gained ground following the strong U.S. jobs report the week before. Germany’s DAX 30, Spain’s IBEX 35, and France’s CAC 40 all trended higher in what traders have been calling a “Goldilocks” environment in that trade concerns calmed, oil prices were steady, and volatile bond yields and interest rate uncertainty were no longer forefront topics. However, by midweek, investor sentiment turned more negative amid President Trump’s staffing reshuffles, U.K. Prime Minister Theresa May’s assertion (confirmed by Britain’s major allies, including the U.S.) that Russia was connected to the chemical poisoning of a former spy on British soil, and news of softer-than-expected economic data.

By the end of the week, trade volumes were subdued and somewhat stuck in a holding pattern as investors worked through the geopolitical uncertainty. Meanwhile, the European Central Bank (ECB) signaled that it would continue its monetary policy and that it would have to have more confidence that inflation was rising before ending net asset purchases. Eurozone industrial production fell 1.0 percent in January compared with the month before.

In Asia, stocks advanced in China as the government there announced that it would merge its banking and insurance regulators, a long-awaited move that aims to tighten control of the country’s financial sector and curb the risks that have accompanied years of rapid credit growth. In Japan, stocks were mixed as a long-simmering real estate scandal resurfaced during the week, raising fresh questions about the ability of Prime Minister Shinzo Abe to weather the storm.

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Stocks Back in the Black

Domestic stocks rebounded from the previous week’s losses, bringing all the major indexes back into positive territory YTD. The tech-heavy Nasdaq fared best and managed to set a new intraday high on Friday, following another strong jobs number. The small-cap Russell 2000 also performed especially well. Along with information technology shares, financials, industrials and business services, and materials shares led the S&P 500’s gains, while utilities stocks lagged.

Traders faced multiple crosswinds last week. The economic environment appeared to be the most prominent tailwind, with stocks recording their biggest gains for the week following the release of the Labor Department’s closely watched employment survey on Friday. The U.S. economy added 313,000 jobs in February, a much stronger number than economists expected and the biggest gain since July 2016. In the first two months of the year, the United States has already added more than half a million jobs. February also marked the 89th consecutive month of job gains, the longest streak since the government began keeping track in the 1940s. The unemployment rate held steady at 4.1 percent, the lowest level in 17 years, for the fifth consecutive month. Wages grew 2.6 percent YOY, a few notches below the pace in January. More modest wage growth should help to cool fears about inflation and rising interest rates, both of which spooked the markets last month. The initial wage growth figure from January was revised down a bit, too. This news pushed stocks higher and bonds lower.

M&A news also seemed to push markets forward last week. On Monday, the financials sector got a boost from news that French multinational insurance giant AXA was acquiring XL Group for $15.3 billion. Thursday brought news of an even bigger deal in the health care sector, with health insurer Cigna announcing a deal to buy pharmacy benefits provider Express Scripts for $54 billion, a 30 percent premium to the latter’s trading price before the announcement. Many traders expect a pickup in U.S. merger activity as companies deploy savings from recent tax reform and repatriate profits held overseas.

Last week’s gains would likely have been even stronger if not for the week’s major headwind — concerns that new tariffs on steel and aluminum imports might lead to a broader trade war. Kicking his “America First” trade policy into high gear and despite criticism from virtually all economists, President Trump signed orders Thursday implementing global tariffs on steel and aluminum while signaling more aggressive pressure on trading partners to come, especially China.

In a surprise move, after originally emphasizing that no countries would be exempt from the 25 percent tariff on steel or the 10 percent aluminum tariff, the president backed down and excluded Mexico and Canada from the tariffs and allowed for the possibility that other countries could also be spared for national security reasons. Moreover, his official proclamations also offer some workarounds for companies. For example, under the new rules, an importer can ask the Commerce Department for a waiver if there’s a limited supply of the product in the U.S. or if national security is at stake. Accordingly, aluminum can makers, pipeline builders and car companies are already building their cases for why the tariffs shouldn’t apply to them. These actions eased market fears, and set the stage for the jobs-number rally on Friday.

Also last week, President Trump accepted an invitation to meet with North Korean leader Kim Jong Un, a meeting that would mark the first time a serving U.S. president sat down with the isolated country’s leadership. U.S. officials said the meeting would take place within the next “couple of months” at a location yet to be determined. By all accounts, the obstacles to an agreement are formidable. However, it seems that President Trump believes to his core that his singular charisma and “talent” (a word he uses so often) can solve the world’s most intractable problems. There doesn’t seem to be any consensus about what this news means for markets.

The major European equity indexes ended last week firmly in positive territory too, as traders seemed to shrug off the various geopolitical uncertainties. One notable exception was Germany’s DAX 30, which ended the week lower. Germany is a heavy exporter of steel products, automobiles, and machinery and is particularly exposed to the new tariffs. The Italian election that was held the previous weekend featured gains for anti-establishment parties and resulted in a hung parliament in which no single party or alliance won enough seats to easily form a coalition government. Nevertheless, traders kept Italy’s benchmark FTSE MIB Index in positive territory last week. The pan-European index STOXX 600, the UK’s FTSE 100, and France’s CAC 40 also moved higher.

After news broke that the White House had accepted North Korean leader Kim Jong Un’s invitation to meet, Asian shares rallied to close the week higher, capping a volatile week of trading. South Korea’s KOSPI Index rose more than 2 percent, and the Hong Kong Hang Seng Index made a U-turn and finished up more than 1 percent. The yen slid over 1 percent against the U.S. dollar as investors sold safe havens, and credit default swaps on South Korean sovereign bonds fell the most since November 2016.

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Sharp Sell-Off

Stocks worldwide recorded sharp losses last week. Information technology and consumer staples shares held up best in the S&P 500, while industrials and business services shares fared worst. A decline in industrials giant Caterpillar weighed especially on the narrowly focused Dow, while the smaller-cap benchmarks and the tech-heavy Nasdaq fared best.

Last week started out well, although on light trading volumes. However, stocks headed sharply lower on Tuesday and continued downward throughout the rest of the week as inflation and interest rate fears re-emerged. In testimony before the House Financial Services Committee, Federal Reserve Chair Jerome Powell said that he and fellow policymakers were “going to be taking the developments since the December meeting into account and writing down our new rate paths.” Some interpreted that remark to imply that recent strong economic and inflation data would prompt the Fed to raise rates four times in 2018, versus the three hikes previously expected.

These fears calmed a bit on Wednesday morning following the release of revised data from the Commerce Department that showed that the economy had grown a bit less than previously estimated in the final quarter of 2017. Stocks rose on the news but then fell back sharply in late trading, which traders generally attributed to month-end selling pressures. On Thursday, Fed Chair Powell took his turn before the Senate Banking Committee, this time striking a more dovish tone, according to observers. However, Powell’s reassurances may have been offset by remarks from Federal Reserve Bank of New York President William Dudley, who said in a speech that he would characterize four rate hikes this year as “gradual.”

Worries over heightened trade frictions also dragged down shares late in the week. Rumors that President Trump would announce a new round of tariffs weighed on sentiment as early as Monday, but most traders were taken by surprise when the president announced on Thursday afternoon that he would institute tariffs on steel imports and aluminum imports. Shares in steel and aluminum-makers jumped on the news, but the stocks of automakers and other heavy steel users fell. Industrial exporters such as Caterpillar were dealt a double blow, facing the threat of both higher input costs and retaliation against their products in overseas markets.

To put the news in context, U.S. steel shares, which are a tiny part of the overall indices, gained a little over $2 billion in market cap on the President’s tariff announcement. The S&P 500 overall lost nearly $350 billion. That’s basically in line with the relative benefits of protecting one industry at the peril of endangering all the others, according to the overwhelming majority of economists.

The market’s declines continued in futures trading Friday morning after the president tweeted that “when a country (USA) is losing many billions of dollars on trade with virtually every country it does business with, trade wars are good, and easy to win.” European Commission President Jean-Claude Juncker fired back Friday afternoon, announcing plans strongly to raise tariffs on imports of U.S. whiskey, motorcycles, and blue jeans. When the President tweeted that “trade wars are good, and easy to win,” the markets clearly and strongly disagreed. Remember, more than 70 percent of S&P 500 companies’ revenue and profit comes from their trade overseas. Stocks finished the week off their Friday morning lows, however, led by small-caps, which are typically less reliant on overseas sales.

The threat of a trade war also had a significant impact on the bond market. After declining for much of the week, the yield on the benchmark 10-year U.S. Treasury note bounced following the president’s tweets, seemingly due to fears that heightened prices for steel and aluminum — and perhaps more goods to come — would feed through into higher inflation.

In sum, last week’s data pretty clearly suggest that economic growth is accelerating. Jobless claims are at their lowest level since December 1969. Real disposable income posted the greatest gain since April 2015 and hourly wages rose by the greatest amount since 2009. Manufacturing increased the most since May 2004 led by strong growth in exports, the biggest jump in six years. Moreover, inventories fell, which suggests pent-up growth. This data together with Fed Chair Powell’s congressional testimony was weighing upon the markets even before the President promised tariffs on steel and aluminum. Not surprisingly, all of this news was seen as inflationary and the markets responded accordingly.

European stocks also traded down last week amid subdued trading volumes, lackluster economic news there, and trade war fears. Both the pan-European STOXX 600 and the German DAX 30 fell just over 2 percent. The UK’s blue chip FTSE 100 fared slightly better but still posted a decline of just over 1 percent. FTSE 100 shares were weak following UK Prime Minister Theresa May’s rejection of the European Union Brexit treaty draft.

Asian stocks registered modest gains early last week but declined as the week progressed amid growing concerns about rising interest rates in the U.S. and a stronger U.S. dollar. However, as elsewhere, the biggest shock occurred with President Trump’s tariff announcement. Japan’s automakers were a particular area of concern. Even though a majority of cars sold in the U.S. by major Japanese automakers are assembled in the U.S., largely from U.S.-sourced steel and aluminum, these tariffs could signal a global move toward higher prices for a number of raw materials that could pressure global automakers. Stocks in China also took a hit due to the announcement that official manufacturing and services indexes unexpectedly slumped in February, signaling that the economy there has started to cool, although a private manufacturing gauge showed that activity at smaller, export-driven companies is still expanding.

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Modestly Higher

Most of the major domestic equity indexes closed last week with modest gains. The tech-heavy Nasdaq performed best, aided by strength in semiconductor stocks early in the week. Better-than-expected results from Hewlett-Packard gave a further boost to tech shares on Friday. Utilities and materials stocks also performed well, while real estate shares lagged as interest rates rose. Consumer staples shares also underperformed, as Wal-Mart sold off early in the week following an earnings miss and guidance that disappointed.

Some stability in closing levels masked considerable intraday swings in the major indexes. After rising when trading resumed on Tuesday morning, stocks reversed course and fell sharply in the afternoon. Traders noted a lack of consensus to explain the selling, although many pointed to some combination of continuing worries over recent volatility, rising interest rates, and the S&P 500 breaking below its 50-day moving average of 2,725.

Intraday volatility continued on Wednesday, when attention seemingly turned to the release of minutes from the Federal Reserve’s late-January policy meeting. Stocks rose initially following the release but then fell back as traders seemed to detect a more hawkish stance among policymakers — even prior to the release of data showing higher inflation in January and a substantial increase in hourly earnings. The minutes indicated that Fed officials have greater confidence in the near-term economic and policy outlook, and most analysts expect another rate increase following the March 20-21 FOMC meeting. Nevertheless, stocks seemed to get a boost on Friday from the Fed’s semiannual report on monetary policy to Congress, which indicated that officials expected inflation to remain below the Fed’s 2 percent 2018 target.

Note that the Fed’s January meeting predated federal government spending increases that were signed into law on February 9. It is unclear whether the fiscal stimulus from the budget agreement will further bolster policymakers’ confidence in their growth and inflation outlook. In combination with recent tax cuts, the budget agreement is also likely to increase government borrowing considerably such that annual federal deficits will likely exceed $1 trillion in coming years. Last week brought evidence of the first ramp-up in government borrowing, with roughly $258 billion in new issuance from the U.S. Treasury, according to Bloomberg. As the market absorbed the new supply, yields increased across the yield curve to their highest levels in several years while multiple benchmark U.S. Treasury issues on the front end of the curve reached their highest yield levels in a decade. Yields decreased on Friday, however, as traders appeared to join a modest “flight to safety” in anticipation of the upcoming Italian elections.

European stocks ended the week generally mixed with relatively light volume. Despite a heavy week of corporate earnings reports and positive economic indicators, major indexes in the region were subdued. The pan-European index STOXX 600 index was essentially flat as traders seemed to be on guard about the prospect of rising inflationary pressures. The German DAX 30 moved marginally higher following reports of solid demand for German exports. Britain’s FTSE 100 moved marginally lower, weighed down by some disappointing corporate earnings and a report that the unemployment rate in the U.K. rose slightly in the fourth quarter of 2017.

In Asia, the major stock market benchmarks rose modestly last week. Data from Japan show that manufacturing activity and exports remain positive, purchasing managers’ index figures remain solidly in expansive territory, and exports rose 12.2 percent in January, exceeding expectations and marking the 14th straight month of gains. Combined with a slight decline in import growth, the rise in exports helped narrow Japan’s trade gap significantly while employment increased at a faster pace and saw its best growth in 11 years.

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Bounce Back

Domestic stocks carried over the momentum they recaptured on Friday of the previous week and last week recorded their best weekly gain since early 2013. The tech-heavy Nasdaq performed best, aided by solid gains from Apple and Cisco Systems. Along with information technology, financials, health care, as well as industrials and business services outperformed within the S&P 500, while energy shares lagged despite a sharp rally in oil prices on Wednesday. Having entered correction territory (a decline of 10 percent or more off recent peaks) the previous week, the indexes ended Friday with YTD gains and only 4-5 percent off their January (all-time) highs.

The market’s rebound appeared to be driven in large part by diminishing fears about higher inflation and interest rates despite some evidence of inflation in the data. Wednesday morning’s CPI came in a bit higher than expected, on both a core (excluding energy and food prices) and overall basis. Stock futures dropped on the release of the figures, but the market recovered its footing later in the day and ended solidly higher. A sharp rise in the prices of apparel as well as home furnishings and supplies was responsible for much of the rise in core inflation, but a similar spike in those categories a year ago was offset by declines in later months. PPI, released on Thursday, was in line with consensus estimates overall, but higher than anticipated on a core basis. This report didn’t seem to register much impact either.

Volatility measures fell back last week too, while trading volumes declined Tuesday to their lowest level in over a month. ETFs and systematic trading vehicles, while continuing to play a higher-than-average role in trading activity, also seemed to diminish somewhat in perceived importance. Nevertheless, some traders were keeping an eye on risk parity funds (an investment strategy that involves shifting allocations between assets in response to volatility) as a potential source of further selling, even though there is little evidence that these funds are a problem.

Aside from inflation, the week’s economic data were mixed. Retail sales fell 0.3 percent in January, with core retail sales (excluding autos and gasoline) falling 0.2 percent, the largest drop in nearly a year. December sales were also revised downward. Weekly initial jobless claims rose slightly but remained near historic lows. Industrial production also fell slightly in January, weighed down by a decline in mining output. Corporate profit growth seemed to be continuing to fire on all cylinders, however. Data and analytics firm FactSet again revised its estimate of fourth-quarter profit growth for the S&P 500 upward, to 15.2 percent (on a year-over-year basis), its best pace since late 2011.

Perhaps reflecting the balance between higher inflation data and mixed economic signals, the yield on the benchmark10-year U.S. Treasury note touched a new four-year high of 2.93 percent but ended last week only modestly higher. The midweek release of January inflation and retail sales data appeared to weigh on sentiment a bit.

European stocks ended last week higher too, with most major indexes showing strength in a variety of sectors as concerns about rising interest rates and inflation seemed to ease there as well. The pan-European STOXX 600 index couldn’t recover the steep losses it logged from the week before, but the appetite for European shares was nevertheless robust, as the STOXX 600 rose around 3 percent for the week. Blue chip indexes, including Germany’s DAX 30 and the UK’s FTSE 100, also strengthened. Tech, banking, and natural resources shares were some of the notable outperformers.

As in the U.S., volatility also trended lower in Europe last week while the euro strengthened against the dollar. A strong euro versus other countries depresses revenue for European companies that sell their goods in overseas markets.

Asian markets also advanced nicely last week, although activity was fairly light there due in large part to a holiday-shortened week. Departing from its usual practice, the People’s Bank of China reportedly drained $216 billion from the country’s financial system in the weeks preceding the Lunar New Year holiday. The PBOC’s recent austerity — following years in which the central bank routinely pumped money into markets to ensure ample liquidity for banks and investors — was seen as part of Beijing’s ongoing crackdown against excessive risk-taking fueled by readily available money.

Correction Territory

Last week’s stock market price action has taken the S&P 500 into correction territory (down 10 percent from the highs) for the first time in two years. Whether we get to “bear territory” is another matter. Of the fifteen true corrections from record highs since 1928 (prior to this one), ten turned into full-blown bear markets while five did not. The average bull market correction is 13 percent and takes just four months to recover, according to Goldman Sachs research. But the pain lasts for 22 months on average if the S&P falls into bear territory. The average decline is 30 percent for bear markets. Perhaps most importantly, stocks have spent 55 percent of the time since 1928 at least 10 percent off the highs, so whether we get to bear territory or not, we’re in completely normal territory.

For the 54 million Americans who are actively contributing to 401(k)s, in 550,000 plus corporate retirement plans across the country, should current levels stand, when they get their next paychecks they will be buy 10 percent more of the stock mutual funds to which they allocate without doing anything. Even though the stock market is the only place I know of where people don’t want to buy on sale, this is fantastic news for anyone who is funding a goal years out into the future.

But that doesn’t mean it’s easy.

There have been a wide variety of proffered explanations for the sudden downturn. As usual, there are some great stories being told now, all with crystal-clear hindsight.

Here are six, although some of them are less explanations and more cries of anguish. None is altogether convincing, which shouldn’t be surprising in that the markets do not need a reason — a trigger — to drop. The explanation I think the most plausible follows. But your mileage may vary.

As reported in this space last week (see here and here), two Fridays ago the U.S. Department of Labor released a strong jobs report showing wages rising at their fastest rate since the global financial crisis nearly ten years ago. The stock market promptly proceeded to plummet, a beating that continued on Monday and Thursday and which has led to much volatility all week. Although I addressed this point last week, it is helpful to reiterate why good news for workers and the economy is bad news for the stock market. The short answer is that the stock market and the economy are quite different things.

Right now, traders seem to be worried that if wages rise too fast, the Federal Reserve will hike interest rates in order to head off inflation down the road. When, earlier this year, the central bank suggested that it would raise rates, much of the market was skeptical, in part because inflation has been so subdued for so long and because the Fed has been reticent to raise rates too fast. However, faster pay gains for workers make it more likely the Fed will follow through, both because rising wages are a sign that the whole economy is heating up and because employers will eventually have to raise prices to keep up with the cost of labor.

Matters were made worse this past Friday in the wee hours of the morning. Republicans have generally been seen as opposed to federal debt and budget deficits. However, Friday’s government funding deal, on the heels of the recent tax cut package, will likely cause the 2019 deficit to balloon to $1.2 trillion, with trillion-dollar deficits to continue indefinitely. Putting aside the policy implications, that’s highly inflationary. Not surprisingly, stocks suffered a rapid sell-off on Wednesday following word that Senate leaders had reached the spending deal that came to fruition early Friday.

If the Fed does hike rates quickly, the pace of growth should slow a bit and could put a damper on corporate profits. But that’s probably not the main reason the market is all worked up. Stock prices have been supported for almost a decade by low interest rates around the world. Investors (especially retirees) haven’t been able to make much money on safer assets like American and European government bonds. Instead, they’ve piled money into riskier bets like sovereign debt from developing nations and stocks. As interest rates go up, and money managers (retirees too) can make a better return on vanilla investments like U.S. Treasuries and other bonds, we should expect stocks to deflate a bit.

The current volatility is a good reminder that the Dow and the S&P are not barometers for the well-being of the whole economy. Indeed, the Dow isn’t even a good barometer of the stock market. Sometimes prices go up because the economy is doing well. Sometimes they go down because of it. And as of this month, the economy seems just a bit too strong for the market’s taste.

So let’s get down to particulars. Last week, domestic stocks suffered their worst weekly decline in two years. The major benchmarks fell largely in tandem, and all entered correction territory. Friday was especially volatile, although stocks ended the day up a bit after a late rally. Things could have been much worse! Despite the downturn, the S&P 500 is still up over 13 percent from a year ago.

Much attention was focused on the narrow Dow Jones Industrial Average last week, which suffered declines on both Monday and Thursday exceeding 1,000 points, the largest (by points) in history, if not close to a record in terms of percentages. On a percentage basis, the Dow’s 4.6 percent drop on Monday ranked only 25th among declines since 1960 and 108th overall. Having reached all-time lows in 2017, the CBOE Volatility Index (VIX), spiked to its highest level in several years. No sector escaped the downdraft, and correlations — the tendency of stocks to move in sync with each other — increased as selling pressure intensified late in the week.

Thursday brought further evidence of a tightening labor market, with weekly jobless claims falling to their lowest level since January 1973, when the U.S. labor market was a little over half its current size. Much of the week’s other economic data also surprised on the upside, increasing the prospects for higher inflation and interest rates. The Institute for Supply Management’s gauge of service sector activity rose more than expected, as did wholesale inventories in December. New job openings declined a bit, however. Despite inflation and deficit fears, longer-term U.S. Treasury yields dropped slightly as investors sought government bonds and other perceived “safe havens.”

The market’s sharp decline stood in contrast to continued favorable news about corporate earnings. As the fourth-quarter earnings reporting season began to wind down, data and analytics firm FactSet raised its estimate of overall earnings growth (on a year-over-year basis) for the S&P 500 to 14.0 percent, which would mark the third quarter in the past four of double-digit gains. Accordingly, economic and earnings fundamentals continue to be constructive for stocks, despite the price action.

European stocks were down overall during a week of volatility and fears about the global ramifications of a broad stock sell-off in the U.S. Early last week, the pan-European benchmark Stoxx 600 posted its biggest one-day percentage drop since June 2016. Despite a brief respite midweek, European stocks continued to slide as the week came to a close. The UK blue chip FTSE 100 Index, whose companies earn much of their revenue from outside the UK, dropped to a one-year low, hobbled both by the global rout in equities and a weakened pound. Germany’s DAX 30 and France’s CAC 40 were also weak. Banks, utilities, and energy stocks were notable laggards.

The week was not devoid of good economic news in Europe, however. Quarterly corporate earnings reported during the week were largely positive there too. China’s demand for European imports remained strong, and French industrial production rose more than expected in its latest reading. In Germany, Chancellor Angela Merkel finally hammered out a new government coalition between her conservative alliance and the left-leaning Social Democrats. Alas, investors shrugged at the news, as the German DAX and the euro barely moved following the announcement.

Asian stocks followed suit. The Nikkei was off more than 8 percent for the week and the dollar weakened further. Chinese stocks ranked among the biggest losers last week as domestic benchmarks in China slid more than 10 percent from their most recent peaks. In previous sell-offs, Chinese state-backed funds have stepped in and bought shares to stem market declines, but there was little evidence of state-led buying this time.

While last week’s pain is still fresh, there are some good lessons to be learned.

1.    Trying to time the market is dangerous business indeed. Although many (most?) analysts recognized the the market was pricy, nobody called this correction specifically. Moreover, the U.S. and virtually all global economies remain strong and are generally improving. Perhaps most tellingly, those who may have escaped some or all of the current drawdown have no good idea when or how to get back in.

2.    Hedges need to be diversified. Between late 2007 and early 2009, from the stock market’s peak to trough, the average managed-futures hedge fund gained 12 percent while stocks dropped 41 percent. On Monday, when the S&P lost 4 percent, managed futures funds lost 3 percent. They were trend-following, as advertised, but the trend turned on a dime. They turned out to be long and wrong, like the market generally. If that was your only hedge, you weren’t really hedged at all.

3.    Picking up nickels is dangerous. Those who sell (write) options are said to be “picking up nickels in front of a steamroller.” The fast turn in market fortunes hurt those nickel-picker-uppers a lot last week. For example, those whose option-writing effectively shorted volatility, got crushed (e.g., LJMIX lost more than 80 percent). Writing options can seem like easy money. It isn’t.

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