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.