The WMA Weekly Market Wrap v.180306

March 6, 2018

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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