Market Update

Posted on March 23, 2018 by Gemmer Asset

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Market Recap

Tough week for the equity markets. For the week the S&P lost -6.0% while small-caps were hit for -4.8%. The international markets were down between -3.6% and -4.7%, less than U.S. large-caps due in part to a weak dollar. Worries about trade wars and the Fed conspired to drive prices lower, and significant cracks in certain social media stocks didn’t help confidence (Facebook lost -13.9% this week). But despite the roughly 1,150 point loss in the Dow on Thursday and Friday alone, the main indexes are still just flirting with official correction territory (defined as -10%). For example, the Dow is off -11.6% from its high back in late January while the S&P is down -9.9% and the NASDAQ -6.8%.

Bond yields played a modest safe haven role. 10-year yields dipped -2bps for the week and intermediate-term government bonds gained +0.3%. Gold was more of a safe harbor with a gain of +2.44%.

The Fed Paints a Brighter Picture….

Let’s talk about the Fed first. As widely expected they hiked rates by 0.25% on Wednesday and painted a relatively bright outlook, at least as it relates to the economy. As part of their quarterly data dump, they released their economic projections through 2020. As you can see below, they were modestly more upbeat on growth in 2018 and 2019 and think unemployment falls to just 3.6% in 2019.


A couple notable points from this table. First, they don’t think growth will surpass 3.0% despite the tax cuts. Secondly, they don’t see inflation overshooting their 2% target. To quote from the Fed’s statement:

“The economic outlook has strengthened in recent months…The Committee expects that, with further gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace in the medium term and labor market conditions will remain strong.”

This upbeat outlook led some members of the Fed to revise higher their expectation for rates over the coming years. The light blue dots below are from the December meeting and show where all the policymakers thought rates would be in 2018, 2019, 2020, and over the long-run.


The dark blue dots are from this last meeting. The median of the dots remained unchanged in 2018 (predicting three hikes) but now imply a third hike in 2019 and two hikes in 2020. Even the 2018 call is a close thing. It would only take one dot to move higher to imply four hikes this year.

At the press conference Chairman Powell went out of the way to emphasize how data dependent policy is. It was actually refreshing to hear him talk about how hard it is for the Fed (or anyone) to predict policy beyond the very near term. For example, when responding to a question about the dot plot he said:

“Like any set of forecasts, those forecasts will change over time… depending on how the outlook for the economy changes.”

Finally, Powell noted that policy in 2020 will be mildly restrictive. This probably means that the Feds sees a 3.5% Fed Funds rate as one that will slow growth and boost unemployment.

Powell has a tough job ahead of him – hiking rates just enough to slow growth and inflation without triggering a recession. Oh, yes, and 2020 will be an election year. I bet he can’t wait!!

…While the Outlook for Trade Darkens

Powell’s job also got harder on Thursday after the Trump administration rolled out another cannon in the trade war, this time aimed squarely at China. To follow-up on the steel and aluminum tariffs, Trump announced a plan to impose 25% tariffs on up to $60bn of annual imports from China. To quote the Financial Times:

“In what White House officials billed as a historic move against Chinese ‘economic aggression’, President Donald Trump on Thursday was set to order US officials to levy tariffs against China in response to a finding that Beijing has for decades pursued a strategy of unfairly acquiring US intellectual property”

The aim is to address the $375bn trade deficit with China. U.S. officials plan to target 10 strategic sectors identified by Beijing as part of a “Made in China 2025” strategic plan pushed by Xi Jinping. Those sectors included robotics, aerospace, maritime and modern rail equipment as well as electric vehicles, and biopharma products.

The imposition of the tariffs is not immediate, but subject to a 30-day ‘comment’ period.

In addition, the FT points out:

“Likewise, Mr Trump on Thursday was set to order the US Treasury to come up with a plan to impose new restrictions on Chinese investment in areas like those within 60 days, officials said. Such a regime would be parallel to the Committee on Foreign Investment in the US, which now examines foreign investments for potential threats to US national security and has in recent years taking an increasingly dim view of Chinese acquisitions.”

Critics were quick to respond, pointing out two key problems with the new policy.

First, the tariffs are essentially a tax on domestic consumers. For example, top retailers from Walmart to Apple have sent letters to Trump urging him not to do this because it would worsen inequality and, “punish American working families with higher prices.” The Tax Foundation pointed out that Trump’s tariffs on China would cancel out about 20% of the benefits of the recent GOP tax cuts.

The other problem concerns retaliation. Senior Chinese officials have made it clear they’ll take “necessary measures” to retaliate for Trump’s tariffs. In response to the steel and aluminum tariffs China said their target 128 U.S. products, worth roughly $3bn, with tariffs. We should expect more action in response to this latest move. Rumors are that Beijing will target goods and jobs in parts of America that voted for Trump. At the top of China’s list are agricultural products likes soybeans and hogs.

Soybeans and grains are the second largest U.S. export to China (see the chart below). Trump carried eight of the top 10 soy-producing states, and the critical swing states of Michigan and Wisconsin are both in the top 15 soybean producers. It wouldn’t be a shock to see airplanes on China’s hit list as well (Boeing sells one in four or their airplanes to China).


In an ironic twist one of the harder hit sectors of the market on Thursday were steel stocks. U.S. Steel lost -11% while Nucor and AK Steel were off -6.5% and -8.7% respectively. Aluminum stocks were also hit hard with Century Aluminum down -17.8%. Of course, these stocks soared after the steel and aluminum tariffs were rolled out a few weeks ago. However, new broad exemptions combined with the new round of China tariffs are proving to be toxic. The new China tariffs, in particular, are problematic because it increases the odds of a tit-for-tat trade war that no one wins, especially big industrial companies that need a healthy global economy.

How this evolves is impossible to guess. Probably the fairest take comes from Zhang Yu at the International Monetary Institute in Beijing.

“The next one to two months will be a crucial game of chess between the US and China. Right now the two sides are testing each other, exerting pressure, and feeling out to find the bottom line.”

Have a good weekend.

Charles Email Sig

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