Trade disputes, corporate earnings announcements, and rising interest rates have been the center of market news as we head into the third quarter. While our economy and corporations have seen positive growth, it is still important to consider the effects that geopolitical tension and monetary policy have on the market.
In June, President Donald Trump imposed tariffs on aluminum, steel, and car imports from the European Union, Canada, and Mexico. The goal of these tariffs, which are taxes on imported goods, is to protect domestic business by making it more expensive to purchase foreign goods. Additionally, Trump has levied tariffs on $50 billion worth of Chinese goods while threatening to raise the amount to $500 billion.
Thus far the results of imposing the tariffs have been mixed. Real GDP increased to 4.1 percent in the second quarter of 2018, which is the highest it has been since 2014. This growth in GDP is a result of increased personal consumption expenditures along with an increase in exports and government spending. Personal consumption expenditures (PCE) is the primary measure of consumer spending on goods and services in the U.S. economy. Additionally, the tariffs contributed to the growth in exports mainly because farmers rushed to ship supply of soybeans to China in fear of retaliatory tariffs and growing tensions.
As shown in the graph above, 2018 first quarter GDP performance dipped. Stagnant growth in consumer spending was the primary factor contributing to this. Given the GDP results from the second quarter our economy is looking at a solid rebound.
However, the tariffs have generated some market volatility due to fears of igniting a trade war with China. CNBC found that negative trade developments caused the Dow Jones Industrial Average to decrease by an average of 1.7%, whereas stock prices rose back and the Dow restored its value upon news of easing trade tensions. The Dow is an extremely important measure of the market, in that it tracks the trading performance of 30 large, public companies based in the United States. The chart below illustrates the market volatility we have seen in the Dow Jones over the past 3 months. President Trump first imposed his steel and aluminum tariffs on Thursday, March 1st. As shown in the graph, the Dow sharply declined around the time of this announcement.
While trade tensions have increased volatility, second quarter corporate earnings are coming in strong, restoring some stability in the markets. So far, roughly 28% of the companies that make up the S&P 500 have reported earnings, and earnings are up 20% for companies in the index. Factors such as corporate tax cuts have contributed to this earnings growth. These strong earning numbers, mixed with the positive economic numbers we are seeing, may lead to inflation. While not all inflation is bad, it will cause the Federal Reserve (“Fed”) to act. The PCE, which is the Federal Reserve’s preferred inflation measure was on target, hitting 2% for the first time in 6 years.
The Fed is currently in the process of raising interest rates to prevent the economy from growing too rapidly. The Federal Funds rate was increased to 2% this past June and there are signals that the Fed will raise rates two more times by the end of this year. Chair of the Federal Reserve, Jerome Powell, has been very communicative regarding his plans to increase rates, and as a result, these policy changes have not surprised the markets. One thing to watch for is the Fed monetary policy becoming overly-tight. The yield spread between the 2-year and the 10-year treasury is currently 25 basis points, which is the smallest it has been since 2007. This decreasing spread could potentially lead to an inverted yield curve. An inverted yield curve occurs when short-term rates are higher than long-term rates. It is often viewed as a pre-recession indicator, and historically it has been fairly accurate. However, the timing of the subsequent recession varies and has occurred anywhere from 6 to 24 months after the yield curve inverts. The inverted yield curve may be a coincidence of the strength of the U.S. economy compared to the rest of the world.
Like most months, we are taking the good with the bad. Strong earning and economic growth, coupled with political uncertainty and market volatility, will yield mixed results. However, when you have a well thought out financial plan that takes these risks into consideration, you should remain calm. As always if you have any questions about the market, or your financial plan, please don’t hesitate to reach out!
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual security. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing.
All performance referenced is historical and is no guarantee of future results. Indexes are unmanaged and cannot be invested into directly. Economic forecasts set forth may not develop as predicted.
Investing involves risks including possible loss of principle. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments.