Markets ignore trade and political concerns

David Joy – Chief Market Strategist, Ameriprise Financial
Weekly markets commentary — June 11, 2018


U.S. equities enjoyed a third straight week of gains, as the S&P 500 index climbed another 1.6 percent. During this three-week period, the index has risen 2.4 percent, as investors have focused on evidence of firming economic activity, and chosen to overlook, at least for now, their concerns over trade tensions and politics. And it wasn’t technology that led stocks higher this time, although as a sector it did rise modestly. Rather it was consumer discretionary stocks that led the way higher last week, followed by materials, consumer staples and financials.  

There wasn’t much to latch onto on the economic front last week, except for a solid non-manufacturing ISM report. But the growing sense that second quarter activity is rebounding nicely following the modest first quarter has increasingly taken hold following the robust May jobs report and two straight strong consumer spending reports in March and April. The ten-year U.S. Treasury note yield climbed five basis points to 2.95 percent, while the two-year yield climbed three, to 2.50 percent. And high yield credit spreads narrowed slightly. 

Italian bond yields remained elevated, as investors had second thoughts about the new coalition government. After spiking to a high yield of 3.13 percent the previous week, the ten-year Italian bond retraced much of that move, falling back to a yield of 2.50 percent at the start of last week. But a speech by the new prime minister on Tuesday unnerved investors anew, as it highlighted the differences with the European Union regarding fiscal policy, sending the ten-year yield back up to 3.11 percent by the end the week. 

Trade remains top of mind for investors

It is difficult to assess just where we are headed with trade relations. The G-7 meeting last week ended with recriminations between the U.S. and Canada, and with the rest of the group trying to assess the implications of the U.S. suggestion of a G-7 free trade, free-subsidy zone. An escalating trade war would certainly be in no one’s best interest. But a case can be made that the U.S. is relatively better positioned as negotiations continue. U.S. exports are roughly 15 percent of GDP. While that is certainly meaningful, it is relatively less important for Mexico, where exports represent roughly 38 percent of GDP, or for Canada at 31 percent, Germany at 46 percent, or China at 20 percent. 

In addition, for these countries the U.S. is an extremely important trade destination. Mexico sends approximately 80 percent of its exports to the U.S., and Canada sends 73 percent, while China sends 18 percent and Germany roughly nine percent.  In contrast, the U.S. sends roughly 16 percent of its exports to Mexico and 18 percent of its exports to Canada. The U.S. sends about eight percent to China and about three percent to Germany. 

And not to suggest that a trade war is where we are headed, but it is important to point out the importance of trade to the global economy. The imposition of the Smoot-Hawley tariff bill in 1930 is often cited as a contributing factor in exacerbating the great depression. Between 1929-1934 global trade declined by two-thirds. How much these tariffs did or did not contribute to that decline is debated. But at the time, global trade amounted to just nine percent of global GDP. Today, trade equals roughly 57 percent of global GDP. The point is that trade is far more important today than it was then, making it in everyone’s interest to avoid allowing current tensions to deteriorate. 

Economic data and the fed will be closely watched this week

Investors will be confronted with a barrage of information to digest this week. On the economic front, reports on consumer prices, retail sales, industrial production and consumer sentiment are scheduled. The Federal Reserve meets this week and is widely expected to once again raise the overnight rate by a quarter-point, making what it has to say about its future intentions the point of focus. Perhaps more importantly, the European Central Bank also meets and will be monitored closely for what it does or doesn’t say about the timeline for winding down its quantitative easing program, especially in light of Italy’s new government and burdensome sovereign debt at 130 percent of GDP. 

And lastly, there is the summit in Singapore between the U.S. and North Korea, where the stakes are perhaps the highest of all.