07/23/2018
U.S. equities hung on to post their third straight weekly gain last week, but just barely. The threat from Washington of an expansion in the trade war to cover virtually the entirety of Chinese imports, along with some direct jawboning of the Federal Reserve, dampened what little enthusiasm there was. The more severe reaction was in the bond market, where the yield on the ten-year Treasury note jumped by five basis points on Friday to end the week at a one month high of 2.89 percent, and the 2-10 year spread widened from 24 to 30 basis points. The dollar also slumped late in the week, giving a temporary reprieve to developing market equities.

A good start to second quarter earnings season and a continuation of solid economic reports wasn’t enough to overcome the rhetorical policy headwinds. Retail sales in June matched expectations, and the May figure was revised sharply higher. Industrial production also exceeded expectations, especially manufacturing, although this time the May report was revised downward. Jobless claims fell and leading indicators rose. The one exception was the June report on housing starts, which plunged 12.3 percent, compared to a consensus expected drop of 2.2 percent.
The first full week of second quarter earnings reports was another source of good news. According to Factset, the expected earnings growth rate rose to 20.8 percent, up from 19.8 percent the previous week, as companies exceeded expectations by more than the historical average.[i] In the week ahead, a full third of S&P 500 companies are scheduled to report their results, bringing us to the halfway point of earnings season.

The intensifying trade war is beginning to generate increasingly vocal pushback from normally friendly quarters. Last week, Sen. Orrin Hatch, the Senate Finance Committee Chairman, sent a letter to the White House threatening legislative action if the administration fails to reconsider its tariff policy. In his congressional testimony last week, Fed Chair Powell noted that growth and wages can be impaired by protectionism, and that although the data doesn’t show evidence of that yet, the Fed is hearing a “rising chorus of concern”. Meanwhile, the Wall Street Journal’s Editorial Board on Saturday cited examples of “real and growing damage”, labelling the trade war “arbitrary and punitive”. And members of the G-20 meeting in Buenos Aires over the weekend expressed their displeasure with the U.S. stance on trade.

The consensus first estimate of second quarter GDP on Friday is now expected to show growth at an annual rate of 4.3 percent according to Bloomberg, more than double the pace of the first quarter.[ii] Durable goods orders for June on Thursday are expected to rebound from a soft May, while new and existing home sales are both expected to reflect the same headwinds reflected in last week’s report on housing starts, including higher building costs, rising interest rates, and limited inventory.

Headlining this week’s earnings calendar are Alphabet and Amazon, but they will have plenty of company including Intel, 3M, Boeing, McDonald’s, Ford, GM, ExxonMobil, and Chevron among others.

The trend in stocks remains positive as the S&P 500 currently sits comfortably above its short and intermediate trend lines. Since the start of the second quarter the index is higher by 6.1 percent. But, worries over the trade war and the economic damage it might do seem to have limited the ability of stocks to fully reflect the strong economic and earnings data. Trade issues are unlikely to be resolved quickly and may linger through the upcoming mid-term election. A mid-June survey conducted by Gallup suggests that most Americans do not see trade as a pressing issue and many believe that China, in particular, does engage in unfair trade practices.[iii] Those attitudes might change if the trade war begins to bite, but they seem to indicate that for now, on the issue of trade, the administration has some political running room.         

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[i] Factset “Earnings Insight”, July 20, 2018
[ii] Bloomberg “U.S. 4% GDP Growth Seen More ‘Luck of the Draw’ Than New Reality”, July 23, 2018
[iii] Gallup “Americans Say China Trade Unfair, Trade With Canada, EU Fair” Frank Newport, July 9,2018