07/02/2019
The long-awaited meeting between presidents Trump and Xi has concluded with the two sides agreeing to resume trade negotiations. The U.S. indefinitely suspended the imposition of new tariffs but left in place those already in effect. The U.S. also agreed to allow the resumption of certain technology sales to Huawei, a precondition upon which the Chinese insisted. And the Chinese agreed to buy more U.S. agricultural products.

The meeting did not result in any major breakthrough that might form the basis for a definitive agreement, but none was expected. The fact that the two countries are once again talking is a positive development and will likely be viewed as such by investors, but only up to a point. And, as expected, global stock markets are rallying on the news in early Monday trading. But whether the trade war ultimately proves to have been worth the disruption and cost will depend on where these negotiations lead, and for how long they extend.

In the meantime, since the tariffs and tensions that have slowed the global economy remain in place, this meeting will not result in any immediate burst of optimism among corporate decision makers. And it likely gives the Federal Reserve more reason to consider lowering interest rates when it meets at the end of the month.

June was the Strongest Month for Stocks in Years

Stocks drifted last week ahead of the U.S.-China meeting, but overall the month of June was the strongest in years. The S&P 500 slipped 0.3 percent for the week, but added 6.9 percent for the month, bringing its year-to-date gain to 17.3 percent. The June rally was triggered by Fed chairman Powell’s dovish comments to a Chicago symposium early in the month and represents a complete reversal of the 6.6 percent decline in May that was triggered by the escalation of trade tensions.

Bonds continued to reflect a world of moderating growth with little inflation. The yield on the ten-year note fell four basis points to 2.01 percent last week, after beginning the month at a yield of 2.13 percent. The two-year note slid two basis points to end the week at 1.76 percent. It began the month at 1.95 percent. They began the year at 2.68 and 2.50 percent respectively.

Last week the core Personal Consumption Expenditure (PCE) reading for May showed prices rising at a modest 1.6 percent year-over-year, while the headline rate was also unchanged at 1.5 percent, still below the Fed’s target. High yield spreads widened slightly last week, from 395 to 407 basis points, but for the month overall narrowed by 52 basis points. Spreads began the year at 533 basis points (a basis point is 1/100th of a percent).

The Fed’s Challenge? Balancing a Strong Consumer Sector with a Weakening Manufacturing Sector

The challenge for the Fed is how to balance the strong consumer sector of the economy with the weakening manufacturing sector. The definitive readings for both are on this week’s calendar. On Monday, the ISM report on manufacturing activity is scheduled, and on Friday we will get the June jobs report. The ISM index is expected to slow further from last month’s 52.1 reading. Anything below 50 indicates that the sector is contracting. But, since manufacturing represents approximately just 11 percent of U.S. GDP, it would take a reading below 43 to indicate a recessionary type contraction. The most recent contractionary reading was in August 2016. However, the index has been declining since its subsequent peak of 60.8 in August 2018. As for the jobs report, the Bloomberg consensus anticipates non-farm jobs growth of 160,000 and an unchanged unemployment rate of 3.6 percent. Year-over-year growth in average hourly earnings is expected to edge higher to 3.2 percent.

Lastly, second quarter earnings season will get underway shortly, and another decline is expected following the modest decline of the first quarter. According to Factset, an earnings decline of 2.6 percent is expected. Third quarter expectations have also turned fractionally negative.

With the modestly positive agreement to restart trade negotiations between the U.S. and China, the bullish narrative now pivots to the Fed meeting at the end of July, when it is overwhelmingly expected to lower the overnight rate by a quarter point. Another such cut is anticipated in September. However, even assuming the Fed cuts as expected, actual progress on trade must be achieved for the global economy to stabilize, and for equity prices to move sustainably higher.
 
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The S&P 500 is an index containing the stocks of 500 large-cap corporations, most of which are American. The index is the most notable of the many indices owned and maintained by Standard & Poor's, a division of McGraw-Hill.

The ISM manufacturing index is a national manufacturing index based on a survey of purchasing executives at roughly 300 industrial companies.

The personal consumption expenditure (PCE) measure is the component statistic for consumption in gross domestic product (GDP) collected by the United States Bureau of Economic Analysis (BEA).

Indexes are unmanaged and are not available for direct investment.

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