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Financial Markets Commentary For the week of July 16, 2018

Key Market Data

07/06/2018 07/13/2018 One Week Change YTD One Year
S&P 500 Index 2,759.82 2,801.31 +1.50% +5.86% +16.67%
MSCI EAFE Index 1,969.61 1,972.68 +0.16% -1.69% +6.93%
Barclays Capital U.S. Aggregate Bond Index 2,018.09 2,021.77 +0.18% -1.20% +0.05%
10-year Treasury Note Rate 2.823% 2.828% +0.5 basis points +42.2 basis points +48.3 basis points

The trade war has begun in earnest but American investors, after a mid-week glitch, seem confident that the American economy can weather the conflict. Indeed, all three major indexes were up for the second week straight and the Nasdaq hit a record high on both Thursday and Friday. For the week, the Dow gained 2.3 percent, the Nasdaq 1.8 percent and the S&P 500 1.5 percent.

Going into last week, the burning question was how investors would react to the $34 billion in tariffs on Chinese goods the United States put in place on July 6 and China’s prompt retaliation in kind. As it turned out, the jobs report for June and the prospect of another strong earnings season were enough to send the markets north. The indexes only declined on one day last week (Wednesday), after the White House said it would respond to China’s tariffs with another $200 billion of its own (covering a wide range of consumer products for the first time), unless China reduced its trade surplus and stopped stealing intellectual property. Senator Orrin Hatch (R-UT), the Chairman of the Senate Committee on Finance, was on board with being more aggressive with China but not the tariffs, saying the proposed round “appears reckless.” However, U.S. Trade Representative Robert Lighthizer said it was an “appropriate response” to China’s actions. The new tariffs would not go into effect until after hearings in late August, giving the two sides plenty of time to negotiate. But on Thursday, U.S. Secretary of the Treasury Steven Mnuchin appeared before the House Financial Services Committee and admitted that while he supported the tariffs, negotiations with China had “broken down.” Meanwhile, China said the U.S. was “acting erratically” and had “abandoned the consensuses that two sides have reached.”

As China doesn’t import enough to match the United States tariff for tariff, it may look to other steps such as making it more difficult for U.S. businesses working in China by holding up deals and tightening the inspection of U.S. goods. As a side note, China reported that its trade surplus with the U.S. hit a new high of $28.97 billion in June, partly because it ramped up exports to beat the tariffs. China did win a major victory last week when the White House lifted the ban on ZTE Corporation, China’s second largest telecom, which had been prohibited from buying U.S. parts and software because it did business with North Korea and Iran. ZTE has since paid a $1 billion fine, among other steps, and its stock rose 24 percent in Hong Kong after the announcement.

President Trump’s tour: the Brexit, NATO and Putin

The already fraught Brexit got even more complicated last week. First, two key government figures resigned over Prime Minister Theresa May’s most recent proposal to the European Union (EU). Visiting President Trump conducted an interview – which he then dismissed as “fake news” – challenging her handling of the Brexit negotiations. (He later told her to sue the EU.) David Davis, who had been the lead Brexit negotiator, stepped down. The next day Boris Johnson, the Foreign Secretary, followed him out the door. Both protested the fact that May’s proposal includes adhering to EU rules and regulations for some manufactured goods, with Johnson saying, “We are truly headed for the status of a colony.” President Trump had arrived from a North Atlantic Treaty Organization (NATO) meeting where he scolded fellow members for not fulfilling their obligations for defense spending, but also expressed support for the mutual defense pact. Today, he’ll meet with Russia’s President Vladimir Putin, a meeting that became more complicated on Friday when the Justice Department indicted twelve Russians for interfering in the 2016 election.

Powell sleeping soundly

The Chairman of the Federal Reserve Jerome Powell will testify before the House and Senate this week, but last week investors could get a preview of what he’s likely to say from the Fed’s semiannual Monetary Policy Report and a radio interview Mr. Powell gave on Marketplace. The report, which was upbeat about the economy, also noted that the nation’s banking system is “substantially more resilient than during the decade before the financial crisis.” During his radio interview, Powell said, “I sleep pretty well on the economy right now,” but added that the trade wars could be “very challenging.” The Fed is still expected to make two more rate hikes this year.

Inflation continues to climb

Based on Powell’s comments and the Fed’s report, inflation is more of a concern than it has been for some time, and last week’s updates on producer and consumer price indexes illustrated why. The Producer Price Index (PPI) rose 0.3 percent in June from the month before; over the last year it was up 3.4 percent, the biggest year over year gain since 2011. Core PPI climbed 0.3 percent and 2.8 percent for the year. The Consumer Price Index (CPI) increased 0.1 percent in June and 2.9 percent over the past year, its largest such gain since 2012. Core CPI was up 0.1 percent in June and 2.3 percent for the year.

AT&T and Comcast

The government said it will appeal the recent ruling that allowed AT&T’s acquisition of Time Warner to move forward, though the CEO of AT&T Randall L. Stephenson described the chance of the deal being overturned as “really remote.” The ruling may have scared off Comcast, which has been in a bidding war with Disney for 21st Century Fox. Comcast has instead turned its attention to battling Fox for control of Europe’s Sky TV, a key component of the Disney-Fox deal.

Q2 earnings

The second quarter earnings season began last week and strong returns from PepsiCo, among others, helped push the market into the black. According to FactSet, earnings for the quarter for S&P 500 companies will be up 19.9 percent from a year earlier, which would make it the second-best quarter since 2010. In other news, the National Federation of Independent Business (NFIB)’s Index of small business confidence fell from 107.8 in June to 107.2 in June (but that was still the sixth highest reading in the survey’s history). The University of Michigan said that concerns about the trade war sent consumer sentiment in July to a six-month low of 97.1. First-time jobless claims for the week ended July 7 dipped 18,000 from the week before to 214,000; the four-week moving average fell 1,750 to 223,000.

A look ahead

This week’s updates will include the latest on business inventories, industrial production and capacity utilization, housing starts and building permits, the Federal Reserve Beige Book, consumer comfort and the Conference Board’s Leading Economic index.