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Stock Rally Pauses as Middle East Tensions Flare For the week of January 6, 2020

Key Market Data

12/27/2019 01/03/2020 One Week Change YTD One Year
S&P 500 Index 3,240.02 3,234.85 -0.16% +0.15% +34.81%
MSCI EAFE Index 2,042.90 2,042.46 -0.02% +0.27% +23.80%
Barclays Capital U.S. Aggregate Bond Index 2,228.08 2,236.95 +0.40% +0.54% +8.56%
10-year Treasury Note Rate 1.877% 1.789% -8.8 basis points -13.0 basis points -76.5 basis points

Oil and gold futures surged Thursday night after President Donald Trump ordered a drone strike that killed Iran’s top commander General Qasem Soleimani in Iraq. By Friday morning, the “Santa Claus Rally” narrative was promptly shelved as stocks fell while investors considered potential knock-on effects from heightened geopolitical risks with Iran — more on this later. In other news, data from the U.S. manufacturing sector sent decidedly mixed signals, China opened the monetary spigot and the Federal Reserve focused on messaging around its 2 percent inflation target.

As we look ahead this week, we’ll get key data on U.S. workers and wages (keep an eye on non-supervisory workers’ earnings), and another read on growth in non-manufacturing sectors, which command the largest share of the U.S. economy.

WALL STREET WRAP

Investors assess fallout from airstrike in Iraq: Oil prices rose amid investor concern that retaliation from Iran (which has been promised) could disrupt the production and transport of oil, particularly through in the Strait of Hormuz (where 20 percent of the world’s oil shipments originate). More broadly, markets are now pricing new uncertainties. Are we headed to another extended conflict in the Middle East? How might that affect various sectors of the economy or inflation? These are questions that will likely weigh over markets in the weeks or months ahead as the situation unfolds. Keep in mind, Iran attacked oil facilities in Saudi Arabia on Sept. 14, leading to the biggest jump in oil prices in decades, but that faded shortly thereafter. However, stocks could be volatile in the coming weeks as investors navigate a dynamic geopolitical situation.

Manufacturing still in muddy waters: The IHS Markit U.S. Manufacturing PMI index dipped slightly in December, hitting 52.4 compared to a 52.6 in November, but output was markedly improved compared to a rather sluggish summer (any reading above 50 indicates a growth in business activity). In fact, the closing three months of the year were the strongest since the first quarter of 2019 with many manufacturers reporting growth in new business and demand, particularly for exports. The upward swing in business pushed companies to expand their workforces in December, with the rate of job creation at its fastest clip since May.

This ISM Manufacturing PMI for December came in at 47.2, a decrease of 0.9 from November. It’s the weakest reading in the U.S. since June 2009. "Global trade remains the most significant cross-industry issue, but there are signs that several industry sectors will improve as a result of the phase-one trade agreement between the U.S. and China,” Timothy Fiore, chair of the ISM, said Friday. The Markit and ISM surveys are similar but compiled by different services. That’s why you won’t always see

Easy going in China: Stocks jumped on Thursday, the first trading day of 2020, after China’s central bank kicked off the new year with a new round of monetary easing. The People’s Bank of China lowered the reserves banks are required to hold by 50 basis points, basically freeing $115 billion that banks can now use to lend and put to work in the economy rather than holding. Meanwhile, President Trump took to Twitter to announce he would sign a preliminary, phase-one trade deal with China on Jan. 15 in Washington. President Trump said he’ll be traveling to Beijing later in 2020 to begin negotiations on a “phase-two” deal.

Signs of a rebound in Asia: Around the world, production picked up for major economies, such as South Korea, Malaysia and India. Data from China, the second-largest economy, pointed to an increase in activity. Still, the industrial slump in Europe continues to linger, with the IHS Markit Manufacturing PMI falling to 43.7 from 44.1 in December.

Inflation expectations a focus for Fed: Persistently low inflation, in part due to global economic weakness, was a concern shared by Fed officials, according to minutes from their December meeting. Officials expressed unease that the public’s long-term expectations for lower inflation could, reflexively, keep actual inflation below the Fed’s 2 percent target. As a result, that could limit the effectiveness of rate cuts in a future downturn and potentially worsen the impact on businesses and households. Fed officials agreed that they’ll need to communicate more clearly to articulate their rationale for hitting a persistent, 2 percent target to anchor expectations, reinforce the Fed’s credibility and prevent a self-fulling cycle.

In terms of interest rates, officials indicated they were in no hurry to change course in either direction. However, a few Fed officials raised concern that keeping interest rates low over a long period could encourage the kind of excessive risk-taking that knocks the financial sector out of balance.

THE WEEK AHEAD

Will wage growth continue? This week we’ll be keeping an eye on a slew of data about the American worker, from unemployment figures to wages. Analysts were hard-pressed to find a weak spot in last month’s employment data, as key metrics all came in strong. Growth in wages for non-supervisory workers was a particularly bright spot last month as that indicates workers at the top and bottom of the pay scale are seeing their income rise faster than inflation. Given early feedback from manufacturers, we could see a repeat performance this month for employment data.

A closer look at the broader U.S. economy: While we’re still waiting for clearer signs that manufacturing has shaken off its 2019 slump, it’s the non-manufacturing sectors that claim the lion’s share of the U.S. economy and drives the bulk of GDP growth. This week we’ll see a pair of reports from the nonmanufacturing sectors from the same services, IHS Markit and the ISM.

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