Interest rate and trade war fears reignited volatility, and U.S. stocks briefly dipped back into negative territory for the year. New Fed Chairman Jerome Powell testified to Congress on Tuesday and Thursday, indicating that he sees strength in the economy. This makes four, rather than three, quarter-point rate hikes in 2018 appear more likely. President Trump said he would slap tariffs on steel and aluminum imports and tweeted that trade wars can be “good.” The moves were met with little support even in his own party, and led to more selling.
S&P 500: 2,691 (-2.0%)
FTSE All-World ex-US: (-2.8%)
US 10 Year Treasury Yield: 2.86% (-0.02%)
Gold: $1,322 (-0.5%)
EUR/USD: $1.233 (+0.3 %)
- Monday – GE said it will overhaul its board and add three outside directors as it seeks to restructure and stem the flow of bad news and poor operating results.
- Monday – In response to reports of harassment and poor corporate culture, Fidelity said it is considering revamping its portfolio management process toward a team approach.
- Tuesday – Amazon acquired Ring, a maker of video doorbells, for just over $1 billion.
- Tuesday – Comcast said it is planning a bid for European pay-TV Sky, entering a bidding war with 21st Century Fox and Disney.
- Tuesday – Fed Chairman Powell said in Congress that he believes the economy has strengthened in the past few months and downplayed concerns of a flattening yield curve.
- Wednesday – The SEC issued dozens of subpoenas to technology companies and advisors related to the cryptocurrency markets. The focus appears to be initial coin offerings.
- Wednesday – The NFL partnered with Pizza Hut a day after splitting with Papa John’s.
- Wednesday – Bill Ackman abandoned his five-year bet against Herbalife.
- Thursday – President Trump said he plans to approve 25% duties on steel imports and 10% duties on aluminum.
- Friday – Stocks initially extended losses as President Trump tweeted that trade in some cases “trade wars are good,” but rebounded into positive territory by the end of the day.
Stocks declined for the week, but it was a two-part story. Tuesday and Wednesday were a reaction to new Fed Chairman Powell’s congressional testimony. Powell basically stuck to the existing narrative, but when asked what could lead to four rate hikes this year instead of three he stated that he believes the economy has strengthened and that other committee members feel the same. So, short-term rates are now somewhat more likely to go up by 1% this year, as opposed to 0.75%.
Stocks reacted negatively. This makes sense. Higher interest rates create a headwind for companies that borrow money and make bonds more compelling relative to stocks. But it is important to maintain perspective. First, Fed rate hikes are highly fluid and it remains highly uncertain what the Fed will actually do this year. Second, the Fed only controls short-term interest rates. Longer term Treasury yields actually fell this week, highlighting the powerful diversification benefits of bonds in general. Finally, a 0.25% difference in interest rates, if it materializes, will not make or break anything. As a highly oversimplified example, if stock investors demanded a 0.25% higher earnings yield as a result, it would mean 4-5% lower stock prices – holding all else equal. But all else is not equal. The Fed will raise rates if the economy is strong and there are signs of higher inflation, in which case earnings should be growing as well. The earnings yield of stocks remains significantly higher than Treasuries and suggests stocks should be able to withstand moderate bond yield increases.
Thursday’s declines were related to President Trump’s plan to introduce steel and aluminum tariffs. Isolated, these don’t have a big impact on the market overall, but it could signal the beginning of more protectionist policy and trade wars. This could be truly bearish. But as has been the trend, this geopolitical concern appears to have been quickly shrugged off by investors who were ready to buy back by the middle of Friday’s trading session.
This week served as a good reminder that the market is rarely driven by just one factor. That’s why it is so hard to time the ups and downs. Investors with a strategic long-term plan can feel more confident and don’t have to worry about outguessing the Fed or the President.