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Weekly Market Digest: Will Tariffs Lead to a Recession?

Renewed fears of a trade conflict driven recession fueled volatility in capital markets. Stocks finished modestly lower and bonds and gold rose. Most of the selling came on Monday following President Trump’s assertion that he would add 10% tariffs on an additional $300 billion worth of goods from China and a subsequent response by China allowing the yuan to drop below the symbolic 7 level. Plummeting interest rates also spooked some investors with the 10 year Treasury yield dropping below 1.7% at one point along with growing expectations that the ECB would push rates further into negative territory.

Weekly Returns

S&P 500: 2,919 (-0.5%)
FTSE All-World ex-US (VEU): (-1.2%)
US 10 Year Treasury Yield: 1.74% (-0.12)
Gold: $1,497 (+3.9%)
EUR/USD: $1.120 (+0.8%)

Major Events

  • Monday – Stocks sank after the Chinese yuan fell below 7, China said state owned enterprises would stop buying US agriculture products, and President Trump accused China of currency manipulation.
  • Tuesday – US crude oil fell below $54, down over 20% from a recent high.
  • Wednesday – Falling interest rates drove a Fannie Mae index for consumer confidence in housing to a record high, despite prices starting to decline in some of the priciest metros.
  • Wednesday – India, Thailand and New Zealand all cut rates, prompting fears of a global race to devalue currencies.
  • Thursday – Overall Chinese exports posted a 3.3% year over year gain despite tariffs.
  • Friday – President Trump said it would be fine if trade talks with China in September are cancelled and also said he has no plans to devalue the US dollar.

Our Take

This week featured a big down day, a big up day and a big intra-day reversal as stock and bond prices fluctuated wildly on trade conflict news. Ultimately, what matters for stocks is not trade tariffs but earnings and economic growth. Many believe tariffs will guide the US and global economy into recession.

Predicting the timing of recessions is nearly impossible, and in our opinion not a healthy practice for investors. But we note that even if all Chinese imports are taxed at 10%, the maximum $50 billion direct impact on US consumers would be similar to or less than a 0.5% increase in effective federal tax rates. Tariffs will have a direct and costly impact on some particular companies and industries, but overall we don’t think they will be the cause of a recession. If President Trump moves to 25% tariffs, it could start to be more impactful.

All this recession fear has interest rates testing record lows. That is scary if you believe the bond market can predict recessions. But it is very exciting for equity owners if you believe in the impact of relative valuations. The dividend yield on the S&P 500 surpassed the 10 year Treasury yield for the first time since 2016 and the earnings yield on stocks is a very healthy 4% higher than bonds. Overseas, interest rates are negative in much of the developed world, making lower priced stocks there perhaps even more attractive. Which theory will win? Only time will tell, but we urge investors not to focus too much on either side of the story without considering the other.

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