Stocks Ignore Potential Trade War With China

Stocks Fall Slightly On Friday

The stock market was down decently early in the day on trade war fears, but the S&P 500 only closed down 0.1% as it rallied in the afternoon. Trump stated he would impose a 25% tariff on up to $50 billion of Chinese goods. Specifically, America will put a 25% tariff on 818 goods worth $34 billion starting July 6th. Duties on $16 billion worth of Chinese imports will undergo public review before they are enacted. In response, China stated it will be implementing a 25% tariff on $50 billion of American goods. There will be 659 goods taxed. Only 114 of the goods were announced on Friday. The goods include soybeans, electric vehicles, seafood, pork, crude oil, diesel, and magnetic resonance kits.

The chart below shows the effect the Chinese tariffs had on corn and soybean prices. By rallying slightly in the afternoon, equities decided to believe there will be further negotiations before this action effects the economy. That’s a remarkable level of patience since these actions look legitimate. The other explanation is simply that the current size of these tariffs isn’t enough to hurt the global economy yet.

Treasuries, Commodities, & The Dollar

Finally, the yield curve didn’t flatten. With the latest quick flattening, a stagnant curve is a welcome change for the bulls who want to avoid a recession in the next 1-2 years. Keep in mind, it’s possible for the curve to slow down its flattening for a while. That would occur if the Fed tempers its hawkishness and the core PCE remains below 2%. I think the core PCE will go above 2% because of easy comparisons later this year, but it will likely decelerate when the comparisons get tougher. It would be smart if the Fed followed what it said in its Minutes which would be to not react hawkishly if core PCE gets slightly above 2%. Specifically, the 10 year bond yield was down 1.46 basis points and the 2 year yield was down 1.64 basis points. The difference between the two yield is now 37 basis points.

Commodity prices fell on fears Chinese demand is weakening as the price of copper fell 8.6 cents to $3.14 which is a 2.67% decline. Gold fell 2% to $1,282 and silver fell 4% to $16.57. Oil fell 2.7% to $65.06 as the market is anticipating OPEC will increase production. This fear was behind the decline from the low $70s. In the past few days oil drifted higher; this decline reinforces that fear. I’m not expecting much of a reaction after the meeting as the selling pressure shows the market knows production will increase. I have previously misstated the date of the meeting. It will take place in Vienna on June 22nd to the 23rd.

The dollar index was down 9 cents after it spiked higher earlier in the week to an 11 month high. The peak on Friday was $95.13. The $95 handle is a very important technical handle which will test the strength of this bull run.

Great Retail Sales Report

I have stated that if the consumer spending growth is strong in Q2, the GDP growth will be amazing because the rest of the economy is doing well. All indications are that the consumer has rebounded in Q2. This thesis was supported by the May retail sales report which showed month over month headline sales growth doubled the consensus estimate and the revised growth in April.

Retail sales were up 6% year over year as you can see from the chart below. That’s the second highest growth rate in the past 6 years. Retail sales excluding autos were up 0.9% month over month which beat the consensus by 4 tenths. Excluding autos and gas, retail sales were up 0.8% month over month which also doubled the estimates. The knock on retail sales in April was they were helped by gas price increases. This report was also helped by them, but the underlying results were also strong. The control group saw sales increase 0.5% which beat estimates by one tenth.

Specifically, sales for motor vehicles were up 0.5% and building materials were up 2.4%. The physical store sales had a great month, while online sales showed weakness which is surprising and likely temporary. Department store sales were up 1.5% in May and 0.7% in April. Restaurant sales were up 1.3%. I remember how restaurant sales weakness was supposed to be a sign of a recession in 2016 and 2017. There are always anomalies in the data which is why it never makes sense to only rely on one metric. Clothing store sales were up 1.2% in May and 1.3% in April. As I mentioned, gasoline sales did help the headline report as they were up 2% in May and 1% in April. As you can see, they helped results in May even more which implies the consumption expenditures report will also be helped by gas prices.

Blockbuster Q2 GDP Growth?

Many predictions indicate the Q2 GDP growth will be close to 4%. Goldman Sachs’ model expects 4% growth and the average of the estimates in the CNBC rapid tracker is 3.9%. The St. Louis Fed Nowcast expects GDP growth to be 3.62%. There is a sharp divergence between the NY Fed Nowcast which expects 2.98% growth and the Atlanta Fed Nowcast, seen in the chart below, which expects 4.8% growth. One reason why there is such a divergence is the NY Fed model included the disappointing May industrial production report, which I will review in a subsequent article, and the Atlanta Fed Nowcast doesn’t. That means the Atlanta Fed Nowcast will be revised lower by a bit on Tuesday when the next update comes out.

The update seen below shows the Nowcast went up 2 tenths to 4.8% because the retail sales report caused the estimate for real personal consumption expenditures to increase from 3.4% to 3.6%. This shows you how strong GDP growth can be when manufacturing and the consumer are strong. The NY Fed Nowcast went from 3.08% to 2.98% as the industrial production report pushed it down by 0.24%. On the bright side, the Q3 Nowcast expects GDP growth to be 2.84%, showing a continuation of great results is on the horizon.

 

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