Weekly Market Insight - March 5th 2018

Equities:

President Donald Trump’s announcement of steel and aluminum tariffs suddenly brought the notion of a trade war into sharp focus. That suggested investors are in for a renewed bumpy ride in the equity space.

Now investors must contend with the possibility of higher inflation, higher bond yields and possibly more aggressive monetary policy. However, of deep concern is also the fact that the benefits of the tax cuts could be at least partly offset by the fallout from increased trade tensions.

The stock market endured heavy declines in the past week, with the main US benchmarks posting weekly losses.

The industrials sector was hit the hardest. The Dow Jones Industrial Average DJIA, -0.29% tumbled for four straight sessions and posted a 3% loss over the week. The S&P 500 industrials sectors, -0.03% fell 3.3% over the week.

The S&P 500 SPX, +0.51% fell sharply Thursday after the tariff announcement, but recouped a bit of the lost ground Friday. For the week, the S&P posted a loss of 2%. The Nasdaq Composite COMP, +1.08% booked a 1.1% weekly loss

Implied volatility on the S&P 500, as measured by the Cboe Volatility Index VIX, -12.82% rose 19% on the week to 19.59, compared with a reading near 11 for most of 2017.

U.K. stocks were lower after the close on Friday, as losses in the Industrial Engineering, Automobiles & Parts and Mining sectors led shares lower.

German stocks were lower after the close on Friday, as losses in the Basic Resources, Industrials and Construction sectors led shares lower.

French stocks were lower after the close on Friday, as losses in the Utilities, Basic Materials and Industrials sectors led shares lower.

Fixed Income:

U.S. government debt yields rose Friday after President Donald Trump’s tariff announcement sparked fear of a trade war and more robust inflation.

Kathy Jones, chief fixed income strategist for the Schwab Center for Financial Research said:

“Trade wars and tariffs are bearish for bonds because they raise inflation. Particularly when we look at steel and aluminum, they’re a part of a lot of things we use: autos, beer cans” you name it. If [the tariffs] go through ” and they’re substantial ” it’ll be passed along to the consumer. Ultimately, tariffs tend to slow economic growth … People are looking at it and saying if we get some versions of this and retaliation, it’s just a lose-lose situation.”

Chinese officials could retaliate against unfriendly tariffs by reducing purchases of U.S. debt in the coming years, even as the Treasury Department prepares for a swell in issuance.

China holds just under $1.2 Trillion and their holdings have been slowly drifting lower, China isn’t going to sell Treasury’s, but they could certainly be less active participants at upcoming auctions. That, in turn, would send yields even higher.

Foreign Exchange:

The U.S. Dollar will face headwinds if President Donald Trump’s proposals to impose stiff tariffs on steel and aluminum imports are enacted, with the biggest risk stemming from the possible flight of capital flows needed to finance ballooning U.S. deficits.

Currency markets tend to dislike any form of trade intervention and previous protectionist efforts by the U.S. government have resulted in Dollar weakness.

Let’s not mince our words here; the U.S. is putting a risk premium on U.S. assets by introducing tariffs and going down this protectionist route, which is negative for growth and the Greenback.

Tariffs introduced by Presidents Bill Clinton and George W. Bush in 1995 and 2002 respectively had resulted in a 15% decline in the Dollar, although there were other factors that also undermined the U.S. currency during those periods.