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How Are the Trade War and Fed’s Rate Cut Affecting Markets?

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Thanks for tuning in everybody. I know it’s been a wild ride in the last week and a half, and there are a lot of questions. So, let me first just broadly frame what we see as having happened that caused this corrective phase as well as the increase in volatility.

We can take it back to July 31st, the day of the Fed announcement, which was actually not a surprise that the Fed cut by 25 basis points, or a quarter point. I think what was little bit more surprising was the statement after by chairman Powell and some of the comments made during the press conference, where he actually used the term “mid-cycle,” and that suggested--at least in the minds of investors--that maybe this was not the beginning of a protracted rate-cutting cycle and that it might be a “one and done” kind of situation.

In addition, a rate cut had been priced in, so you might have had a little bit of “buy on the rumor; sell on the news,” but that was followed up by President Trump, in a somewhat surprise manner, announcing that he was planning on implementing 10% tariffs on the remaining $300 billion of goods that the United States imports from China; and that really set off the decline which was about 3% in U.S. equity indices that we saw on Monday.

In turn, we saw some currency devaluation on the part of China, which prompted the labeling of China as a currency manipulator by the Treasury Department; and then fast forward to today, Wednesday, the day I’m taping this, and we have the market U.S. equity indices down by about 1% and the proximate reason for that is a plunge in global yields, including the U.S. treasury yield. In the case of the 30-year bond yield, we’re almost at all-time lows. In the case of the 10-year yield, getting down around 1.6%, 3-year lows, and that has set off additional fears about global growth, and in turn, U.S. growth.

There’s also a factor, I think, that has been under-reported, and it goes back to the date of July 26th--which I think, not coincidentally--was the high in the S&P 500, an all-time high. On that day, the Bureau of Economic Analysis released its update to second quarter GDP, but in conjunction with that, they announced what they call “benchmark revisions.” Not just to GDP--past GDP readings--but also the broadest measure of corporate profits that the BEA tracks, and there was a pretty significant $200 billion downward revision concentrated in the last three years. But what that meant is now the last five years corporate profits broadly have been in a sideways trend versus, based on original estimates, an upward trend. Now, the proximate reason for that downward revision was higher compensation costs and higher insurance costs. Now, positive, of course, are higher compensation costs for workers, but unfortunately, we’re talking about a hit to profit margins as well; and now you add in the ramping up of the trade war, the potential additional tariffs--which by the way hit the consumer much more than the prior tariffs--and you’ve got a potential negative profit-margin story as well. So, I think that’s been another reason why we’ve seen the weakness in the market.

The net is that we continue to think trade is a very important factor. We’ve been saying that since the trade war was launched. It is the most important needle-mover in terms of where we are in the economic trajectory. If it gets worse from here, we think recession risks start to move quite high. In the meantime, we think investors ought to stay fairly defensive, fairly cautious. Use diversification. Use rebalancing. Don’t get, so called “out over your skis,” in terms of equity allocation. This is not a time to take excess risk. We think we’re in for a continued bumpy ride in markets.

On this episode of Stock Market Report, Liz Ann Sonders takes a closer look at how the markets have been recently affected by several factors, including the escalating trade war between the U.S. and China and the Fed’s interest rate cut.

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