By: Lyn Alden
The S&P 500 and the C Fund that tracks it went mildly lower this past week, with concerns regarding the ongoing trade dispute between the United States and China being viewed as the main factor.
Strong U.S. Jobs Report
By most accounts, the U.S. economy is strong. GDP growth is solid, the official unemployment rate is near historic lows at 3.9%, and asset prices like stocks, bonds, and real estate are high across the board.
But the one key thing that has been largely absent from this recovery is wage growth. Inflation-adjusted wage growth has been tepid, and economists have frequently pointed to slow wage growth as one of the points of weakness in an otherwise strong economy. The August jobs report issued last week, however, showed the strongest wage growth since mid-2009. Average hourly earnings rose 2.9% on an annualized basis.
Ironically, although weak wages keeps being pointed to as a type of economic weakness, many Wall Street analysts view the surprise jump in wage growth as a bearish indicator for stocks because they broadly view this to mean that the Federal Reserve will almost assuredly continue raising interest rates.
For example, Ernesto Ramos, head of equities for BMO Global Asset Management recently spoke to Marketwatch about this: “The interpretation of that [jobs report] is that inflation is potentially building up in the economy, driven by the wage growth. […] I think this bakes in the idea of four rate hikes this year, which is not good for the market. Overall this gives a higher probability of more rate hikes over the coming year,” said Ramos. This exact sentiment was echoed across news platforms.
Higher wages means more consumer spending (a very bullish indicator), but also indicates higher inflation. Keeping inflation at reasonable levels (around 2% ideally) is one of the Fed’s two primary mandates, and is one of the main reasons why it is currently increasing interest rates. But rising interest rates also act like gravity on stock valuations, because the cost of business borrowing is higher, and the desirability of bonds and savings accounts increase compared to riskier equity assets.
The U.S. and China currently have tariffs placed on $50 billion on each other’s goods. For weeks now, the U.S. has been preparing tariffs on another $200 billion in Chinese goods, but it’s not set in stone when or if they will be formally put into place. It depends on ongoing negotiation results between the United States and China.
Last Friday on Air Force One, President Trump announced that in addition to those tariffs on $200 billion in goods already being prepared, he’s also ready to go with another $267 billion of goods for a potential third wave of tariffs. The stock market responded with a minor drop on Friday afternoon when this was announced.
Totaling over $500 billion, if these tariffs were implemented it would effectively would mean tariffs on all Chinese goods. In 2017, Chinese imports to the United States totaled $505 billion, and that number has so far been higher in 2018.
This could affect consumer prices, and can increase the expenses of businesses like Apple that rely on Chinese parts. It remains to be seen whether these larger tariffs will be implemented and what the actual effects will be if they are.
There’s Always Something
There’s always a potential reason for markets to drop, always some bearish indicator on the horizon, always something that convinces some people to stay out of the market. For example, here is the year-over-year performance of the MSCI World Index, going back to 1971. The World Index is composed of large and medium companies from the United States and the rest of the developed world, so it is basically like the C Fund and I Fund combined:
As you can see, there are constantly good years, bad years, and medium years.
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