Market News

Quarterly Economic Update: Q1 2018

Potential for Escalating Trade Dispute with China Could Become Concern for Sectors of U.S. Economy

Despite weather-related factors which dampened the pace of job growth in March, demand for labor remained solid as evident in the most recent jobs report. Seasonally-adjusted total nonfarm payrolls increased by 103,000 in March and the unemployment rate was again unchanged at 4.1%, according to the Bureau of Labor Statistics.

It was the sixth consecutive month the U.S. jobs market posted a 4.1% unemployment rate – maintaining its 17-year low. Employers have added to payrolls for 90 straight months. Average hourly earnings rose by 8 cents to $26.82. Over the year, average hourly earnings have increased by 71 cents, or 2.7%.

A continuing bright spot for payroll growth has been the manufacturing sector. Over the past two years, nearly 285,000 manufacturing jobs have been added, including another 22,000 in March compared to the previous month, according to the Bureau of Labor Statistics.

But manufacturers themselves are uneasy over how a potential trade war with China could play out, concerned that the sector would be negatively impacted. On April 5, President Donald Trump said he had instructed the U.S. Trade Representative (USTR) to consider $100 billion in additional tariffs on China.

That followed China’s decision to introduce tariffs on more than 100 U.S. products, including soybeans, autos and aircraft after the USTR had announced $50 billion of proposed tariffs on Chinese imports on April 3. Those tariffs were viewed as a way to potentially force China to eliminate policies and practices aimed at obtaining U.S. companies’ intellectual property.

While there may be agreement among manufacturers that China’s trade practices represent threats to manufacturers’ competitiveness and the jobs of American manufacturing workers, tariffs “are likely to create new challenges in the form of significant added costs for manufacturers and American consumers,” Jay Timmons, the National Association of Manufacturers’ (NAM) president and CEO, said in an April 3 statement.

If tariffs represent “the first bid” in negotiating a more level playing field, manufacturers, NAM says, believe the end product must be a new, strategic approach that includes negotiating a fair, binding and enforceable rules-based trade agreement with China that requires the country to end its unfair trade practices “once and for all.”

Manufacturers are already citing effects from aluminum and steel tariffs announced by President Trump in early March. This comes on top of constraints that industries like chemical producers and computer and electronics makers are experiencing within their supply chains. Shortages of drivers and carriers for shipments is also affecting the food, beverage and tobacco sector, according to respondent feedback from the most recent Institute for Supply Management’s (ISM) March report on business.

Regarding aluminum and steel tariffs, a respondent in the machinery industry said concern over the tariffs is causing “panic buying,” driving near-term prices higher and leading to inventory shortages for non-contract customers. A respondent in the primary metals industry said price increases will begin to impact the company’s performance.

The ISM purchasing manager’s index (PMI) declined in March by 1.5 percentage points from the previous month to 59.3. While the broader indicator of manufacturing activity declined, ISM’s new orders index remained at 60 or above for the 11th straight month, and the index of order backlogs reached its highest reading since May 2004 at 63.

The outcome of any trade battle remains unclear, yet trade tensions may ease if the U.S. and China reach agreement on improving U.S. access to mainland Chinese markets. Chinese President Xi Jinping did announce plans in a speech April 10 to expand the permitted business scope for foreign financial institutions, reduce tariffs on imported automobiles and enforce the legal intellectual property and technology transfers of foreign companies doing business in the country.

Should the trade dispute escalate, that could impact U.S. and global economic growth. In the U.S., inflation-adjusted gross domestic product (GDP) growth was 2.9% in the fourth quarter, according to the final reading, or third estimate, released in late March by the Bureau of Economic Analysis. That figure represented an upward revision from the 2.5% annualized growth rate, which the Bureau had reported in its second estimate released in February.

For the first quarter, the U.S. economy is currently forecast to grow at an annual rate of 2.0%, according to the Atlanta Federal Reserve’s GDPNow forecast model. That forecast was announced on April 10 and the model’s forecasts do tend to fluctuate, as they are updated every few days or so, based partly on major economic releases.

As recently as March 29, the Atlanta Fed’s model calculated annual growth of 2.4% in the first quarter. The estimate has fallen in recent weeks over declining consumer spending and inflation-adjusted private fixed investment growth (which represents business and household spending on fixed assets such as structures, equipment and software used in the production of goods and services).

Real Estate: Mixed Start for 2018 Home Sales, Though Weather, Market Volatility May Have Dampened Interest

Sales of new single-family homes rose marginally in February, at a seasonally-adjusted annual rate of 618,000, the Census Bureau reported in March. That was 0.6% below the revised rate of 622,000 in January. While the sales pace in February was below expectations, the upward revision of sales in January from a preliminary estimate of 593,000 units was viewed as a sign of consistent demand.

“The recent upward revisions to the sales numbers reflect our forecast for a gradual strengthening of the single-family housing sector in 2018,” said Robert Dietz, chief economist of the National Association of Home Builders (NAHB), in a March 23 post on its website. “Demographic tailwinds point to higher demand for single-family homes in the months ahead. Combined with solid job market data, we expect more consumers to enter the housing market this year.”

The NAHB said sales are at a “steady level,” consistent with the organization’s measures of solid builder confidence in the housing market. With rising demand, though, builders will need to manage increasing costs for labor, materials and lots to build on to keep home prices competitively priced.

Indeed, ongoing forces in the housing market have centered on issues such as affordability and available supply. Another recent factor has been whether or not higher mortgage rates will dampen demand. Freddie Mac 30-year, fixed rates are up by more than 30 basis points from the previous year, as shown below. A recent BCJ market news post looked at how these conditions could impact the spring selling season.



In the existing home sales market, total sales (including homes, townhouses and condos) fell 7.1% in February from the previous month to a seasonally-adjusted rate of 5.08 million. Sales are still 2.2% higher compared to the prior year, according to the National Association of Realtors (NAR), which released its figures in late March.

Lawrence Yun, the NAR’s chief economist, said a lull in contract signings in January from the East Coast blizzard and stock market volatility in February may have played some part in the lack of closings in February. “However, the main issue continues to be a supply and affordability problem,” Yun said in a press release. “Finding the right property at an affordable price is burdening many potential buyers.”

Stocks Sell Off in March, Leaving Most Major Benchmarks in the Red for the First Quarter

The potential for an escalating trade dispute between the U.S. and China weighed on the performance of stocks in the final month of the first quarter. Technology shares, which had been a market leader, also sold off in March, but the S&P 500 index’s information technology (IT) sector still managed to gain 3.2% for the quarter. Small cap shares, meanwhile, had a positive month during March, benefiting somewhat from a rotation out of larger cap shares viewed as more exposed to any potential fallout from a trade war.

Overall, the S&P 500 declined by 1.22% for the first quarter – representing the first quarterly loss for the index in the past 10 quarters. Apart from the index’s IT sector, consumer discretionary was the only other of the 11 industry sectors to finish the quarter on the upside, posting gains of more than 2.7%. The Dow Jones Industrial Average fell by 2.5%.

The tech-heavy Nasdaq Composite index rose by 2.3% in the first quarter, but fell 2.9% during March. Technology shares broadly sold off in March over concerns of how Facebook handled user’s data, and whether companies such as Amazon and Google, as well as other companies with social media platforms, would face greater regulatory scrutiny.



Market volatility, which had been subdued during 2017, was evident during the first quarter. The Cboe Volatility Index (VIX) rose considerably by 81% during the quarter. For its part, the S&P 500 had 12 trading days of moves upward by at least 1.0%, and 11 down by at least 1.0%. That compared to only eight moves of at least 1.0% in 2017. There were no moves of 2.0% in 2017, but five trading days in the first quarter of 2018 in which the S&P 500 fell by at least 2.0% and only one trading session in which it was up by at least 2.0%.

As mentioned briefly above, market sentiment appears to be trending in favor of small cap stocks. The S&P SmallCap 600 index finished the first quarter with a gain of only 0.23%, yet rose by 1.9% in March. The Russell 2000 Index, a broad measure of small company shares, fell 0.4% for the quarter but gained 1.1% during March.

In broad terms, smaller companies have less exposure to overseas revenues, deriving a greater percentage of sales domestically. Previously, the backdrop of a weaker dollar was generally viewed as a positive for large cap multinational companies which tend to generate a greater percentage of sales outside of the U.S. Those shares, though, are less favorable in an environment of escalating trade tensions.

Investors appear to have taken notice. Over the past month, according to FactSet data cited in this article, $1.8 billion has flowed into small-cap exchange-traded funds (ETFs) listed in the U.S. That compares to about $18.6 billion that has been withdrawn from large-cap exchange-traded funds.

For more on the prospects for U.S. equities in the coming weeks, please see BCJ’s recent market commentary on moving sideways in the market by Benjamin Bimson, Chief Investment Officer. Be sure to also see the market insights from BCJ on the prospects for earnings season for companies in the S&P 500.

Despite concerns over rising inflation, the prospects for more Treasury supply and government spending, the yield on the 10-year Treasury note ended the quarter at 2.74% – roughly 13 basis points lower than the previous month. The 10-year note’s yield did increase by about 33 basis points for the quarter – its largest quarterly rise since the final quarter of 2016.

Overseas markets, meanwhile, also fared poorly during the quarter, according to data from S&P Dow Jones Indices. The S&P Broad Market Index (BMI) Ex-U.S. declined by 1.7% for the first quarter, and by nearly 2.2% in March. Within developed markets, shares tracked by the S&P BMI in the U.K. declined by 4.7% in the first quarter, those in Canada fell by about 7.9%, and shares in Australia were down by 6.8%.

The S&P Emerging BMI Index gained slightly more than 1.0% for the quarter, but fell by more than 2.8% in March. Among emerging markets, Chinese shares finished the first quarter with a 2.1% gain, even though they fell by about 3.0% in March. Shares in big commodity producing countries like Brazil and Russia were up by 10.3% and 9.2%, respectively, for the quarter. Yet, they also lost ground during March with Brazilian stocks down by about 2.3% and Russian shares falling by nearly 3.2%, according to S&P Dow Jones Indices.

Commodities: As Oil Prices Rise, U.S. Consumers Face Higher Prices at the Pump

Geopolitical risks are also a potential concern

It’s taken nearly a year and a half, but the Organization of the Petroleum Exporting Countries’ (OPEC) agreement to cut production in November 2016 may finally be filtering through to what Americans pay at the gas pump. Back then, OPEC members along with key non-member countries agreed to cut production by up to 1.8 million barrels per day. A key player in the agreement was non-OPEC member Russia, which agreed to ratchet down production by about 300,000 barrels a day. This past December, OPEC members as well as Russia agreed to extend the agreement through 2018.

Oil prices have risen by more than 40% since OPEC and non-members first struck the deal, even as U.S. shale production has been booming. Through the first quarter, West Texas Intermediate (WTI) futures rose by about 7.5% to nearly $65.00 a barrel.

Tighter supply, continued demand for U.S. exports of oil, fuel and other petroleum products has also been driving gasoline prices higher. According to AAA, average gas prices were at $2.66 – holding their highest price for the year through the first week of April.

“Gas prices are only a penny away from topping the $2.67 high of 2017,” said Jeanette Casselano, AAA spokesperson, in a press release. “The price is likely to increase as spring brings warmer weather and the switchover to summer blend gasoline, but hopefully we will only see mild jumps in coming weeks.”

Downward pressure on oil prices could result from any escalation of trade disputes between the U.S. and China, and also negatively impact consumption for gas and other products. The U.S. has become one of China’s biggest suppliers of propane, among other petroleum products.

On the flip side, a potential contributor for higher oil prices would be geopolitical risk, which could also filter through to higher gas prices.

President Donald Trump is reportedly considering military action or forming a coalition with allies in response to a suspected chemical attack in Syria. Broader concerns would be the potential for a proxy war in Syria as Russia and Iran, two oil producers, have interests in the outcome of Syria’s ongoing civil war.

“This comes after Saudi Arabia is saying they want to see oil at $80 which was our beginning of the year target. Now with the risk rising, tight supplies matter,” Phil Flynn, a senior energy analyst at Price Futures Group in Chicago, wrote in an April 11 market commentary. “Gas prices and crude and distillate have upside risk if we see any disruption from war or weather.”




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