The ramp up in world trade tensions will test investor sentiment in the week ahead.
Wall Street has remained largely positive in the leadup to the July 6 tariffs imposed on $US34 billion of each other's goods by the US and China.
Markets rose again on Friday as US labour market data for June showed a better-than-expected 213,000 jobs were created last month. At the same time, wage inflation has been subdued and the unemployment rate ticked higher in response to a rise in the labour-participation rate, helping to ease worries about wage-driven inflation.
New CPI inflation data on the US economy, due on July 12, are likely to show consumer inflation pushing close to 3% and maybe even hitting the highest level in almost a decade. Rising rents, higher medical costs and a surge in gasoline prices have driven inflation higher over the past year.
However, the Federal Reserve relies more on a separate gauge known as the PCE index, which shows inflation to be somewhat lower. The yearly rate was 2.3% in May, just a bit over the Fed’s long-run target of 2%. And the Fed expects that number to recede in the coming months.
Another positive for markets is second-quarter corporate earnings, which are scheduled to kick off this week, with bank profits estimated to increase more than 20% in the second quarter.
On Friday, the Dow Jones Industrial Average rose 100 points, or 0.4%, to 24,456.48, a 0.8% rise for the week. The S&P 500 rose 0.9% to 2759.82, a 1.5% weekly gain, and the Nasdaq Composite rallied 1.3% to 7688.39 for a 2.4% increase over the week.
Mood starts to swing
However, the mood is starting to swing. In the latest AAII Investor Sentiment survey, the percentage of investors who describe themselves as bullish, meaning they expect stocks to be higher in six months, fell to a three-month low in the latest week.
Only 27.9% of those polled are optimistic, well below the 38.5% historical average, and at a level that AAII described as “unusually low,” meaning it is one standard deviation below the long-term average.
The ratio of bearish investors stands at 39.3%, notably above the long-term average of 30.5% but down 1.5 percentage points from the previous week, when it was at an unusually high level.
Nearly a third of investors describe themselves as neutral on the market; this reading has been above the historical average of 31% for 20 straight weeks, a sign of how mixed investors are about Wall Street’s prospects over the rest of 2018.
Optimism among small businesses – a segment of the economy with little exposure to trade issues – is at its second-highest level of the past 45 years, while a reading of consumer confidence is near an 18-year high.
In another sign that investors may not be particularly afraid, the Cboe Volatility Index is at 13.52, well below its long-term average between 19 and 20. While the VIX is up 22.5% thus far this year — following an atypically quiet year in 2017 — it has dropped 16% over the past year.
Trade war risks rise
Wells Fargo Investment Institute strategist Peter Donisanu says: “We believe that the risks related to a trade war involving the US and China have notably increased over the past couple of weeks. While we expect cooler heads to prevail, a prolonged trade spat could affect our current market views and targets.”
That view is supported by TS Lombard managing of global macro director Dario Perkins: “Like most investors, we were assuming Trump’s trade war was mostly ‘noise.’ We thought the likeliest outcome was a series of skirmishes, full of inconsequential measures and symbolic victories, which wouldn’t ultimately undermine the macroeconomic outlook.
“Now, as trade tensions escalate — perhaps even to the brink of a full-scale trade war — the risks to markets are obviously increasing.”
In China, shares continued to drop. The Shanghai Index shed 4% for the week and is 23% below its 2018 and firmly in a bear market. The currency is also continuing to fall.
Expected data this week include readings on credit impulse, which is important as it leads global and Chinese activity by about three quarters, trade and inflation, both of which are likely to be higher.
Citi sees a Chinese slowdown as the major risk to the global growth outlook. The economies that would be most exposed to this include those in the Asian supply chains and commodity exporters. For example, Taiwan value-added exports to China are 10% of GDP. In Singapore it is 6% and in Korea 5.7%.
In Europe, eurozone industrial production is expected to increase following the stronger-than-expected rebound in the German figure, which added to the evidence of stabilising growth momentum.
Bonds and commodities
US government bond yields mostly fell on Friday, extending their downward slide for the week.
The 10-year note yield was down 0.9 basis point to 2.831%, adding to a decline for the week of 1.6 basis points.
In commodities, US and global oil benchmarks finished last week on a mixed note, with both booking their first weekly losses in three weeks amid signs of rising crude supplies.
The US benchmark settled at $US73.80 a barrel, down 0.5% for the week. Brent, the global benchmark, finished at $US77.11 a barrel, a weekly slide of 2.7%.
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