Trade Wars: A Motif in the Market
Tariffs have become a motif in the market, with Canada imposing $12B in retaliatory tariffs on U.S. industrial metals and agricultural goods while the U.S.’s rhetoric with China has increased. Earlier in the month, a proposed 10% tariff on $200B of imported consumer goods from China was announced only to have the ante increased 10 days later to cover all U.S. imports from China totaling just over $500B. In a move to help offset the impact tariffs would have on U.S. exports of soybeans, corn, and beef, the administration announced a $12B subsidy based on a law not used since the Great Depression.
Despite the theatre featuring trade wars, the S&P 500 and Dow Industrials posted positive gains in July. With earnings in focus during the month, more than half of the S&P 500 reported on the upside providing some evidence behind the 4.1% Q2 GDP number reported as July ended. However, some volatility has been injected into the market coinciding with real concerns about trade and worries that headwinds to corporate earnings may follow if the risks of trade policy aren’t averted.
The Federal Open Market Committee (FOMC) minutes from their June meeting were released which provided some insight on how the Committee has been reading the market’s tea leaves. The Committee observes the economy as strong and expects inflation to run at a sustained 2%, giving credence to their course for gradual rate hikes toward their 3% long-run estimate. This optimism of an improved economy, however, was tempered with the moderate wage growth despite the tight labor market and the additional mention of how trade policy may impact future capital investment. Looking into the 4.1% GDP number, the key driver for growth has been from Capital Investment.
With the uncertainty surrounding the end-game with trade, the Treasury yield curve has continued to flatten, with the 2/10 spread tightening another 40bps in July. The net futures position in 5, 10, and long dated Treasuries have been negative, indicating the net short duration bets in the market and the expectation of a possible treasury sell-off.
The dollar has continued to rally in July, in part due to a potential spill over from the trade war. With the administration accusing China and the European Union of currency manipulation, the fear of currency contagion could be on the coat-tails of an escalating trade war. A run-away USD could also hurt commodities. The broad index (HFRI Hedge Fund of Funds Index) was down, as were industrial metals, precious metals, and energy futures.
The broad hedge fund indexes were down in July with 3 of the 8 hedge fund strategies positive. Equity Hedge strategies were positive at 0.72% followed by Distressed and Merger Arbitrage (both Event-Driven strategies). Global Macro strategies underperformed all others.1
Key Economic Data2
- The U.S. Bureau of Economic Analysis (BEA) second quarter 2018 advanced GDP came in at 4.1%. Real GDP grew by 2.0% in the first quarter of 2018, 2.9% in the fourth quarter of 2017, and 3.2% in the third quarter of 2017.
- Headline inflation (U.S. Consumer Price Index for All Urban Consumers seasonally adjusted (CPI-U SA)) was at 0.1%. Core inflation (CPI-Ex Food and Energy) came in at 0.2%. For the last 12 months, the CPI-U NSA was 2.9% and the CPI-Ex Food and Energy was 2.3%.
- The U.S. Bureau of Labor Statistics (U.S. BLS) announced that non-farm payrolls changed by 213,000 compared to the prior change of 223,000. Private sector payroll employment gained 202,000 compared to 218,000 from the prior period. The unemployment rate rose .2% to 4.0%. The underemployment rate also rose by 0.2% to 7.8%. The labor force participation rate remained at 63%.
- The U.S. Department of Housing and Urban Development (HUD) and the U.S. Census Bureau jointly announced that sales of new single-family houses were down 5.3% to 631,000. Housing starts were also down by 12.3% to 1,173K from 1,350K. Building permits were down -2.20% to 1,273K. Existing home sales were 5.38 million units, a change of -0.60%.
- The Conference Board Consumer Confidence Index was 127.4.
1. Bloomberg, as of 7/31/18.
2. IndexIQ, FactSet, as of 7/31/18.
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Treasury Securities are backed by the full faith and credit of the United States government as to payment of principal and interest if held to maturity.
The 10-year Treasury note is a debt obligation issued by the United States government with a maturity of 10 years upon initial issuance. A 10-year Treasury note pays interest at a fixed rate once every six months, and pays the face value to the holder at maturity.
A credit spread is the difference in yield between two bonds of similar maturity, but different credit quality.
The Consumer Confidence Index (CCI) is an indicator designed to measure consumer confidence, which is defined as the degree of optimism on the state of the U.S. economy that consumers are expressing through their activities of savings and spending.
The Consumer Confidence Survey® reflects prevailing business conditions and likely developments for the months ahead. This monthly report details consumer attitudes and buying intentions, with data available by age, income, and region.
Consumer Price Index for All Urban Consumers (CPI-U) – A measure that examines the changes in the price of a basket of goods and services purchased by urban consumers.
Convertible arbitrage is a market-neutral investment strategy often employed by hedge funds that involves the simultaneous purchase of convertible securities and the short sale of the same issuer’s common stock.
Distressed/Restructuring strategies which employ an investment process focused on corporate fixed income instruments, primarily on corporate credit instruments of companies trading at significant discounts to their value at issuance or obliged (par value) at maturity as a result of either formal bankruptcy proceeding or financial market perception of near term proceedings.
Distressed securities are securities over companies or government entities that are experiencing financial or operational distress, default, or are under bankruptcy.
Event Driven investing is designed to capture price movement generated by a significant pending corporate event, such as a merger, corporate restructuring, liquidation, bankruptcy, or reorganization.
Equity Hedge investing buys stocks that are undervalued and short sells stocks that are overvalued. This strategy may commonly employ variable exposure as well as the use of leverage.
Global Macro strategy is a strategy that bases its holdings, such as long and short positions in various equity, fixed-income, currency, commodities, and futures markets, primarily on the overall economic and political views of various countries, or their macroeconomic principles.
Relative-value arbitrage is an investment strategy that seeks to take advantage of price differentials between related financial instruments, such as stocks and bonds, by simultaneously buying and selling the different securities—thereby allowing investors to potentially profit from the “relative value” of the two securities.
The Dow Jones Industrial Average (DJIA) is a price-weighted average of 30 significant stocks traded on the New York Stock Exchange (NYSE) and the NASDAQ.
HFRI Hedge Fund of Funds Index – Fund of Funds invest with multiple managers through funds or managed accounts. The strategy designs a diversified portfolio of managers with the objective of significantly lowering the risk (volatility) of investing with an individual manager. The Fund of Funds manager has discretion in choosing which strategies to invest in for the portfolio.
The S&P 500 Index is a capitalization-weighted index of 500 stocks. The index is designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The U.S. Consumer Price Index (CPI) is a set of consumer price indices calculated by the U.S. Bureau of Labor Statistics (BLS). To be precise, the BLS routinely computes many different CPIs that are used for different purposes. Each is a time series measure of the price of consumer goods and services.
The U.S. Consumer Confidence Index (CCI) is an indicator designed to measure consumer confidence, which is defined as the degree of optimism on the state of the economy that consumers are expressing through their activities of savings and spending.
A yield curve is a curve on a graph in which the yield of fixed-interest securities is plotted against the length of time they have to run to maturity.
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