Consumers Are Markets’ Steely Backbone

The Week in Review

  • Tariffs as Inflation Bugbear
  • Consumer Strength Persists
  • Looking Ahead

By its very definition, a streak comes to an end. That’s what happened in February, when the S&P 500 index posted its first monthly decline in 16 months. As volatility returns, the markets have embarked on a less agreeable streak that continued Thursday, with the Dow Jones Industrial Average falling by at least 1% for the third consecutive day. Market volatility is now higher year-to-date than its average for the last five years, but it is not off the charts.

Yesterday’s market turbulence came as traders reacted to President Trump’s announcement of a plan to enact tariffs on steel and aluminum imports. We’ll dig deeper below, but, as you know, we avoid overreacting to headlines by staying focused on the fundamentals—earnings, economic data and interest rates. We’re watching closely to see if the tariffs, not tariff talk, jeopardize those fundamentals, which have so far been on solid footing.

For the year through Thursday, the Dow Jones Industrial Average is flat at 0.0% on a total return basis, while the broader S&P 500 index has gained 0.5%. The MSCI EAFE index, a measure of developed international stock markets, is down 1.1%. As of Thursday, the yield on the Bloomberg Barclays U.S. Aggregate Bond index has climbed to 3.11% from 2.71% at 2017’s end. On a total return basis, the U.S. bond market has declined 1.8% for the year.

Tariffs as Inflation Bugbear

It has long been the case that trigger-happy stock traders react to headlines and press the “sell” button well before making an educated assessment of what’s truly important among the day-to-day headlines that cross their screens. President Trump’s offhand remarks yesterday revealing plans to enact 25% and 10% tariffs on imported steel and aluminum, respectively, sparked fears of a global trade war and spooked traders into selling.

The tariff talk is just the latest inflationary concern following on recent data showing wage increases accelerated in January. The thinking is that, at least in the short-term, such a policy would almost certainly lead to higher steel and aluminum prices for U.S. buyers as well as higher prices for cars, trucks and other products that rely on these metals. That said, imported aluminum and steel accounted for just $19.5 billion in sales in 2017—only 0.2% of U.S. GDP—while domestic production is about two-and-a-half times that level at roughly 0.5% of GDP. While they are important businesses, steel and aluminum concerns have not been dominant in our consumer-driven economy for decades.

The unknown that is driving market reaction is the one we mentioned earlier—a global trade war. And given that we are still awaiting the details of what the proposed tariffs will look like in practice, we are not rushing to any conclusions. Plus, we wouldn’t be surprised to see cooler heads prevail in the West Wing once the problems created by such a step make themselves clear. Nonetheless, we are watching this closely, as disruptions to global trade could negatively impact the fundamentals we’ve built our outlook upon.

Consumer Strength Persists

Tax cuts began to show their impact upon wallets and pocketbooks in January, as personal incomes rose 0.4% during the month and were up 3.8% from the same time a year ago. Boosted by one-time bonuses primarily attributable to corporate tax cuts, Americans’ disposable income posted the biggest monthly gain in nearly three years after adjusting for inflation and taxes. And, after a robust holiday shopping season, consumers tightened the purse strings and tucked away more of what they made, as the savings rate bounced back to 3.2% from a 10-year low of 2.5% in December, a dip we thought was related to the holiday shopping spree. The return to a more typical savings rate suggests that consumers are confident, but not irrationally exuberant.

Indeed, consumer surveys report optimism is at its highest levels since 2000, and for good reason. Jobless claims are the lowest they’ve been since December 1969, even more impressive when you consider how many more people are in today’s workforce. The unemployment rate remains at 4.1%, a 17-year low. We’ll get a look at February’s employment data next Friday. 

We believe that these factors, among others, provide the solid foundation for consumers’ rosy outlook as well as their ability to continue to drive economic growth in the months ahead.  

Looking Ahead

Next week, we’ll be on the lookout for more clarity on the steel and aluminum tariffs. Additionally, we’ll digest reports on the service sector, factory orders, consumer credit, February employment and the Federal Reserve’s “Beige Book” of anecdotal reports from around the country.

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Please note: This update was prepared on Friday, March 2, 2018, prior to the market’s close.

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