VIA NOVA UPDATE: The facts beat fears again.

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  • Stocks advanced on favorable economic reports.
  • Key economic reports beat expectations.  Low wage inflation argues against aggressive Fed rate hikes.
  • The U.S. imposed tariffs on Chinese goods and China retaliated as expected.
  • Trade developments and inflation reports will be the focus in the coming week.

Stocks advanced on favorable economic reports.

U.S. stocks posted solid gains in the holiday-shortened week helped by stronger than expected increases in two key economic reports and despite the imposition of trade tariffs on China and China’s corresponding retaliation.  The S&P 500 gained 1.56% paced by gains in all but one sector.  Health care, technology, telecom and utilities enjoyed above average improvement, while energy stocks fell slightly.  Still, trade tensions were felt in the more export-oriented Dow Jones Industrial Average (DJIA) which added only half that of the S&P 500.  Indeed, the DJIA is essentially flat so far in 2018, compared to a 4.25% increase in the broader S&P 500.

Small cap stocks, inherently more domestically focused, had another good week.  The Russell 2000 jumped 3.12% and is up more than double that of the S&P 500 so far in 2018.  International stocks rose moderately but remained negative year to date, while emerging market stocks fell further into the red.  Trade tensions appear to have had a more negative impact on the international markets so far due to a relatively heavier reliance on exports in the respective countries.

Bond yields fell slightly for the week helping the broad Bloomberg Barclays Aggregate Bond Index add 0.25%.  Wage inflation was lower than expected in the latest employment report which raised hopes that the Federal Reserve might increase interest rates just one more time this year instead of two.  The yield on the 10-year Treasury note closed the week at 2.84% which was up from the beginning of the year, but down significantly from the 3.12% level hit in May.  The bond yields were a positive for REITs, while oil prices slipped on expected increases in oil production from Saudi Arabia and Russia.  Gold prices were mostly unchanged.

Key economic reports beat expectations.  Low wage inflation argues against aggressive Fed rate hikes.

Two key pieces of economic data, the employment report and the ISM Manufacturing Index, are released in the first week of the month and offer useful clues to the strength or weakness of later releases like personal income and industrial production.  Both reports were better than expected.  The ISM Manufacturing Index rose in June pointing to increasing manufacturing activity.  Job growth also beat expectations last month suggesting more gains in personal income.  The unemployment rate rose back to 4% from 3.8%, but that was due to a jump in the number of people re-entering the labor force, which is another sign of confidence.  The one puzzling piece of data from the employment report was that wage growth held steady at 2.7% year over year despite calls from pundits for an acceleration in wages due to tight labor markets.  Expectations have also suggested that the Federal Reserve might have to increase interest rates faster than previously expected to counter the potential inflationary pressure.  So far, that has not happened, suggesting the Federal Reserve might stick to its original plan to increase interest rates only gradually.

The U.S. imposed tariffs on Chinese goods and China retaliated as expected.

Friday, the U.S. imposed tariffs on $34 billion of Chinese goods, and China responded with tariffs on agricultural products.  Canada imposed tariffs on beef and farm products, and the EU threatened its own tariffs if the U.S. imposes tariffs on autos.

We believe the purpose of the aggressive negotiating tactics is to extract more favorable trade terms in a relatively short time.  Trade negotiations typically run on for years.  However, in a preliminary sign of a possible breakthrough, German Chancellor Angela Merkel indicated support for some back-channel efforts to eliminate tariffs on auto imports.  “Preliminary” and “possible” are not words that suggest the worst is over for trade tensions, but the announcement does suggest an effort from both sides to reach a breakthrough.  Stay tuned.

Trade developments, NATO and inflation reports will be the focus in the coming week.

Traders will be coming back to work this week after the Independence Day holiday.  The Consumer Price Index will likely be the most closely watched economic report, though the consensus forecast is for another benign increase. 

Normally, a NATO Summit is not a big market event, but we could see some fireworks if President Trump scolds U.S. allies for not living up to defense spending commitments.  Finally, the markets will be watching nervously for more trade and tariff announcements.