Trade de-escalation lifted the S&P 500 near a new record.

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  • Lagging sectors lead the market rise.

  • Trade overtures from both the U.S. and China suggest possible “détente.”

  • Economic data showed strong consumer spending, but also a rise in core inflation.

  • Week Ahead: Not a quiet weekend. A rate cut from the Fed is likely at the FOMC meeting.

Lagging sectors lead the market rise.

Good news on trade negotiations and retail sales helped lift the S&P 500 by 1% in the latest week within a ½% of the record close in late July.  However, the composition of the advance reflected a bit of “catch-up” by some lagging sectors like financials, industrials and materials.  In addition, small-cap stocks, which have underperformed the S&P 500 for some time, gained nearly 5%.  The broader participation in the rally (large and small cap stocks) is usually a positive sign of future gains.

Part of the progress in stocks came at the expense of bonds.  The yield on the 10-year Treasury bond, which fell below 1½% in early September, jumped to 1.9%, sending the Merrill Lynch Broad U.S. Market Index down -1.7%.  Such sharp moves are unusual and could reflect technical factors as well as a larger than expected rise in core consumer inflation, which excludes food and energy.  Mortgage rates rebounded on the move after falling sharply in recent months.  In other markets, oil and gold prices fell as investors shifted back toward equities.

Trade overtures from both the U.S. and China suggest possible “détente.”

Trade overtures from both the U.S. and China suggest possible “détente.”  The U.S. suggested it might delay the imposition of new tariffs by a couple of weeks to show good faith and avoid potential disruptions on October 1, when China will celebrate the 70th anniversary of the Peoples Republic.  China, in turn, indicated it would increase purchases of U.S. agricultural goods, give companies greater access to the Chinese market and boost intellectual property protections.  Trade talks are expected to resume at a lower level in the coming week with higher level discussions to follow in October.

The announcements are good news for the markets in that they suggest an important de-escalation of trade tensions.  The downward spiral in rhetoric appears to have been stopped.  However, we do not believe that a comprehensive trade deal is likely in the foreseeable future, because the changes sought by the U.S. are seen by China as impinging on the structure and operation of the Chinese economy.

Economic data showed strong consumer spending, but also a rise in core inflation.

The latest batch of economic reports showed continued consumer strength.  Retail sales increased more than expected in August and rose at a robust 6½% annual pace over the past three months.  Initial jobless claims declined suggesting a continuing tight labor market.  However, core inflation, which excludes the volatile food and energy components, increased more than expected last month and rose at a nearly 3½% annual rate over the past three months.  Overall inflation, as measured by the Consumer Price Index, is still running below the Federal Reserve’s two percent target.  The Federal Reserve will have to sort out the meaning and implications of the divergent data when they hold their next Federal Open Market Committee (FOMC) meeting in the coming week.

Week Ahead: Not a quiet weekend.  A rate cut from the Fed is likely at the FOMC meeting.

Some weekends are quiet, and others are not.  Over the weekend, Houthi rebels claimed responsibility for attacking and damaging oil facilities in Saudi Arabia representing 5.7 million barrels a day of global production.  Oil futures prices rose sharply on the news as expected, but President Trump immediately authorized tapping the U.S. Strategic Petroleum Reserve if necessary, to help stabilize prices.  The successful attacks suggest the global oil supply is more vulnerable than previously thought.  In addition, GM union workers voted to go on strike on Sunday for the first time in twelve years.  Strikes tend to reduce output and GDP.  Both the attacks on Saudi Arabia and the GM strike represent new downside risks to the outlook.

All eyes will be on the Federal Reserve on Wednesday afternoon after they conclude their latest Federal Open Market Committee meeting.  We, along with most analysts, expect another ¼% reduction in the overnight federal funds rate, its primary policy tool.  Particular attention will be given to the post-meeting press conference where Chairman Powell will discuss the Fed’s economic and policy outlook.  Don’t be surprised to hear the Chairman reference the new risks mentioned above.  There were dissenting votes by some FOMC members at the last meeting when the Fed cut rates.