The second quarter was a good one for U.S. stock investors. The S&P 500 index climbed 2.9 percent, erasing first quarter losses and leaving the index up 1.7 percent through half of 2018. Global stocks were down 0.1 percent in the second quarter and are down 1.5 percent for the year. Bonds posted a second straight quarter of losses, down 0.2 percent. Bonds are down 1.6 percent this year We expect market volatility to continue as the Federal Reserve continues to raise short-term interest rates and until trade disputes are resolved.
China’s stock market is now in a bear market. The Shanghai Stock Exchange (SSE) Composite Index, which reflects the performance of all shares that trade on the Shanghai Stock Exchange, dropped into bear market territory last week, reported CNBC. The Index has fallen more than 20 percent from its previous high. It appears some investors saw an opportunity and bought the dip since the SSE Index bounced higher last Friday, gaining more than 2 percent.
Slower economic growth and rising trade tensions were responsible for much of the red ink in China, reported Barron’s, but the Chinese government may be playing a role, too:
“What’s got global market watchers worried is that China’s stocks are sliding in tandem with its currency, the renminbi or yuan…That suggests China is using the exchange rate as a weapon. ‘The most effective way for China to retaliate [against] rising U.S. tariffs is to weaken the yuan,’ according to the July Bank Credit Analyst. That could roil financial markets, however. The dual declines in China’s equity market and currency are raising concerns of a repeat of 2015. Treasury strategists at NatWest Markets recall that the drop in the yuan that summer sparked severe equity market losses, including a 10.5 percent correction in the S&P 500.”
That may explain, in part, why U.S. Treasury bills were so popular last week, although it probably didn’t hurt the yield on short-term Treasuries was roughly equivalent to the dividends paid by the Standard & Poor’s 500 Index.
The spread between the 10 year U.S. Government bond and 90 day U.S. T-Bill declined in June and now sits at the lowest reading since 2005. As a reminder to our readers, we are watching this relationship between long-term and short-term interest rates, since historically this spread has turned negative prior to the last 6 recessions.
It also seems like the crypto-mania from late last year has died down. As of last Friday, Bitcoin is down 70% from its December 2017 high. Bitcoin is getting ever-closer to matching the Nasdaq's 78% peak-to-trough plunge after the U.S. dot-com bubble burst.
When it comes to the American Association of Individual Investors (AAII) Sentiment Survey, respondents tend to be more bullish than bearish about U.S. stock markets. The survey’s historical averages are:
- 5 percent bullish
- 0 percent neutral
- 5 percent bearish
As the second quarter of 2018 began, investors were feeling less optimistic than usual. (About 36.6 percent were bearish and 31.9 percent bullish.) Their outlook was informed by a variety of factors, according to an early April article in The New York Times, which said:
“First there was the risk that the economy might be growing too fast, which could prompt central banks to hike interest rates sooner than expected. Then there was the risk of a trade war ignited by the White House imposing tariffs on certain products, an action that quickly prompted countries like China to erect trade barriers of their own. Next came the threat of a government crackdown on technology companies, after revelations of their misuse of customer data.”
As the quarter progressed, investor optimism increased on signs of economic strength. In early June, CNBC reported the economy appeared to be “operating close to full employment, with an unemployment rate at 3.8 percent, inflation still hovering at or below 2 percent, and business and consumer confidence strong.”
Robust corporate earnings helped spur optimism, too. FactSet Insight wrote, “The S&P 500 reported earnings growth of 25 percent for the first quarter – the highest growth since Q3 2010.”5In mid-June, the AAII survey showed 44.8 percent of respondents were feeling bullish, 21.7 percent were bearish, and 33.5 percent were neutral.
As talk of tariffs and trade wars resumed, investor optimism plummeted. By the end of June, just 27.9 percent of respondents were bullish and more than 39 percent reported they were feeling bearish. AAII explained:
“Many – but not all – individual investors anticipate continued volatility and/or think that the current political backdrop could have a further impact on the stock market. Trade policy is influencing some individual investors’ sentiment as well. While many approve of the Federal Reserve’s plan to continue gradually raising interest rates, some AAII members are concerned about the impact that rising rates will have. Also influencing sentiment are valuations, tax cuts, earnings growth, and economic growth.”
Despite a downturn in bullishness, major U.S. stock indices moved higher last week.
Core PCE (personal consumption expenditures) finally reached the Federal Reserve’s stated target, almost. With some beneficial rounding, the Fed’s preferred measure of inflation reached its 2 percent target. It is the first time the measure has reached 2 percent in the last six years.
The May data suggest the trend is toward moderately higher inflation. May was the six month in a row the monthly data increased by 0.2 percent. Higher energy prices, which are not part of the core measure, continue to increase. The added boost from energy prices pushed overall prices up 2.3 percent over where they were last year.
As long as employment growth remains strong and wages continue to increase, we expect core inflation to march higher and regularly meet or exceed 2 percent in coming months.
Sources: Federal Reserve Bank of St. Louis, https://www.federalreserve.gov/monetarypolicy/openmarket.htm;
PCEPI Personal Consumption Expenditures: Chain Price Index
The Department of Labor’s monthly jobs report provides an early indication of economic strength and inflationary pressures, and the June report showed very positive signs. The economy added 213,000 nonfarm payroll jobs, and the unemployment rate inched higher to 4 percent. The rise in unemployment was caused by a large increase in labor force participation (more people entered the workforce), not job loss, so that was taken as a good sign. Given the robust labor market, wage gains were one point below expectations at 2.7 percent. The pace of wage growth appears manageable, which is significant because a jump in the average hourly earnings triggered February’s correction.
The United States versus China trade battle had been primarily based on rhetoric. But, just after midnight Monday, rhetoric turned into action. The United States placed a 25 percent tariff on $34 billion worth of Chinese goods, and China retaliated by placing a 25 percent tariff on $34 billion worth of U.S. goods, such as soybeans and automobiles. The rhetoric continued as Trump threatened tariffs could reach as high as $500 billion, which is the total value of Chinese imports last year, and China accused Trump of starting the largest trade war in history.
If China reduces its imports from the United States, it could hit a number of key U.S. industries and regions. The chart above shows the industry’s most vulnerable to Chinese tariffs.
Key points for the week
- The United States added 213,000 new jobs in June.
- Wage increases remained manageable, and additional workers entered the labor force.
- The United States and China each placed 25 percent tariffs on $34 billion worth of goods.
What are we reading?
Below are some articles we paid particularly close attention to this week. We encourage our readers to follow the links.
Many companies are now trying to draw new employees by offering to help pay their student loans. With the unemployment rate dropping to historically low levels, it appears that employers are finding innovative ways to attract the best talent.
Supreme Court Decision Opens Path for State Sales Taxation of Internet Sales
The Supreme Court ruled that States can impose state sales taxes even if the business does not have a physical presence in the state. Many states are likely to pass laws requiring retailers selling online to collect state sales tax on transactions. Some states are passing laws exempting businesses selling into states with small sales volume, but each states law may differ.
The Bush family added a new member last week, a service dog named Sully HW Bush. Sully is quite amazing. He can perform a two-page list of commands ranging from answering the phone to fetching needed items. Sully is the product of a nonprofit organization, America’s VetDogs, which provides service dogs to veterans free of charge. Sully even has an Instagram account to spread awareness of the importance of service dogs for individuals with disabilities.
The World Cup is a time when people around the world come together to watch amazing athletes play the world’s most popular sport. It’s also a time when viewers get to know flags of countries around the world. For one grandmother wearing a red, blue and white, star-draped shirt to celebrate Independence Day, the World Cup made her realize that festive shirt is the flag of Panama. She’s been wearing it for 25 years.
there’s a carbon dioxide (CO2) shortage. really, it’s true.
Many people agree the world has too much CO2. It’s the reason representatives from countries around the world signed the Paris Climate Agreement. They committed to “adopt green energy sources, cut down on climate change emissions, and limit the rise of global temperatures,” reported National Public Radio.
The effort has been less successful than many had hoped, according to the International Energy Association (IEA). After several years without increases, energy-related emission rose by 1.4 percent in 2017. That’s the rough equivalent of putting 170 million more cars on the road, reported Scientific American.
Emissions rose primarily in Asia, although the European Union (EU) saw increases, too. The biggest decline was in the United States. There’s a certain irony there, since President Trump announced he would withdraw from the agreement in June 2017, reported The Washington Post.
Despite realizing a 1.5 percent increase in emissions, the EU is experiencing a shortage of food-grade CO2. The Economist reported:
“Food-grade CO2 is a vital ingredient: it puts the fizz in carbonated drinks and beer, knocks out animals before slaughter and, as one of the gases inside packaging, delays meat and salad from going off. A shortage of the stuff has therefore created havoc in food makers’ supply chains.”
The EU’s food-grade CO2 is a harvested by-product of processes for making ammonia and other chemicals, reported The Economist. Three of Britain’s five ammonia plants have been closed because farmers are using less fertilizer, and CO2 does not deliver enough revenue to keep the plants running.
Let’s hope the shortage of CO2 doesn’t affect the supply of beverages available to World Cup fans.
What Happens When the Well Runs Dry?
To the relief of many South Africans, Day Zero has been pushed back to 2019. Day Zero is the date on which Cape Town will run out of water, and its four million residents will begin to collect daily water rations of about seven gallons per person per day from specific collection points. Day Zero will make complying with current water restrictions, which limit use to 13 gallons per person per day, seem positively extravagant.
Thirteen gallons isn’t much water. “That’s enough for a 90-second shower, a half-gallon of drinking water, a sink full to handwash dishes or laundry, one cooked meal, two hand washings, two teeth brushings, and one toilet flush. I figured I could save an extra couple of gallons by forgoing the daily flush in favor of a dry composting toilet,” wrote a Cape Town resident in an article for Time.
By way of comparison, the U.S. Department of Interior estimates the average person in the United States uses 80 to 100 gallons of water each day.
How much is enough?
Fresh water is rapidly becoming a scarce resource. During the past 50 years, as populations have expanded and economies have grown, water consumption has tripled globally. Experts say the demand shows no signs of slowing.
Most of the fresh water on our planet is not on the surface. Icecaps and glaciers hold about 68 percent of our fresh water supply, ground water accounts for about 30 percent, and surface water – found in lakes, rivers, and swamps – is just 0.3 percent.
While personal conservation efforts can help, individuals don’t consume most of the water used in the world. They are, however, beneficiaries of many of the processes and products that require water. In the United States, 77 percent of fresh water is used for crop irrigation and electric power generation. Cities and businesses account for another 20 percent of water demand, while livestock and aquaculture account for 3 percent.
The journal Nature recently published research showing the world is depleting groundwater at an alarming rate. “A vast majority of the world’s population lives in countries sourcing nearly all their staple crop imports from partners who deplete groundwater to produce these crops, highlighting risks for global food and water security. Some countries, such as the USA, Mexico, Iran, and China, are particularly exposed to these risks.”
A side effect: sinking
One of the side effects of pumping too much groundwater from aquifers is places are sinking. It’s a condition is known as subsidence. For example, the Central Valley in California, which produces more than one-third of our country’s vegetables and two-thirds of its fruit and nuts,pulls a lot of groundwater to grow crops. As a result, the area has been sinking.
The Central Valley area suffered a five-year drought through 2016. Farmers addressed the lack of water by drilling deeper wells, up to 2,000 feet deep, and tapping into previously untouched aquifers. As groundwater has been extracted, the region has been sinking by about two feet per year. These changes are affecting the integrity of roads, bridges, canals, and other infrastructure, reported BBC, creating expensive issues for residents.
Island countries and cities near coastlines that pull too much groundwater suffer a rather ironic side effect: flooding. The city of Jakarta, Indonesia, is sinking about seven inches a year. At the same time, sea levels have been rising. At high tide the ocean pours over seawalls flooding the city.
Tokyo had a similar problem. In 1968, it was sinking by nine inches a year. The government solved the problem by passing laws limiting groundwater pumping and subsidence slowed. In early 2000, the city was sinking less than one-half inch a year, reported BBC.
Investing in solutions
McKinsey & Company estimates water supplies will meet just 60 percent of global demand by 2030. While there will be significant differences in supply and demand profiles by region, companies that deliver innovative technologies and processes for resolving issues related to water scarcity and sustainability could perform well. McKinsey wrote:
“Many solutions that will help companies use water more efficiently in their operations – from farms to semiconductor fabs, bottling plants to nuclear ones, steel mills to oil rigs – will be new products and services under development today…the broadest range of opportunities for new products and services falls into three areas: improving the productivity of water treatment and distribution, of water-intensive industrial and power processes, or of water usage in agriculture.”
Governments will also have an important role to play by establishing regulations that shape the market and adopting practices that limit water waste. For instance, the Hampton Roads Sanitation District in Virginia is testing a new process designed to replenish aquifers. It treats 150 million gallons of wastewater each day so the water meets drinking water standards and has the same profile as groundwater. The treated wastewater is then pumped back into the aquifer.
The supply and demand profile for water is changing. This creates risks and opportunities investors may want to keep an eye on.
"Strength does not come from physical capacity. It comes from an indomitable will."
~ Mohandas Gandhi
"Every one minute you spend in planning will save you at least three minutes in execution."
~ Crawford Greenwalt, Chairman of DuPont
“I learned to make my mind large, as the universe is large, so that there is room for contradictions.”
~ Maxine Hong Kingston, Chinese American author
“My garden is an honest place. Every tree and every vine are incapable of concealment and tell after two or three months exactly what sort of treatment they have had. The sower may mistake and sow his peas crookedly; the peas make no mistake, but come up and show his line.”
~ Ralph Waldo Emerson
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RJFS and SPC do not offer or provide legal or tax advice. Tax services and analysis are provided by the related firm, S&M through a separate engagement letter with clients. Portions of this newsletter were prepared by Carson Group Coaching. Carson Group Coaching is not affiliated with RJFS, SPC or S&M. The information contained in this report does not purport to be a complete description of the securities, markets, or developments referred to in this material. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. Any information is not a complete summary or statement of all available data necessary for making an investment decision and does not constitute a recommendation. This information is not intended as a solicitation of an offer to buy, hold or sell any security referred to herein. There is no assurance any of the trends mentioned will continue in the future. Any opinions are those of the author and not necessarily those of RJFS. Any expression of opinion is as of this date and is subject to change without notice.
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