Don’t Discount the Power of the Fed

Trade conflicts and the dollar appear to be moving markets, but don’t discount the power of the Fed.

As the first half of 2018 draws to a close, let’s see how various factors played out during that time, starting with the overall stock market. Here, the major indexes started the year by hitting a series of record highs in January, declined for a while in February, then recovered a bit prior to falling again in April.

Those same major markets then briefly recovered before beginning their most recent decline. The Dow Jones Industrial Average has lagged the other major benchmarks lately. It recently declined below its 200-day moving average after spending 501 consecutive trading days above it. Its previous decline below the 200-day moving average was following the Brexit vote in 2016. The Dow also was down nine of 10 consecutive days ending June 25.

International markets, especially emerging markets, started the year doing much better than U.S. markets. However, that relationship reversed after the early peaks. International markets tumbled more than the United States in the corrections and haven’t bounced back as strongly in the rebounds.

As was the case earlier in the year, U.S. stocks are not moving in unison. There are significant differences between the performance of various indexes and sectors.

The S&P 500 is up 2.64% so far in 2018, but the Nasdaq 100  is well ahead with a 10.88% gain. The Dow lags with a loss of 0.94%. Small company stocks are surging because they’re less likely to be hurt by either a strong dollar or reduced international trade. The Russell 2000 is up 9.16% for 2018, and the S&P 600 is up 11.08%.

U.S. stocks are back to dominating the global markets, and their relative strength is increasing. The U.S. indexes are outperforming the MSCI World-ex U.S. Index by the widest margin in at least 20 years. The U.S. outperformance against emerging markets isn’t as historic, but it still is significant.

We’re also seeing changes within the U.S. indexes. The technology sector has been leading the markets for a while, but in the last five days, it has dipped 2.56%. Only telecommunications and materials have larger recent losses. Utilities are down 0.32% for the year to date and real estate is down 0.22%. In the last four weeks, though, utilities are up 2.91% and real estate is up 2.86%. We could be in the early stages of a market rotation.

Most analysts are attributing the changes in the market since January to trade conflicts and the dollar.

The president began emphasizing trade policy and using tough rhetoric early in the year, and leaders of other countries responded in kind. As a result, trade conflicts and talk of international tariffs have rattled the markets.

The dollar declined steadily for all of 2017, with the only exception to this decline being a brief rally in the fall. However, the dollar has been rallying for the last three months of 2018. Against major currency indexes, it is up more than 6% over that time. Against emerging market currency indexes, the dollar is up more than 10%.

A strong dollar hurts global companies by making their goods more expensive to foreign buyers. This explains why the Dow Jones is lagging the other benchmarks by so much lately. The Dow is composed of only 30 stocks that are predominantly global companies. The S&P 500 is more diverse. Small stock indexes such as the Russell 2000 aren’t hurt as much by a rising dollar because they have mostly domestic customers.

The unexpected surge in the dollar also hurts international investments, as they lose value against U.S. investments when their local currencies decline. Global investors sell the non-U.S. currencies and investments to prevent further losses.

However, don’t exaggerate the effects of the dollar and trade conflicts. Central banks have been tightening monetary policy and taking liquidity out of the markets. Financial markets historically do poorly after the tightening begins. Tighter monetary policy also can be a reason why the dollar is rising against other currencies, as the Fed is ahead of other central banks in the tightening cycle.

It is likely that most of these market changes were going to happen anyway because of tighter monetary policy and higher interest rates. The dollar’s surge and the trade conflicts might simply be triggers or excuses investors used to change their portfolios in response to the tightening.

The Data

Manufacturing is slowing a little, while the service sector is picking up. Both still indicate growth is strong, according to the PMI Composite Flash Index. The composite rose to 56.0 from 55.7. The manufacturing component fell to 54.6 from 56.6, and services rose to 56.5 from 55.7.

The Dallas Fed Manufacturing Survey gave some mixed signals. The General Activity Index rose to a strong 36.5 from 26.8. However, the Production Index declined to 23.3 from 35.2. That’s still a strong number, and new orders increased to the highest level of 2018, which indicates that production might increase over the next month.

The Richmond Fed Manufacturing Index rose to 20 from 16. That’s strong growth and well above expectations.

Yet, Durable Goods Orders were disappointing for the second straight month. The headline number showed a decline of 0.6% for orders. After excluding the volatile transportation sector, orders declined 0.3%. Core capital goods, which is a measure of business investment in equipment, declined 0.2%.

The good news is that last month’s orders were revised higher to substantially better numbers. Last month’s orders, after excluding transportation, increased 1.9%, compared to 0.9% in the original release. Core capital goods increased 2.3%, compared to an original report of 1.0%.

New home sales surged for the month, helped by lower prices. Sales increased about 6.6% for the month and are up 14.1% over 12 months. Unfortunately, prices declined 1.7% for the month and 3.3% for 12 months.

Existing home sales declined 0.5% following a 1.3% decline last month, according to the National Association of Realtors (NAR). The weakest region is the South, which also is the largest region in the survey.

Overall, home prices increased at a slower rate, according to the Corelogic Case-Shiller Home Price Index. Prices increased 0.2% in the latest month and 6.6% over 12 months.

Consumer Confidence, as measured by The Conference Board, finally is showing some weakness. It declined to 126.4 from 128.8. That’s still very high historically, but while the Present Situation responses still are near recent highs, Expectations have been declining since March 2017. The current spread between the two has been matched or exceeded only five times since the mid-1960s.

In addition, there’s a huge generation gap in the survey. Confidence among those under age 35 has been dropping steadily, while there’s only been a modest dip recently for those over 55. The gap between the two age groups is the largest since 1980.

The Markets

The S&P 500 lost 2.40% for the week ended with Wednesday’s close. The Dow Jones Industrial Average declined 2.17%. The Russell 2000 fell 3.88%. The All-Country World Index dropped 2.45%. Emerging market equities tumbled 3.99%.

Long-term treasuries rose 1.83% for the week. Investment-grade bonds gained 0.62%. Treasury Inflation-Protected Securities (TIPS) added 0.84%. High-yield bonds fell 0.65%.

The dollar rose 0.32%.

Energy-based commodities soared 3.52% for the week. Broader-based commodities rose 0.33%. Gold lost 1.48%.

Bob’s News & Updates

The number of regular viewers for my Retirement Watch Spotlight Series continues to increase. The June online seminar is my semiannual detailed economic and investment outlook titled “The Challenging Phase For Investors Begins.” You can watch these seminars from the comfort of your home or office at times you choose. To learn more about my new Spotlight Series, click here.

A recent five-star review of my book on Amazon said, “A complete retirement guide! One of the best books on this topic!” With so many reviews saying similar things, I recommend you buy the book or give it as a gift to a friend. Click for more details on the revised edition of “The New Rules of Retirement.”

I’m now a regular contributor to the Forbes.com blog. You can view my contributor page here.

Do your heirs know how to handle an inherited IRA? If not, they’ll join the long list of heirs who made simple mistakes that triggered additional taxes and penalties. To avoid this result, be sure your heirs have a copy of Bob Carlson’s Guide to Inheriting IRAs.