MCF Weekly Capital Market Review - January 20th, 2020

After nearly two years of negotiations, the US and China signed a partial trade deal known as “Phase One.” The US agreed to cut the tariff rate from 15% to 7.5% on $120 billion of Chinese goods while backing off on further increases; $250 billion (roughly half) are still at the higher 25% tariff rate. China agreed to criminal penalties for those who steal commercial secrets in addition to cracking down on pirated goods and to submit an action plan in 30 days to the US on enforcing these commitments. China also will cease pressure on US companies to give up intellectual property in American-Chinese joint ventures.[1] China agreed to purchase $77.7 billion of additional US goods and is no longer labeled a currency manipulator.

The trade deal is a constructive yet problematic step. First, it is a partial deal. There are several notable items missing that left both sides empty-handed, for now. For the US, it does not address state-sponsored hacking by China, state subsidies to Chinese companies, nor other important intellectual property protections. For China, the bulk of tariffs remain in effect and mobile phone manufacturer Huawei is still blacklisted. Another issue is that many commitments were prior commitments made by China that went unenforced after the fact. The US proclaims to counter China’s possible inaction with an enforcement clause, allowing the US to circumvent the WTO and punish China directly via tariffs or other measures within 90 days of a breach of commitment.

Markets didn’t seem to mind the news either way, with equities steadily climbing up for the week and US equities enjoying a larger move than international equities. Commodities continue to drag as inflation concerns remain low. The first Fed decision of 2020 comes on the 29^th with market expectations counting on no change.[2] Strong economic data has increased the chances of a rate hike, but a rate cut is still far more likely if the Fed does decide to move in 2020. A rate hike is extremely unlikely because the Fed’s adamant goal of hitting its 2% policy objective for inflation (core PCE) continues to lag. Given the Fed’s expected holding pattern, bonds are unlikely to experience the large windfall gains from the three rate cuts of 2019.

What’s next for 2020? Phase One could fall apart if either side accuses the other of failing to honor its commitments; news of the signing is conspicuously absent from Chinese state-sponsored media. We can’t rule out another trade war. However, Trump insists that his team will immediately begin work on a Phase Two deal with China. The forward price-to-earnings ratio of the S&P 500 begins the year just north of an elevated 18 level.[3] Market participants are concerned of slowing global growth and overbought markets, lowering expectations of equity returns going forward. As always, politics from a presidential election year could provide some ups and downs as it did in 2016.

Core CPI remained unchanged at 2.3%. Producer prices continue to point to lower inflation with year-over-year core PPI subdued at 1.1% for December. The business outlook survey from the Philadelphia Fed roared back after a weak December. Consumer sentiment remained strong and within consensus. Housing permits and starts were both strong, showing continued acceleration in housing. This week should be quiet on data with very few releases slated for the week.

INDEX RETURNS

^[1]^{https://www.bloomberg.com/news/articles/2020-01-15/u-s-china-sign-phase-one-of-trade-deal-trump-calls-remarkable}

^{[2] https://www.cmegroup.com/trading/interest-rates/countdown-to-fomc.html}

^{[3] https://www.yardeni.com/pub/stockmktperatio.pdf}

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^{REFLECTED INDICES}

^{S&P Composite 1500® Index combines three leading indices, the S&P 500®, the S&P MidCap 400®, and the S&P SmallCap 600® to cover approximately 90% of the US market capitalization. It is designed for investors seeking to replicate the performance of the US equity market or benchmark against a representative universe of tradable stocks. Investors cannot invest in an index.}

^{MSCI ACWI ex USA Index captures large and mid-cap representation across 22 of 23 Developed Markets (DM) countries (excluding the US) and 23 Emerging Markets (EM) countries. With 1,859 constituents, the index covers approximately 85% of the global equity opportunity set outside the US. Investors cannot invest in an index.}

^{Bloomberg Barclays Global Aggregate ex-USD Index is a measure of global investment grade debt from 24 local currency markets. This multi- currency benchmark includes treasury, government-related, corporate and securitized fixed-rate bonds from both developed and emerging markets issuers. Investors cannot invest in an index.}

^{Bloomberg Barclays High Yield Corporate Bond Index measures the USD-denominated, high yield, fixed-rate corporate bond market. Securities are classified as high yield if the middle rating of Moody's, Fitch and S&P is Ba1/BB+/BB+ or below. Bonds from issuers with an emerging markets country of risk, based on Barclays EM country definition, are excluded. Investors cannot invest in an index.}

^{Bloomberg Commodity Indices are a family of ﬁnancial benchmarks designed to provide liquid and diversiﬁed exposure to physical commodities via futures contracts. The Bloomberg Commodity Index (BCOM) is a highly liquid and diversiﬁed benchmark for commodity investments.}

^{Bloomberg Barclays US Aggregate Bond Index is a broad-based flagship benchmark that measures the investment grade, US dollar-denominated, fixed- rate taxable bond market. The index includes Treasuries, government-related and corporate securities, MBS (agency fixed-rate and hybrid ARM pass- through), ABS and CMBS (agency and non-agency). Provided the necessary inclusion rules are met, US Aggregate eligible securities also contribute to the multi-currency Global Aggregate Index and the US universal Index, which includes high yield and emerging markets debt. The US Aggregate Index was created in 1986 with history backfilled to January 1, 1976. Investors cannot invest in an index.}

^{Bloomberg Barclays 1-10 Year US Government Inflation-Linked Bond Index tracks the 1-10-year inflation protected sector of the United States Treasury market. Investors cannot invest in an index.}

^{Bloomberg Barclays US Treasury 1-3 Year Index measures the performance of public obligations of the US Treasury with maturities of 1-3 years, including securities roll up to the US Aggregate, US Universal, and Global Aggregate Indices. Investors cannot invest in an index.}

^{Bloomberg Barclays US Treasury Bellwethers 3 Month Index is an unmanaged index representing the on-the-run (most recently auctioned) US Treasury bill with 3 months’ maturity. Investors cannot invest in an index.}