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  • Charles Schwab and Co.

Bears Remain in Control

U.S. equities finished solidly lower for a third-straight session, while also notching a weekly loss for a fourth-consecutive week, amid the pervasive worries over trade, which ratcheted higher after President Donald Trump threatened to increase tariffs on Mexico. Treasury yields added to a recent slump amid the uneasiness, and the U.S. dollar was weaker, with an upbeat U.S. personal income and spending report mitigated by disappointing reads on consumer sentiment and regional manufacturing, as well as discouraging data overseas. Meanwhile, crude oil prices tumbled and gold jumped. News on the equity front surrounded some earnings from the retail sector, with Gap suffering following its earnings report, but Williams-Sonoma getting a boost from its quarterly figures.

The Dow Jones Industrial Average (DJIA) tumbled 355 points (1.4%) to 24,815, the S&P 500 Index declined 37 points (1.3%) to 2,752, and the Nasdaq Composite plunged 115 points (1.5%) to 7,453. In heavy volume, 982 million shares were traded on the NYSE and 2.2 billion shares changed hands on the Nasdaq. WTI crude oil dropped $3.09 to $53.50 per barrel and wholesale gasoline was down $0.08 at $1.77 per gallon. Elsewhere, the Bloomberg gold spot price jumped $17.46 to $1,306.11 per ounce, and the Dollar Index— a comparison of the U.S. dollar to six major world currencies—lost 0.4% to 97.77. Markets were lower for the week, as the DJIA fell 3.0%, the S&P 500 Index lost 2.8%, and the Nasdaq Composite declined 2.9%.

Costco Wholesale Corporation (COST $236) reported fiscal Q3 earnings-per-share (EPS) of $2.05, including a non-recurring tax item benefitting EPS by $0.16, compared to the $1.83 FactSet estimate. Revenues rose 7.4% year-over-year (y/y) to $34.7 billion, roughly in line with forecasts, and its same-store sales grew 5.5%, compared to the forecasted 5.1% gain. Shares were lower.

Gap Inc. (GPS $19) posted Q1 earnings of $0.60 per share, or $0.24 ex-items, versus the expected $0.32, as revenues decreased 2.0% y/y to $3.7 billion, below the forecasted $3.8 billion. Q1 same-store sales fell 4.0% y/y, compared to the estimated 1.5% decline, with sales at its namesake stores falling sharply, joined by decreases in same-store sales out of its Old Navy and Banana Republic units. The company lowered its full-year guidance, noting an "extremely challenging" quarter. Shares fell sharply.

Williams-Sonoma Inc. (WSM $58) announced Q1 EPS of $0.66, or $0.81 ex-items, versus the expected $0.69, as revenues rose 3.2% y/y to $1.2 billion, roughly in line with forecasts. Q1 same-store sales rose 3.5% y/y, exceeding the projected 1.7% gain, as the company noted continued growth in customer acquisitions and engagement. WSM increased its full-year earnings outlook, noting the strong start to the year and early strength seen in Q2. Shares rallied over 10%.

Income and spending top forecasts, consumer sentiment improves month-over-month

Personal income (chart) rose 0.5% month-over-month (m/m) in April, versus the Bloomberg forecast of a 0.3% gain, and compared to March's unrevised 0.1% rise. Personal spending gained 0.3%, north of estimates of a 0.2% increase, and following March's upwardly-revised 1.1% rise. The April savings rate as a percentage of disposable income was 6.2%. The PCE Deflator was up 0.3% m/m, matching expectations and above the prior month's unrevised 0.2% advance. Compared to last year, the deflator was 1.5% higher, versus expectations of a 1.6% increase and March's downwardly-adjusted 1.4% gain. Excluding food and energy, the PCE Core Index was up 0.2% m/m, in line with expectations and above the prior month's upwardly-revised 0.1% increase. The index was 1.6% higher y/y, matching estimates, and slightly above March's downwardly-revised 1.5% rise.

The final May University of Michigan Consumer Sentiment Index (chart) was adjusted lower to 100.0, from the preliminary figure of 102.4 and below expectations of 101.5. However, the index was above April's 97.2 level. The 1-year inflation forecast jumped to 2.9% from April's 2.5% rate, and the 5-10 year inflation outlook rose to 2.6% from 2.3%.

The Chicago PMI Index improved to 54.2 in May from April's 52.6 level and compared to the expected increase to 54.0. A reading above 50 denotes expansion.

Treasuries were solidly higher, as the yield on the 2-year note dropped 12 basis points (bps) to 1.94%, the yield on the 10-year note fell 9 bps to 2.13%, and the 30-year bond rate decreased 8 bps to 2.57%. The global stock markets were under heavy pressure as escalated trade tensions were amplified by President Donald Trump threatening increased tariffs on Mexico, aimed at combating illegal immigration. The Mexican peso fell sharply and the trade concerns joined increasing global economic growth worries following some mixed data, which have fostered a drop in bond yields and a coinciding inversion of a key portion of the Treasury yield curve.

For a look at the current environment, check out Schwab’s Chief Investment Strategist Liz Ann Sonders' latest commentary, Street Fightin’ Man: President Trump Ups Trade War Ante, discussing the economic implications of the trade war and tariffs; currently and prospectively. Also, Schwab's Chief Fixed Income Strategist Kathy Jones notes in her latest article, Interest Rates May Be "Lower for Longer": What's an Income Investor to Do?, that the prospect for bond yields staying lower for longer means investing for income is likely to remain challenging for the foreseeable future.

Europe and Asia broadly lower growth and trade concerns

European equities saw widespread losses, led by a drop in the auto sector, as trade tensions were escalated by the surprising threat out of the U.S. to increase tariffs on Mexico. Global growth concerns ae also intensified, as a disappointing Chinese manufacturing report was met with an unexpected drop in German retail sales, cooler-than-expected consumer price inflation data out of Germany, and a y/y contraction for Italy's Q1 GDP. The euro and British pound rose versus the U.S. dollar, while bond yields in the region were lower. Schwab's Chief Global Investment Strategist Jeffrey Kleintop, CFA, discusses the global markets in his latest article, Borrowed Time: Final Rate Hikes And Stock Market Rallies. Jeff points out that stock markets around the world have rallied after the Federal Reserve's final interest rate hike of the economic cycle. He adds that history suggests that the stock market rally since the last Fed rate hike on December 19, 2018 may be on borrowed time.

Stocks in Asia finished mostly lower, with automakers seeing heavy pressure on the unexpected threat to increase tariffs on Mexico from the U.S., while a softer-than-expected Chinese manufacturing report exacerbated resurfacing global growth concerns. Japanese equities fell, with a strong gain in the yen adding to the pressure from the trade worries. The move came as the nation's industrial production rose more than expected for April and a May read on consumer price inflation out of Tokyo came in cooler than forecasted. Stocks in mainland China and Hong Kong declined after the nation's official Manufacturing PMI Index fell back into contraction territory by a larger amount than expected for May. Indian securities traded to the downside ahead of the country's Q1 GDP report, which showed after the closing bell that growth decelerated by a much larger amount than anticipated. However, a gain in the materials sector helped lift shares in Australia, while those traded in South Korea also ticked to the upside after the Bank of Korea held its monetary policy stance unchanged. Schwab's Jeffrey Kleintop, CFA, discusses the plethora of global risks in his article, Geopolitics: Examining The Top Five Risks, while also noting in his commentary, Diversification: Finally Back After 20 Years, that the trend in the degree to which the world's stock markets move in sync with each other has fallen to the lowest level in 20 years, adding that the lower correlation enhances the potential risk-reducing benefits of diversification.

Stocks post worst month of year on intensified trade tensions and festering growth concerns

U.S. stocks fell sharply, with the S&P 500 posting a fourth-straight weekly drop and the Dow registering a sixth-consecutive fall, as escalating trade tensions continued to be met with exacerbated global growth worries. China threatened to use its dominance in rare earth exports—about 80% of U.S. rare earth supplies come from China, per Bloomberg—as a weapon in the trade war with the U.S. that has seen both parties increase tariffs on each other. Friday's unexpected threat by President Trump to increase tariffs on Mexico added another layer to the trade uncertainty and global growth concerns festered as data remained mixed, while Treasury yields continued to tumble, with the 10-year note rate hitting the lowest in 20 months and the inversion of a key portion of the yield curve intensified. U.S. data showed the first revision of Q1 GDP growth was stronger than expected and Consumer Confidence hit a sixth-month high, but this week's return to contraction for Chinese manufacturing output capped off a string of disappointing May global reports from the sector. Moreover, U.K. Brexit uncertainty ramped up and Italian budgetary worries resurfaced in the wake of last weekend's European parliamentary elections. All major equity sectors fell on the week, led by energy as crude oil prices dropped sharply, while the U.S. dollar nudged higher.

Volatility is likely to continue next week, with trade uncertainty likely persisting and the economic calendar delivering a host of key reports, culminating with Friday's May nonfarm payroll report as the strong labor market has been a main contributor in keeping recessions concerns in check. Ahead of the jobs report, the ISM will release its Manufacturing and non-Manufacturing reports and factory orders will hit the tape, along with the trade balance and the Fed's Beige Book. Also, leading up to the June 19th monetary policy decision from the Federal Open Market Committee (FOMC), we will get a host of Fedspeak, headlined by Tuesday morning's discussion of policy strategy by Chairman Jerome Powell.

As noted in our latest Schwab Market Perspective: Trade Tension Takes Turn at Top, rising trade tensions have rattled the markets and volatility is likely to remain elevated until there is more clarity; but it's increasingly likely this could be a long slog. Although on the back burner recently, economic data has been mixed and we're concerned that the longer the trade dispute lingers, the bigger the hit will be to business and consumer confidence. There may be some international locations that are worth a look in the midst of the trade drama, as some areas may be able to stay out of the fray. There remains a yawning gap between the market’s expectation of a 90% likelihood of an FOMC rate cut by year end and the Fed’s official forecasts, which suggest the next move will be another hike. We believe economic data would have to deteriorate much more for a rate cut to come to pass near-term—and as usual, the convergence between the market and the Fed could contribute to volatility in the coming months.

Next week's international docket will also be robust with reports due out including: Australia—Reserve Bank of Australia's monetary policy decision, trade balance and Q1 GDP. China—Caixin's Manufacturing and Services PMIs. India—Reserve Bank of India monetary policy decision. Japan—Q1 capital spending, household spending and earnings figures. Eurozone—European Central Bank monetary policy decision, consumer price inflation, Markit's business activity reports, retail sales and Q1 GDP, along with German factory orders, industrial production and trade balance. U.K.—Markit's business activity reports and the Bank of England's inflation forecast.

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