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Geopolitical Flare-up Stalls Rally

U.S. equities fell today amid heightened tensions between the U.S. and Iran following a U.S. airstrike in Iraq that claimed the life of a top Iranian military official. In a flight for safety, U.S. Treasuries were higher and the U.S. dollar rose versus most of its major peers. However, losses versus the safe-haven, Japanese yen kept the Dollar Index flat for the day. Oil and gold prices were higher. Piling on to a troubling geopolitical picture, economic data today showed the U.S. manufacturing sector contracted at an increased pace in December. In light equity news, Incyte Corp had disappointing results from a trial of its treatment of acute GVHD, while Tesla reported stronger-than-expected Q4 deliveries. Global markets were mixed.

The Dow Jones Industrial Average fell 234 points (0.8%) to 28,635, the S&P 500 fell 18 points (0.6%) to 3,240 and the NASDAQ shed 71 points (0.8%) to 9,021. 732 million shares were traded on the NYSE and 2.5 billion shares changed hands on the NASDAQ. WTI oil added $1.81 to $62.99 per barrel and wholesale gasoline was flat at $1.7 per gallon. Elsewhere, the Bloomberg gold spot price added $19.88 to $1,549.01 per ounce. The Dollar Index—a comparison of the U.S. dollar to six major world currencies—was flat. For the week, the Dow and S&P were flat, while the NASDAQ was up 0.2%.

Incyte Corporation (INCY $77) fell sharply after the company announced results from a phase 3 study of its treatment for acute GVHD that did not meet the primary endpoint.

Tesla Inc. (TSLA $446) reported Q4 deliveries of 112,000 electric vehicles, topping the 106,160 FactSet estimate, with 2019 deliveries coming in at 367,500, 50% more than the previous year and in line with its full-year guidance. The company noted that it continues to focus on expanding production in both the U.S. as well as its newly launched facility in Shanghai. Shares were higher.

Schwab’s Chief Investment Strategist Liz Ann Sonders offers a look at the stock markets as the New Year begins in her 2020 U.S. Market Outlook: Ramble On?, noting that this year is set to start on a high note, with consumers and the Fed keeping the economy and market afloat; but risks remain elevated, including trade and elections. Also, for analysis of potential tactical moves in your portfolio, check out the Schwab Center for Financial Research’s latest, Schwab Sector Views: 'Tis the Season for Consumer Discretionary … or Not?, in which we maintain our lone outperform rating for the health care sector and an underperform rating for the communications services group.

Manufacturing output misses, Treasury yields fall amid heightened geopolitical concerns

The December Institute for Supply Management (ISM) Manufacturing Index (chart) declined to 47.2 from November's 48.1 level, and compared to the Bloomberg forecast of an increase to 49.0. This was the fifth month in a row the index remained in contraction territory (a reading below 50), as new orders dipped further below 50, and production and employment both saw their paces of contractions accelerate noticeably, while inventories rose but remained south of 50. The ISM said global trade remains the most significant cross-industry issue, but there are signs that several industry sectors will improve as a result of the "phase one" U.S.-China trade agreement.

The soft manufacturing report has been countered by consistently solid nonfarm payroll reports, highlighting the ongoing bifurcation in the economy; with the consumer bucking manufacturing's malaise, as discussed by Schwab’s Liz Ann Sonders in her article, Split Personality: U.S. Economy's Bifurcation Persists. Liz Ann points out that the bifurcation is also seen in the stark differential between CEO and consumer confidence, while noting that profitability and employment data continues to be key to watch for any signs of the bifurcation breaking down.

Construction spending (chart) rose 0.6% month-over-month (m/m) in November, versus projections of a 0.4% increase, and following October's upwardly-revised 0.1% rise from an initially-reported 0.8% drop. Residential spending grew 1.8% m/m but non-residential spending slipped 0.3%.

The Fed released the minutes from its December monetary policy meeting at which the Central Bank held rates steady and signaled it would likely remain in the current range through this year. The minutes showed wide agreement on the future policy path. The minutes were dovish with participants pointing out that inflation remains below the 2% target and that despite very low unemployment, the lack of mounting inflation pressure is possibly due to a still low labor participation rate. The meeting is discussed by Schwab's Liz Ann Sonders in her commentary, Fed Holds Rates Steady, as Expected.

Treasuries were higher as the curve experienced a bull flattener, in which long-term rates fall faster than short term rates. The yield on the 2-year note declined 4 basis points (bps) to 1.53%, while the yield on the 10-year note fell 9 bps to 1.79% and the 30-year bond rate also slipped 9 bps to 2.25%. Bond yields are trimming a recent run and the U.S. dollar is paring a slide as of late, ahead of some key economic data and as geopolitical concerns have flared up after a U.S. airstrike in Iraq killed a top Iranian general. Schwab's Chief Fixed Income Strategist Kathy Jones notes in her 2020 Market Outlook: Fixed Income that ten-year Treasury yields should move higher in 2020 as recession fears ease. Kathy points out the lagged impact of the Federal Reserve's interest rate cuts, signs of stabilization in the global economy and a modest uptick in inflation expectations should provide a boost to intermediate- and long-term bond yields. However, she cautions that the risk to our outlook is the ongoing threat of trade tariffs weighing on business investment.

Finally, in afternoon action, the Fed will release the minutes from its December monetary policy meeting at which the Central Bank held rates steady and signaled it would likely remain in the current range through this year, while raising the bar for inflation to trigger consideration for a rate hike campaign. The meeting is discussed by Schwab's Liz Ann Sonders in her commentary, Fed Holds Rates Steady, as Expected.

Geopolitics roil global markets

Global equities finished mixed, as geopolitical concerns flared up after U.S. airstrikes in Iraq killed a top Iranian military commander. The euro and British pound fell versus the U.S. dollar, while the safe-haven Japanese yen posted gains. Economic data showed German unemployment rose more than expected for last month, and Markit's U.K. Construction PMI Index unexpectedly fell further into contraction territory for December. Hong Kong reported another sharp drop in retail sales for November. Schwab's Chief Global Investment Strategist Jeffrey Kleintop, CFA, notes in his 2020 Global Market Outlook: New Heroes Needed, that in 2020, global economic growth may depend on comprehensive trade deals and fiscal stimulus rather than actions by central bankers to reverse last year’s slowdown in manufacturing and business investment.

The U.K. FTSE 100 Index gained 0.2% and Switzerland's Swiss Market Index traded 0.8% to the upside, while France's CAC-40 Index was little changed, Germany's DAX Index dropped 1.3%, Spain's IBEX 35 Index decreased 0.5%, and Italy's FTSE MIB Index was down 0.6%. Markets in Japan remained closed. China's Shanghai Composite Index dipped 0.1% and the Hong Kong Hang Seng Index declined 0.3%. India's S&P BSE Sensex 30 Index traded 0.4% lower and South Korea's Kospi Index ticked 0.1% higher. Australia's S&P/ASX 200 Index rose 0.6%.

Stocks eke out gains as calendar turns to 2020

U.S. stocks closed out 2019 in record high territory and picked up in 2020 where they left off. Optimism remained regarding the signing of a U.S.-China "phase one" deal this month, while further stimulus measures and manufacturing data out of China preserved expectations that global central banks will remain highly accommodative with their monetary policies and kept recession fears at ease. However, stocks pared gains as the holiday-shortened week matured, courtesy of Friday's decline on heightened geopolitical tensions in the wake of a U.S. airstrike in Iraq that killed a top Iranian military leader. Domestic economic data was mixed, with the trade deficit surprisingly shrinking and jobless claims remaining historically low, but Consumer Confidence unexpectedly dipped and the ISM showed the contraction in manufacturing output accelerated unexpectedly. Treasury yields gave back some of a recent run and the U.S. dollar continued to slip slightly, while gold extended a rally as of late and crude oil prices continued to climb, bolstered by the ramped-up geopolitical uneasiness. Energy issues led to the upside amid the rise in oil prices, along with the tech sector on the lingering positive trade sentiment, though materials and consumer staples stocks came under pressure.

Next week the markets will see the first full week of trading of the New Year and the economic calendar will be robust, with the ISM and Markit delivering December reads on the key services sector output, while factory orders and jobless claims will likely garner some attention. However, Friday's December nonfarm payroll report will likely carry the most weight, given the heightened focus on the bifurcation between the manufacturing/capex and services/consumption sectors.

As noted in our latest Schwab Market Perspective: Are We There Yet?, some pundits and investors have dismissed still-soft manufacturing, pointing to its increasingly-smaller share of the total U.S. economy. Yet, the reality is that it is more cyclical in nature—with a higher correlation to corporate profits—and tends to lead the rest of the economy. In other words, manufacturing punches above its weight. Absent a meaningful rebound in soft or survey-based measures (such as the ISM indexes) and hard data (such as industrial production and business investment), manufacturing's malaise may start to spill over into services, with employment being the main transmission mechanism. Fortunately, the labor market has remained firm.

Along with a host of global services sector activity reports, the international economic calendar next week may provide some market-moving catalysts, in the form of: Australia—building approvals, trade balance and consumer confidence. China—inflation statistics and lending figures. India—annual GDP estimate and industrial production. Japan—wage figures and household spending. Eurozone—retail sales, consumer price inflation, economic confidence, and investor confidence, along with German factory orders, trade balance and industrial production.

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Important Disclosures

Schwab Center for Financial Research ("SCFR") is a division of Charles Schwab & Co., Inc. The information contained herein is obtained from third-party sources and believed to be reliable, but its accuracy or completeness is not guaranteed. This report is for informational purposes only and is not a solicitation, or a recommendation that any particular investor should purchase or sell any particular security. The investment information mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision. All expressions of opinions are subject to change without notice in reaction to shifting market conditions.

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