Tariff Threats To Mexico And China Send Stocks Down In May

|
Includes: ADRU, BBEU, BIBL, CHGX, CRF, DBEU, DBEZ, DDM, DEZU, DIA, DMRL, DOG, DUSA, DXD, EDOM, EDOW, EEA, EEH, EPS, EPV, EQL, ESGL, EURL, EZU, FEEU, FEP, FEU, FEUZ, FEX, FEZ, FIEE, FIEU, FLEE, FWDD, GSEU, GSEW, HEDJ, HEZU, HFXE, HUSV, IEUR, IEV, IVV, IWL, IWM, JHML, JKD, OMFS, OTPIX, PMOM, PPLC, PSQ, PTEU, QID, QLD, QQEW, QQQ, QQQE, QQXT, RFEU, RSP, RVRS, RWM, RYARX, RYRSX, SCAP, SCHX, SDOW, SDS, SFLA, SFY, SH, SMLL, SPDN, SPLX, SPSM, SPUU, SPXE, SPXL, SPXN, SPXS, SPXT, SPXU, SPXV, SPY, SQQQ, SRTY, SSO, SYE, TNA, TQQQ, TWM, TZA, UDOW, UDPIX, UPRO, UPV, URTY, USA, USMC, UWM, VFINX, VGK, VOO, VTWO, VV, ZF
by: Louis Navellier
Summary

On Friday, the 10-year Treasury bond yield collapsed to 2.13% after the stock market sold off in the wake of the surprise tariffs imposed on Mexico.

The other factor that spooked the stock market on Friday was that China's National Bureau of Statistics reported that its purchasing managers index slipped to 49.4 in May, down from 50.1 in April.

A vote for the European Parliament became a referendum on each country's leaders and, by and large, existing leadership was dealt a stunning blow by populist movements. Also, the cloud of uncertainty over the EU persists.

Naturally, this weakens the British pound and euro, so the U.S. dollar continues to strengthen as the preferred reserve currency.

On Friday, the 10-year Treasury bond yield collapsed to 2.13% (a 20-month low) after the stock market sold off in the wake of the surprise tariffs imposed on Mexico, to be enacted on June 10th if the Mexican government does not sufficiently cooperate with the Trump Administration to help stop the flood of illegal immigrants into the U.S. I expect that Mexico will cooperate to avoid the tariffs, since Mexico is led by savvy business people who do not want to jeopardize their lucrative trade deals with the U.S.

The other factor that spooked the stock market on Friday was that China's National Bureau of Statistics reported that its purchasing managers index (PMI) slipped to 49.4 in May, down from 50.1 in April. Since any reading below 50 signals a contraction, China's official PMI signals that U.S. tariffs on $200 billion in Chinese goods may finally be taking a toll. The Wall Street Journal on Wednesday had a great article on how "The Real Winners from Trump's Tariffs Are China's Neighbors," like South Korea, Taiwan, Vietnam, and other countries in Southeast Asia, which are taking business away from China.

Overall, despite the fact that the S&P 500 "cracked" its 200-day moving average on Friday, I expect that when trade fears subside there will be a major stock market rebound, since low Treasury bond yields make the stock market incredibly attractive. Plunging crude oil prices are reigniting deflation fears, and thanks to falling market rates, it is now inevitable that the Fed will have to cut key short-term interest rates later this year to get in line with market rates. Any such statement from Fed Chair Jerome Powell, Economic Advisor Larry Kudlow, or perhaps President Trump could spark a major stock market rebound.

The European Union Looks Increasingly Dis-United

The aftermath of the European Parliament elections is still being evaluated, but a couple things are very clear. First, a vote for the European Parliament became a referendum on each country's leaders and, by and large, existing leadership was dealt a stunning blow by populist movements. Second, the cloud of uncertainty over the European Union (EU) persists. Brexit is still on track for an October 31st exit, multiple countries are likely to violate the EU's budget restrictions, and continued capital flight will cause U.S. Treasury yields to continue to fall. (I explained this concept in more detail in my latest podcast.)

There is no doubt that the populist movement led by the Brexit Party in Britain and the green movements in continental Europe are breaking up the ruling class in Italy and Spain and perhaps France and Germany as well. As a result, Marine Le Pen's euro-skeptic National Rally party achieved the majority of votes in France and the Greens (Les Verts) scored an impressive third, so French President Emmanuel Macron (whose centrist party took second place) now faces a formidable political challenge from both sides, as well as the national "yellow-vest" protests. German Chancellor Angela Merkel's Christian Democratic Union lost substantial seats to the Social Democratic Party and the Greens, so her successor is in doubt.

With the leadership of Britain, France, Germany, Italy, and Spain in chaos after recent elections, selecting a new leader of the European Commission to replace Jean-Claude Juncker will be next to impossible, since ruling coalitions are in disarray and new elections will likely be forthcoming. Furthermore, French President Macron and German Chancellor Merkel disagree on who should run the European Commission.

When you throw in Brexit in the upcoming months, the continued disintegration of the European Union looks inevitable. Naturally, this weakens the British pound and euro, so the U.S. dollar continues to strengthen as the preferred reserve currency. Furthermore, since interest rates in the EU are negative in many countries, capital flight continues to put downward pressure on Treasury yields.

In the meantime, many of the ousted and wounded ruling elite are holed up in Montreux, Switzerland on the shores of Lake Geneva for the Bilderberg Group summit. Some of the attendees include former U.S. Secretary of State Henry Kissinger, former CIA Director David Petraeus, former Secretary of Defense James Baker, and former Treasury Secretary Robert Rubin. Other interesting attendees include Roger Altman (Evercore), Dominic Barton (McKinsey & Company), Mark Carney (Bank of England), Niall Ferguson (Hoover Institution), Mary Kay Henry (SEIU), Stephen Kotkin (Princeton), Henry Kravis (KKR), Jared Kushner (The White House), former Senator Claire McCaskill (NBC News), Eric Schmidt (Google founder), Jens Stoltenberg (NATO Secretary General), Peter Thiel (Thiel Capital), and former Daimler Chairman Dieter Zetsche (Mercedes). These influential people from very powerful organizations must now try to make sense of what the world will look like as populist movements sweep the globe.

As I discussed in last Wednesday's podcast, my simple conclusion is that the U.S. is the clear winner as you look around the world. The U.S. has (1) the largest and strongest economy, (2) the strongest central bank, and (3) a strong, colorful leader who is a cheerleader for the U.S. economy. President Trump is now doing what China has been doing for years. He has effectively "weaponized" the U.S. economy and is expected to continue to prevail in the Chinese trade spat. The U.S. dollar is clearly the preferred reserve currency in the world. Since commodities are priced in U.S. dollars, deflationary pressure is expected to spread, as collapsing crude oil prices have been demonstrating in recent weeks. Furthermore, negative interest rates in Japan and continental Europe will continue to push U.S. Treasury yields lower.

I feel that it is now inevitable that the Fed will have to cut key interest rates as market rates continue to decline. The fact that the Treasury yield curve is inverted is just temporary, since the Fed does not want its Fed Funds rate to interfere with market rates. As a result, I now expect that the Fed will openly debate a key interest rate cut at its upcoming Federal Open Market Committee (FOMC) meetings.

GDP Up 3.1%, Consumer Confidence Sky-High, but Home Sales Down

The economic news last week was mixed, but net positive. The good news was that the Conference Board on Tuesday announced that its consumer confidence index surged to 134.1 in May, up from 129.2 in April and is now at the highest level in six months. Some of the consumer confidence components were even more impressive, such as the "present situation" index, which rose to an 18½ year high of 175.2, and the "future expectation" index, which rose to 106.6 in May (up from 102.7 in April). Naturally, high consumer confidence bodes well for continued strong retail sales and GDP growth in the quarter.

The Commerce Department reported on Thursday that first-quarter GDP was revised down slightly to a 3.1% annual pace (from the 3.2% previous estimated) due to slower-than-expected business investment, which grew 2.3%. Corporate profits declined 2.8% in the first quarter, which is the biggest decline since 2015, but profits have risen 3.1% in the past 12 months. This is the second quarter in a row that corporate profits have declined. The average company in the S&P 500 is now characterized by contracting operating margins, as most earnings are now growing slower than sales. The other drag on first-quarter GDP growth was durable goods orders, which declined 4.6%, the biggest decline in 10 years.

The bright spot in the first-quarter GDP was that exports rose 4.8%, while imports only increased by 2.5%, so the trade deficit was less of a drag on overall GDP growth. The Atlanta Fed is currently estimating second-quarter GDP growth at a 1.3% annual pace, but frequent revisions are common; so if retail sales remain strong, I expect at least 2% annual GDP growth in the second quarter. We could see a higher GDP if China commits to fair trade, but their GDP will fall sharply if they remain stubborn on their indefensible position of not respecting intellectual property rights through product piracy.

The bad news was that the National Association of Realtors on Thursday reported that pending home sales declined 1.5% in April, which was well below economists' consensus estimate of a 0.5% decline. This marks the 16th straight month where pending home sales have declined on a trailing 12-month basis. Only the more affordable Midwest saw pending home sales rise 1.3%. Despite the fact that median home prices are moderating and mortgage rates are falling, the inventory of existing homes for sale remains tight. However, due to falling interest rates, existing home sales should improve in the upcoming months.

Disclosure: *Navellier may hold securities in one or more investment strategies offered to its clients.

Disclaimer: Please click here for important disclosures located in the "About" section of the Navellier & Associates profile that accompany this article.

Editor's Note: The summary bullets for this article were chosen by Seeking Alpha editors.