cmdtyInsights Weekly Commodity Market Report

Interest rates and trade tensions cause sharp downside stock market correction

The U.S. stock market plunged this week with the S&P so far down -5.1% on the week and the Nasdaq 100 down -5.9% on the week. From their respective record highs, the S&P 500 index has corrected lower by -7.8% and Nasdaq 100 has corrected lower by -10.5%

There are a plethora of reasons for this week’s sell-off including heavy profit-taking in tech stocks and the blackout period for corporate buybacks during earnings season. However, the main reasons are interest rates, trade tensions, and peak earnings. The 10-year T-note yield saw an upside breakout beginning last week and reached a 7-1/3 year high of 3.26% on Tuesday. Higher longer-term interest rates mean (1) higher mortgage rates, (2) higher corporate bond yields, (3) reduced stock prices due to a higher interest rate for discounting future cash flows, and (4) increased competition for the stock market from the fixed-income market.

The 10-year T-note yield has been pushed higher by increased expectations for Fed rate hikes through 2019 and by increased inflation expectations with last week’s 4-year high in crude oil prices. The market is now expecting three rate hikes through the end of 2019, more than the two rate hikes that were expected as recently as August. Fed Chair Powell and other Fed officials have delivered a steady diet of comments in the past several weeks touting the strength of the U.S. economy and announcing their intent to continue raising interest rates.

The U.S. stock market is also being undercut by US/Chinese trade tensions as the markets batten down the hatches for what could be a long conflict. The conflict will not only hurt macroeconomic growth but will also hurt corporate earnings. The stock market is bracing for Q3 earnings season where some CEOs will be issuing warnings about lower profit margins caused by (1) the increased cost of imported tariffed finished products or components from China, and (2) higher steel and aluminum costs stemming from U.S. tariffs on imported steel and aluminum.

The recent NAFTA 2.0 agreement was very good news, but trade tensions abound elsewhere. The U.S. only has cease-fires with Japan and Europe. Also, President Trump is still threatening a 25% tariff on imported autos and has given notice that India and Brazil are on his near-term radar.

The U.S. stock market is also seeing weakness since earnings growth peaked in Q1 at +27% after the Jan 1 tax cuts. The market is expecting strong earnings growth in Q3 (+22%) and Q4 (+20%) but the market is then expecting earnings growth in 2019 to ease to +10% from +23% in 2018.

The U.S. stock market is also worried about overseas stocks with Chinese stocks plunging to a 3-3/4 year low and European stocks falling to a 1-3/4 year low. There is also concern about the emerging markets, which remain vulnerable to higher U.S. interest rates and the strong dollar.