• Investors are right to focus on the negative aspects of trade issues, due to growing risks to the economy and financial markets.

• We think the odds for a broad global economic rebound have fallen, but we don’t yet see signs of a U.S. recession.

• Prospects for future significant gains in stocks appear dicey, meaning investors should focus on selectivity.

Trade headlines dominated investor attention last week, as high levels of market volatility persisted. The S&P 500 Index fell 3% on Monday before clawing back most of those losses to end the week down 0.4%.1 The defensive REITs and utilities sectors fared best, while energy and financials performed worst.1 Bond yields continued to fall, with the focus again turning to whether yield curve inversion and negative global interest rates are a growing signal of recession. Investor sentiment was also hurt by ongoing confusion over Federal Reserve policy and deteriorating corporate earnings fundamentals.

Trade Issues Remain A Serious Economic And Market Threat:

Over just the past two weeks, trade negotiations ended without prospects for additional talks, President Trump announced new U.S. tariffs that will go into effect on September 1, China allowed the yuan to sink below the psychologically important seven-to-one ratio to the dollar while also suspending U.S. agricultural imports, and the U.S. Treasury labeled China as a currency manipulator.

By our estimate, the trade war has already caused a 0.5% annualized hit to U.S. GDP growth, and the new tariffs could add 0.25% more. At the margins, trade tensions will probably make the Fed more biased toward rate cuts. But both countries may need to realize more economic damage before an agreement can be reached. At this point, we don’t think the U.S./China trade war will result in an outright recession, but it is clearly causing significant economic and financial market damage.

Risks Are Rising, But Recession Does Not Appear Imminent

Over the past several weeks, we have cautioned investors about further equity volatility given weak global economic growth (chiefly in trade and manufacturing) and unclear prospects for a U.S./China trade deal. We had been holding out hope that such a deal could pave the way for an economic rebound, but recent tensions suggest those prospects are becoming less likely.

But that doesn’t mean that the U.S. is heading for a near-term recession. Credit markets remain solid: Credit spreads have widened only slightly, loan demand is stable and banks remain willing to extend loan to businesses and consumers. At the same time, initial jobless claims are low, with high numbers of job openings. Consumer confidence remains high and income levels are expanding.

To be sure, trade problems are hurting business confidence and earnings, and escalating tensions could cause any weakness in trade and manufacturing to spill into the broader economy. While we think prospects for a global growth rebound have weakened, we don’t see signs of a U.S. recession.

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