Stocks dropped by nearly 3 percent Thursday and another 2 percent on Friday, closing out the steepest one-week percentage decline for US indexes since January 2016. The proximate cause was President Trump's announcement that the U.S. would levy 25 percent tariffs on up to $60 billion dollars worth of Chinese imports.
While there were no details as to which products would be impacted, the amount represents a small fraction (less than 3 percent) of total goods imported from overseas and about 10 percent of what the U.S. imports from China. Additionally, after the example of the steel and aluminum tariffs, which after the initial bluster, were watered down with exemptions for more than 50 percent of imports, it’s more likely than not, that the Chinese tariffs will not have a sizable effect on the economy.
Investors are not so sure, though the tariffs are just one of the reasons that stocks sold off last week. The fear is that the Trump Administration announcement, which has already triggered a reaction from China, could lead to a tit for tat escalation of trade actions. China’s retaliatory tariffs on US imports are estimated to be worth just $3 billion (on 128 American imports, like steel pipes, fresh food and wine and pork and recycled aluminum), suggesting that the world’s second largest economy is trying to avoid an all-out war, “there are good reasons to worry,” according to Capital Economics. Sure, what we have seen thus far seems light, but the President himself said, the actions were the "first of many." Also, the balance of power in the White House has shifted towards protectionists following the departure of Gary Cohn and Rex Tillerson.
The Capital Economics analysis also highlights that China’s response to the tougher US trade talk could take different forms, which might include “implementing much stricter regulatory and compliance checks, or directly instructing Chinese firms to cut orders from the US. This would directly affect some of the largest firms in the S&P 500, who either produce their goods in, or sell a significant proportion of them to, China.”
Meanwhile, forget China and tariffs for a moment and consider another factor that contributed to the sell-off: the Federal Reserve. As expected, the central bank raised rates by a quarter of a percent and also described a Goldilocks scenario, where the economy is not to hot, which would create inflation and not too cold, so jobs are plentiful. Sounds great, but then why did investors get spooked the day after the announcement and sell off interest rate sensitive stocks, like financials?
Maybe because after more fully absorbing the Fed’s projections, it looks like the central bank may hike rates by four, not three times this year and then three more times in 2019. That would make sense if the Fed believes that economic growth will pick up, but why then did officials keep their inflation predictions so benign? Many investors are starting to consider a more hawkish Fed, which would likely have to raise rates faster than expected, which could make the current valuation of stocks out of kilter with reality.
And it rates do rise, how will consumers do? According to Stephanie Pomboy, the founder of economic research firm Macromavens, it might not be pretty. In an interview with Barron’s, she says that rising interest rates will severely impact consumers, who have begun to accumulate debt again and less credit worthy companies, who believed that they were being smart by borrowing a bunch of money at low rates.
Finally, investors are not “liking” the recent imbroglio over privacy and security issues at Facebook. The stock posted a 14 percent weekly decline—its biggest since 2012 and its third worst weekly fall on record. When CEO Mark Zuckerberg said he welcomed regulation, that spooked other tech names like Twitter, Apple and Google parent Alphabet, each losing more than 7 percent for the week. While regulations may be a long way off, the mere idea was excuse enough for investors to take profits after a massive run up in the sector.