Volatility Returns in July As Uncertainty Prevails – Domestic Equity Update:  Volatility among global equities increased in July as concern evolved that earnings expectations may not be feasible should growth falter. Technology earnings were most in the spotlight, weighing on markets. Earnings for seven of the largest companies in the S&P 500 Index are expected to affect index earnings forecasts and growth estimates.  I remain upbeat about future earnings growth and the overall U.S. economy.  Equity markets experienced a brief rotation to small cap stocks from larger caps in July, prompted by the expectation that rates might be headed lower as early as September. Continued disinflation and lower future interest rates will likely enhance small cap stock performance over large caps should these favorable trends continue.  Over the past several months, I’ve gradually increased client allocation to small cap U.S. stocks.

Rates Head Slightly Lower – Fixed Income Overview:  Rates gradually headed lower in July as Treasury and corporate bonds saw yields drop and prices rise. Weaker than expected employment data and slightly slowing economic indicators increased the expectation that the Fed will lower rates in September. Some analysts believe that the Fed may lower even more than expected should economic and employment data continue to weaken – an outcome I consider unlikely at this juncture.  I expect the Fed to cut by 0.25% in September.   The yield on the benchmark 10 year Treasury fell to 4.09%, down from 4.48% at the beginning of July. Some consumer loans based on variable rates may begin to adjust reflecting lower interest rates – particularly mortgage rates.  I’ve reduced client exposure to floating rate bonds, while increasing exposure to longer-term U.S. Treasuries.  Floating rate bonds trend to underperform during periods of declining interest rates, while long dated fixed bonds generally outperform (especially Treasuries).  (Sources: Treasury Dept., Federal Reserve)

China Sells Record Amount of U.S. Government Debt – Federal Deficit Overview:  In the first quarter of 2024, China sold a record amount of $53.3 billion worth of U.S. Treasury and agency bonds. Theses liquidations represent a notable shift in China’s investment strategy and validates a continuation of its efforts to diversify away from U.S. dollar-denominated assets.  It also illustrates the economically precarious place China finds itself – burdened by deflation and a historic real estate market depression.

The sales are part of an ongoing trend where the Chinese government has been gradually shedding billions of dollars of U.S. government debt over the past few years. The sales are largely part of China’s efforts to diversify its foreign reserves and reduce dependence on U.S. dollar assets. Because of the enormous amount of exports to the United States, China has had to acquire and maintain billions in U.S. debt in order to help counter currency imbalances brought about by the massive exports into the U.S.  (Sources: U.S. Treasury Department)

Brief History of Tariffs & How It Affects U.S. Consumers – Consumer Dynamics:  The history of U.S. import tariffs dates back to the early days of the nation. One of the first significant legislative actions of the newly formed United States was the Tariff Act of 1789, also known as the Hamilton Tariff. This act imposed tariffs primarily to generate revenue for the federal government and to protect burgeoning American industries from foreign competition. Alexander Hamilton, the first Secretary of the Treasury, was a strong advocate for using tariffs to promote industrial growth and economic independence.

When the U.S. imposes tariffs on imports, the immediate effect is an increase in the cost of those imported goods. The importer (Target, Walmart etc.) pays the tariff on these goods – not the exporting country. Importers typically pass these increased costs onto consumers, leading to higher retail prices.

Machinery and equipment, including computers and hardware encompassed the largest amount of imports in volume valued at $475.9 billion in 2023. Electrical machinery and related equipment reached $477.1 billion in 2023. These two categories make up the bulk of the imports that U.S. consumers buy, which include televisions, computers, phones, computer equipment, appliances and electrical accessories and components. Automobiles and vehicle parts were the third largest category of imports in 2023 valued at $329.6 billion.

As savings have diminished following the subsidies and assistance programs during the pandemic, consumers have borrowed more adding to credit card and personal loan balances. Elevated rates have placed an additional strain on consumers leading to an increase in delinquencies.

Economists are concerned that newly imposed tariffs on many of these imported products would impose even greater strain on consumers and their spending behavior. Tariffs would be considered inflationary should importing companies pass along the tariffs to consumers in the form of higher prices. Tariffs (if passed along to consumers) are a hidden tax.

How Extreme Weather Affects The U.S. Economy – Economic Dynamics:  Recent extreme heat throughout the U.S. has increased concern as to how out of the ordinary weather affects the economy. Extreme weather events exacerbated by climate change are having significant and growing impacts on the U.S. economy.

The U.S. has experienced, on average, more than one disaster causing over $1 billion in damages each month in recent years. This is a dramatic increase from previous decades when billion-dollar weather disasters were rare. Strain on the nation’s power grid during periods of extreme heat as the demand for electricity rises, places tremendous pressure on the utility and power supplies.

The agricultural sector is particularly vulnerable to extreme weather. Flooding in the Midwest in 2019 led to significant crop losses and disruptions in planting, potentially affecting food prices and markets. Studies suggest that climate change impacts could cost the U.S. economy between 1% to 4% of GDP annually by the end of the century, considering effects on mortality, labor productivity, and the energy sector. Southern and coastal states are projected to experience more substantial economic losses due to higher temperatures and increased exposure to storms and sea level rise. (Sources: whitehouse.gov, weathersource.com)