Despite rising stakes in the trade conflict with China, stocks still rose this week. The US enacted tariffs on $34 billion of Chinese goods and China retaliated immediately with duties on soybeans and airplane parts among others. US stocks (VTI) rose 1.7% for the week and international stocks (VEU) rose 0.7% as investors started to accept that this trade war will play out over a long period of time, and that it is just one factor among many in economic growth and securities prices. A strong jobs report suggested the US economy is still plowing ahead, although official unemployment rose back up to 4.0%

Weekly Returns

S&P 500: 2,760 (+1.6%)
FTSE All-World ex-US (VEU): (+0.7%)
US 10 Year Treasury Yield: 2.82% (-0.04%)
Gold: $1,255 (+0.2%)
EUR/USD: $1.174 (+0.5%)

Major Events

• Monday – Fed officials were reported to have offered deals to Goldman Sachs and Morgan Stanley to freeze dividend payouts in exchange for passing stress tests in a sign of a more relaxed regulatory environment.
• Tuesday – Mexican President-elect Obrador spoke with US President Trump and struck a friendly tone amid trade tensions between the two nations.
• Wednesday – China said it will retaliate to any new trade tariffs, but won’t act first.
• Thursday – Scott Pruitt resigned as head of the EPA and will be replaced by Andrew Wheeler who is a former coal lobbyist and is expected to retain a business-friendly approach.
• Friday – The US enacted tariffs of up to 25% on $34 billion of Chinese goods. China retaliated with similar duties.
• Friday – The US added 213,000 jobs in June, showing strength even as the official unemployment rate rose from 3.8% to 4.0%.
• Friday – Biogen said it had positive mid-stage results on an experimental Alzheimer’s drug, sending shares up nearly 20%.

Our Take

Before trade wars were on anyone’s mind, the most common fear for many investors was “rising interest rates”. The one question we’ve gotten more than any other in the seven years since Personal Capital was launched is: “what are you doing about rising interest rates?”

And yet, rates on longer-maturity bonds are down in that period. This year, the 30 year Treasury yield has risen from 2.81% to 2.94%, which is not much of a move at all. Ten year yields at 2.82% are up for the year, but down since hitting 3% in April. All this shows is how hard it is to predict interest rate changes and the riskiness of making bets based on rate outlooks.

Shorter term interest rates have risen as the Fed has shifted away from post-recession stimulus to balanced concerns over inflation and growth. The result? A flattish yield curve that is close to inverting. That’s got a lot of people nervous because an inverted yield curve has historically been a pretty good predictor of recession, though the timing varies quite a bit.

A flatter yield curve does create headwinds for growth, including less incentive for banks to lend. Still, overall rates remain low and corporate credit is relatively easy to come by. There is a difference between an inverted yield curve with short rates at 2% (about where they are now) and 5% where they were in 2007 or 6% in 1999.

We believe bonds are an important part of most portfolios, but given the flat yield curve there is little incentive to have a high allocation to long dated issues. We like having an allocation to TIPS (Treasury Inflation Protected Securities) as a general rule, but it feels especially prudent now with inflation expectations low despite strong economic growth, low unemployment and possible escalating trade wars.