Stocks plunge, as fresh tensions with China batter tech shares

[NEW YORK] Stocks suffered their steepest drop in eight months on Wednesday, as rising interest rates gnawed at investors and as previously high-flying technology shares tumbled in the face of growing tensions with China.

The Standard & Poor's 500 index fell 3.3 per cent, registering its fifth consecutive daily decline. That is the longest string of down days for the S&P 500, the market's bench mark, since November 2016.

The decline also signalled a change in mood on Wall Street. For months, it had seemed as though nothing could spook stock investors in the United States. Growing corporate profits and surging shares of technology giants pushed major bench marks to a string of record highs.

But concerns about nascent inflation, rising interest rates and the potential for the Federal Reserve to tighten monetary policy came together into a wave of selling on Wednesday. In addition, President Donald Trump's policies towards Beijing have become a drag on technology companies, which rely heavily on China as a manufacturing base. Shares of the companies that make components like semiconductors have been particularly hard hit in the recent selling.

"It looks as though Trump is settling most of the trade skirmishes around the world that he started earlier this year with one important exception," said Ed Yardeni, president of the stock market research firm Yardeni Research. "It looks like China is going to be a long-term issue."

In recent days, interest rates on government bonds - which serve as a baseline for mortgages and other loans - have climbed to levels last seen in 2011, and that is making them a key concern for stock market investors.

Rising interest rates are something of a double-edged sword. They reflect the strength of the US economy, where unemployment is at 49-year lows, but they also mean borrowers looking to buy a home or a car, or invest in a business, will have to pay more to do so. Conventional 30-year mortgage rates are about 5 per cent, for example, hurting both home affordability and the share price of homebuilders.

"Stock markets like rising interest rates because they tend to signal a strong economic backdrop," said Jonathan Golub, chief US equity strategist for Credit Suisse. "That said, stock markets do not like very abrupt, large moves."

Mr Trump, who has boasted about the stock market rally as shares climbed, took Wednesday's selloff as an opportunity to criticise the Federal Reserve, which has also been raising the short-term interest rates under its control. Mr Trump had previously expressed his displeasure with that policy.

"The Fed is making a mistake," he said when asked by reporters about the market drop, shortly after landing in Erie, Pennsylvania, before a campaign rally. "I think the Fed has gone crazy."

He described the recent selling as "a correction that we've been waiting for, for a long time".

But some policies put into place under Mr Trump, like tax cuts and increased government spending that have widened the federal deficit, are also a factor in the rise in borrowing costs.

The worsening tensions between the Trump administration and China also drew blame for the drop on Wednesday.

Earlier in the day, the Treasury Department imposed new rules making it easier to block foreign investment in technology companies on national security grounds, outlining a rigorous review system that is aimed primarily at preventing China from gaining access to sensitive US technology.

"There's an increasing realisation in the market that this is not just about the trade deficit. This is about security concerns. This is about geopolitical strength," said Evan Brown, director of asset allocation at UBS Asset Management. "It's about encouraging US companies to move their supply chains out of China. And so there are questions about a broader disruption and potential legislation or scrutiny in these markets."

Despite the tumble on Wednesday, many market observers expect strong third-quarter earnings will be enough to help stocks recover their recent losses. Those reports will start to flow in earnest this Friday, when some of the largest US banks, JPMorgan Chase, Wells Fargo and Citigroup, are scheduled to post results.

Thanks to the strength of the economy and steep cuts in corporate tax rates, corporate earnings are expected to rise more than 20 per cent from the third quarter of 2017, according to John Butters, an earnings analyst with FactSet. That would be the third consecutive quarter of earnings growth of more than 20 per cent.

But that outlook is not without risks. As the economy heats up, costs are climbing and starting to eat into relatively fat profit margins.

On Wednesday, Fastenal, a company that makes products like industrial supplies used on factory floors, reported better-than-expected profit and sales numbers. But its profit margin was something of a disappointment and the stock fell more than 7 per cent.

"We are starting to see some margin pressure from higher raw materials and energy and labour costs," said Savita Subramanian, equity strategist with Bank of America Merrill Lynch. Still, she stressed that strong economic demand should support corporate profits, even if margins start to contract.

That is one reason she thinks the stock market remains an attractive place for investors, even with rising inflation and interest rates.

"I would stick with equities for the time being," she said.

NYTIMES