Trade War? Stocks Rally Sharply
Trade War Potentially Simmers Down
It's shocking how the trade war situation worked out. The futures market looked weak on Monday night. It seemed inevitable that China would match the tariffs President Trump announced.
However, that’s not what happened. China announced it would tax $60 billion worth of American goods between a 5% and 10% rate effective on September 24th.
The list of American goods being taxed includes 5,207 products. There’s no guarantee that China will not add to the tariffs in the next few weeks. For now, it looks like China isn’t responding in kind.
If President Trump keeps up his tariff threat, raising the rate to 25% and increasing the tariffs to $267 billion worth of goods because China retaliated, China might give in.
In a game of chicken, if both sides are strongly ready to uphold their threat, it could end in disaster. The minute one side shows weakness, the stronger player can up the ante, causing the weaker player to give in.
As you can see from the chart below, there’s a good reason for China to give in to Trump’s demands.
The Shanghai Composite is at the lowest point since 2014. Retail sales, fixed investment, and factory output are all seeing decelerating growth.
Fixed investment growth in the first 8 months of the year was 5.3% which is the lowest growth since at least 1995. The growth rate has hit a new low in 5 consecutive months. Tariffs will cause pressure on Chinese exports, furthering the deceleration of the economy.
Trade War - Stocks Increase Sharply On Tuesday
The market interpreted the Chinese tariffs on American goods as the beginning of the end of the trade war.
It’s very difficult to predict where stocks will go in the near term because if the trade war is seen to be getting worse, stocks can fall about 5%.
If China adds more goods to its list and raises the tax rate because its latest action is seen as weak, investors will quickly lose optimism. If Trump presses China and it gives in, stocks could rally about 5%.
The S&P 500 increased 0.54% and the Nasdaq increased 0.76%.
You can clearly see the optimism on trade in the indexes as the Dow outperformed the Russell 2000 (increase of 0.71% versus 0.44%). The CNN Fear and Greed index is at 73 out of 100 which signals greed.
It’s just 2 points away from extreme greed. Usually, this would make me bearish, but stocks can easily rally more if the trade war is solved.
General Mills was the worst performing stock in the S&P 500 as it fell 7.6%.
The stock declined because it missed revenue estimates by $26 million as they came in at $4.09 billion. The good news for the company is yogurt sales growth was -2%.
This is a big improvement from Q1 2018 which had -22% growth. Netflix was the second-best performer in the S&P 500 as it increased 4.9%. This stock’s performance shows it was a ‘risk on’ day.
Best sectors were consumer discretionary and the industrials which were up 1.27% and 0.89%. The worst sectors were real estate and consumer staples which fell 0.59% and 0.44%.
Trade War - Treasury Yields Soar
Treasury yields soared on Tuesday. The 10-year yield increased from 2.99% to 3.05% and the 2-year yield increased from 2.78% to 2.8%.
As you can see, the difference between the two yields is now 25 basis points as the curve steepened. The 2-year yield is at its cycle high and the 10-year yield is now just 6 basis points away from its cycle high.
The 10-year yield is laser-focused on hourly earnings growth. Since hourly earnings growth in August hit a cycle high, the 10-year yield has been increasing sharply.
I’m always open to changing my perspective if the facts change. If the 10-year yield is going to be correlated with hourly earnings growth, the yield will increase because I see wage growth accelerating.
The labor market isn’t at full employment, but it’s getting close. An increasing 10-year yield means the curve won’t invert in the next few months.
The Fed is being allowed to raise rates 2 more times this year. There is now an 86.9% chance the Fed raises rates at least 2 more times by the end of the year.
There’s even a 5% chance the Fed raises rates at least 3 more times. I wouldn’t be surprised to see a hawkish hike at the September 26th Fed meeting since there isn’t another labor report between now and then.
Disappointing inflation data hasn’t stopped the Fed from rate hikes, which means disappointing inflation from the PCE report shouldn’t stop it.
Trade War - Pain It Can Inflict
Just because the market rallied doesn’t mean we should ignore the potential for a trade war to hurt the economy.
The chart below is a great summary of the current and potential tariffs along with their negative effects on growth. As you can see, all the potential and already enacted tariffs could have a combined 1.5% impact on growth.
That could put the economy in a recession if it already is about to slow naturally as predicted by the ECRI leading index.
The consumer is going to be impacted by the tariffs. That’s terrible news as the consumer drives the economy. As you can see from the chart below, 22% of the proposed $200 billion in taxed goods are consumer goods. 47% are intermediate goods and 30% are capital goods.
(Click on image to enlarge)
Trade War - Conclusion
There will probably be a sharp movement in stocks in the next few weeks when the trade war with China is settled.
President Trump is pushing the envelope which could either encourage China to give in to America’s demands. Or this could cause the U.S. economy to grow much slower than if tariffs weren’t enacted.
China is in a much worse economic situation than America as investment growth is the lowest since at least 1995. This has always implied China is more likely to lose the trade war than America is.
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