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Hitting A Wall: More Red Ink Appears Ready To Spill As New Tariffs Loom

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Hitting A Wall: More Red Ink Appears Ready To Spill As New Tariffs Loom

Anyone hoping they’d wake up to brighter trade tidings might be disappointed this morning.

The news didn’t improve overnight, and in some ways got worse. The outlook for a near-term deal seems to be receding, with pressure on the stock market still ramping up and new U.S. tariffs set to take effect Friday. Media reports early Wednesday said that China has backtracked on most aspects of the deal, reversing previous commitments. 

Although negotiations start again tomorrow in Washington, it’s unclear how the two sides can get to a better place and how long it might take. Remember that as recently as last Friday, a lot of people were thinking the talks might be in their final phase. Now it looks like everything is in question. On Wall Street the tariff situation continues to suck all the air out of the room, but other negative geopolitical news is also in the picture, with U.S./Iran tensions ratcheting higher. 

For investors, it’s been a bumpy ride so far this week, and a smooth landing doesn’t seem any closer today. The CBOE Volatility Index (VIX) jumped above 21 early Wednesday, a new four-month high and a possible sign of more choppy action ahead. At times like these, it can be important for long-term investors to stick with their plans and not obsess over every move in the market. For traders, it might be prudent to take extra care moving in and out of positions.

The market had spent the last month building in premium amid hopes of an imminent trade deal. The last two days—especially Tuesday—saw some of the premium start to get extracted, and it looks like that might get chipped away at again Wednesday. One question is just how much of the SPX’s current level reflects tariff hopes. That could be hard to determine, because the market reacts to so many different variables. The SPX had climbed about 5% between late March and early May. It’s now down about 2% from its highs, but still up 3% in the last six weeks or so and up 15% year-to-date.

European and Asian stocks were flat to lower overnight despite some decent economic data from both Germany and China.

Hope Springs Eternal

If you’re looking for reasons to be hopeful, there could be a few.

First, China hasn’t canceled trade negotiations with the U.S. While that doesn’t necessarily mean new U.S. tariffs won’t take effect later this week as President Trump threatened Sunday, it isn’t a bad thing, either. In the past, Trump has shown a tendency to make big pronouncements on trade and then sometimes walk them back. We’ll have to wait and see if that happens again. Obviously there’s no guarantee, especially if those new media reports are right about China backtracking.

From a technical view, there also might be some hope for bulls. S&P 500 futures bounced off of their 50-day moving average late Tuesday, just below the 2860 level. Sometimes when technical support holds at key moving averages, buyers venture back into the market. That didn’t appear to be the case early Wednesday, however.

A break below moving averages sometimes can spark additional selling. Once the SPX breaks under the 50-day, there’s a long way down to the 200-day moving average of 2775, but that might be another level of support.

Last but not least, while Tuesday’s late comeback from session lows wasn’t as dramatic as Monday’s, the market did make some progress out of the depths in the last 30 minutes of trading. There were hopes at the end of the day Tuesday that the late momentum could spur a bit of positive sentiment heading into Wednesday. However, it looked early on like the only momentum would be to the downside, at least to start the day.

Yield Curve Flattening Again

One indicator that might be worth watching is the 10-year Treasury yield, which has dipped back below 2.45% this week. A test of the year’s lows below 2.4% might indicate much more cautious investor sentiment, but it’s worth remembering that yields have been relatively weak all year thanks in big part to a dovish Fed.

The other thing that might be worth a look is the yield curve, which had been steepening ever since the inversion in late March. The spread between three-month and 10-year Treasury yields fell to less than one basis point by early Wednesday, down from seven basis points last week. Another inversion might renew concerns about the broader economy.

Volatility is another metric to consider keeping an eye on Wednesday, with the VIX climbing above 20 on Tuesday for the first time since January. Many people thought VIX might be hanging out at 20 for a lot of this year, but the sustained stock market rally sent it limping back to lows under 13 by late April. Now it’s back with a vengeance, and perhaps only some sort of positive trade news could send it down again. This week might be a wake-up call for anyone who got complacent about volatility.

The other metric that might be in the news today comes from the U.S. Energy Information Administration as it reports weekly U.S. crude supplies. Last week’s report, which covered the week ended April 26, showed a huge injection of new oil, up near 10 million barrels. It’s not uncommon for supplies to build around this time of year ahead of summer “driving season,” but arguably the big gains last week might have caused some pressure on crude prices.

Since then, crude got slammed again by the China tariff situation. Many investors might be worried that failure to reach an agreement could dampen economic activity, perhaps slowing energy demand. That hurt the Energy sector yesterday, and growing stockpiles—if they show up again—could potentially add to crude’s woes.

Yesterday saw Info Tech, FAANG, and Energy stocks hit hard by tariff worries. Multinationals like Apple Inc (NASDAQ: AAPL), Caterpillar Inc (NYSE: CAT), Boeing Co (NYSE: BA), and Microsoft Corporation (NASDAQ: MSFT), along with semiconductors, all have big exposure to the Chinese market and could stand to be hurt by any new tariffs. If these sectors show any signs of improvement the last three days of the week, that could be a sign that investors are growing more optimistic about the trade situation.

spx-sox-5-7-19_1.jpg

FIGURE 1: SOX RED. The Philadelphia Semiconductor Index (SOX - purple line) trailed the broader S&P 500 Index (SPX - candlestick) over most of the last year, in part due to the ongoing trade discussions with China. Semis staged quite a comeback in the early part of 2019, but this week's trade tensions seem to have weighed heavily on chipmakers. Data source: S&P Dow Jones Indices, Nasdaq. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.  

Staples, Treasuries Could Be in Focus: Last fall when markets took a dive amid tariff concerns, some of the stocks that came out looking better included a few names in Consumer Staples as well as small caps in general. Stocks like The Coca-Cola Co (NYSE: KO) and Procter & Gamble Co (NYSE: PG) did well during trade fireworks, while small-cap stocks, which typically have less exposure to trade, also seemed to hold some allure. With the current tariff “tantrum” just a couple of days old, it’s way too early to get a real sense of what sort of stocks investors might favor this time around if the trade worries persist, but geopolitical turmoil historically tends to favor Staples, Utilities, and the Treasury bond market as many investors seek “safety”—though it should be noted that no investment is truly “safe.” 

Data Diversion: With all the focus on China and tariffs, some economic data this week might not get as much attention as normal. The Producer Price Index (PPI) for April is due Thursday, followed by the April Consumer Price Index (CPI) on Friday. Many investors might be hoping to see some inflationary pressure as a possible sign of economic strength. However, with last week’s employment report showing little sign of any price pressure, and crude prices flopping around like a fish on a hook, it’s unclear if the CPI and PPI will be any different.

Even if these reports do show signs of inflation, it’s possible they might be discounted because inflation isn’t showing up anywhere else. At this point, analysts are looking for a 0.2% rise in both headline and core PPI, a 0.4% rise in headline CPI, and a 0.2% rise in core CPI, according to Briefing.com.

Greenback Stays Firm: Another place some investors tend to put money when geopolitical tension flares up is the U.S. dollar. It’s a bit surprising then, that so far this week the dollar hasn’t put on much weight. Recently, the Dollar Index traded at 97.65, which is relatively mid-range compared with where it’s been the last few months. It doesn’t appear close to testing last month’s highs above 98, but remains well above the year’s lows near 95. If you go back to last September, before trade fears really began to grip the market in Q4, the index was back at 93. At levels like that, the dollar doesn’t tend to hurt U.S. multinationals. At current levels, however, a few major U.S. companies have reported a dollar drag for their Q1 earnings. One concern is if the geopolitical turbulence continues, more “flight-to-safety” trading could send the dollar even higher, potentially putting up a speed block for Q2 earnings.

Information from TDA is not intended to be investment advice or construed as a recommendation or endorsement of any particular investment or investment strategy, and is for illustrative purposes only. Be sure to understand all risks involved with each strategy, including commission costs, before attempting to place any trade.

Posted-In: FAANG TDAmeritradeEarnings News Global Markets Tech General

 

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