Investors Continue To Fret About Global Economy As Trade War Drags On

With about half a month left to go before the United States hits China with another round of tariffs, it seems that investors are growing increasingly worried about the global economic growth ramifications of a prolonged trade war.

In a data point to support those fears, a survey of business sentiment in Germany, Europe’s largest economy, fell much more than expected in August amid worries over trade and a no-deal Brexit. 

Eyeing Treasuries and Commodities

And investors continued to keep a close eye on the U.S. bond market, as a key portion of it is near an inversion, a situation that has preceded most recessions since World War II. As we start the trading day, the yield on the 10-year Treasury is a mere 3 basis points over that of the 2-year Treasury. Still, the past isn’t always precedent, and the inversion indicator isn’t 100% reliable. Also, some of the buying in the 10-year Treasury may be a capital appreciation play rather than safe-haven buying based on economic worries.

Even as investors continue to buy gold as another potential safe haven, oil prices are slumping as worries over global demand help weigh on the key energy commodity. A concern seems to be that a slowing global economy will dent oil-intensive activities like manufacturing and travel. Also, oil is often considered a riskier investment, and investors seem to be in a risk-off kind of mood at the moment. 

Earnings and Inflation Data

As investors keep their eye on how the U.S.-China tensions are playing out in earnings reports, Chinese retailer JD.com Inc. JD shares proved a bright spot as shares were up nearly 9% on the heels of its earnings report. JD reported earnings of 33 cents a share, handily topping the Street view of 6 cents a share. So far this year, JD shares are up about 29%. Next, investors who are watching Chinese retailers can keep their eye on Alibaba Group Holding Ltd. BABA earnings, which are on tap for Thursday.

In economic data this morning, the government’s consumer price index for July showed a rise of 0.3% while core CPI also rose by the same percentage. A Briefing.com consensus had expected the headline figure to come in at 0.3% and a core reading of 0.2%.  While the core reading was a little hotter than expected, it may do little to change what many investors see as the Fed’s dovish trajectory. 

Trade, Protests, and Politics

Monday’s trade was dominated by geopolitical headlines as the economic and high-profile corporate earnings calendar was relatively light.

That left investors to continue focusing on the ongoing trade war between the U.S. and China that isn’t showing signs of cooling off anytime soon. The U.S. has threatened new tariffs starting next month, and China has allowed its currency to drop and announced the halt of agricultural purchases from the U.S. Meanwhile, based on comments from President Trump, it’s far from clear whether the round of trade talks scheduled for September will take place or not.

Adding fuel to the fire of worries about global economic growth, continuing protests in Hong Kong have investors worried about the health of one of the world’s major financial centers. 

With these jitters helping push the market fear gauge, the Cboe Volatility Index (VIX), above 21, investors sought the relative safety of gold, boosting the precious metal’s price nearly 1%, with momentum forging ahead there this morning. Market participants also continued to buy U.S. government debt, another “safe haven,” bringing the yield on the benchmark 10-year Treasury lower. 

The spread between the 2-year and 10-year Treasuries also narrowed, threatening a so-called inversion where a longer term yield is lower than a shorter term one. Many analysts believe an inversion of that part of the yield curve would be a major recession signal. 

With Treasury yields falling, the Financials sector dropped the most of any of the S&P sectors, falling more than 1.9%. Banks can find it more difficult to make money when longer term yields fall relative to shorter term ones as that shrinks the margin on what they make in interest on loans versus what they pay out on deposits.

One potential ray of hope amid all the worries about global economic growth is that they feed into the narrative of a potentially larger Federal Reserve rate cut. A cut is fully priced in for the September, based on the futures market, with most participants expecting a 25-basis-points trim but some expecting a cut of 50-basis-points. But, as we discuss below, there are some reasons why the Fed might be cautious about another rate cut.

FIGURE 1: YIELD SIGN. The yield on the 10-year Treasury (TNX – candlestick) has been under pressure as investors have sought the relative safety of U.S. government debt amid worries about a slowing global economy as the U.S.-China trade dispute drags on. Investors have also been buying gold (/GC – purple line) in addition to Treasuries as a potential safe haven. Data source: Cboe Global Markets, CME Group. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

Bond Conundrum: One thing to consider about the slump in bond yields is that it may not be solely a reaction to investors’ fear about the global economy. True, there definitely appears to be a flight-to-safety component to the buying of government debt. But there also may simply be a trade component as well, as some opportunists continue to buy bonds until the yield reaches a point where they think it's low enough. Remember: Bond prices move inversely to yields.

These “bond bulls” may believe yields are too high because of an assumption that the Fed will be increasingly dovish as global economies recede. But there may be a disconnect between the extent of bond buying and the actual fundamentals of the economy. If there’s a move the other way in bonds, how quickly and to what extent Treasuries sell off could help tell us how much was just trading versus how much was fear about the economy. It’s like the old adage—as more people move to one side of the boat, the risk increases that it will capsize.  

Fear and Facts: Amid the rally in gold, bonds and the VIX, it might be tempting to play Chicken Little and think the sky is falling/world is ending/glass is half empty. But while those who are selling equities do have legitimate concerns about global growth given the ongoing trade issues, economic numbers out of the U.S. simply aren’t terrible. If you’ll recall, the most recent GDP estimate from the government beat expectations. And we’ve seen decent jobs numbers. Those data points seem to indicate the world’s largest economy hasn’t been slowing down to a level at which the Fed will want to keep cutting and cutting. Of course, GDP and jobs data are backward looking, and the market tries to price in the future. So, things might unravel, but then again, they might not.

Tariff Tension Trend: As we’ve said before in this column, earnings drive the market over the long run, but raw numbers aren’t the only important thing to watch for during earnings season. Commentary from company executives can also be a key way to gain insight into the state of the market and the economy. With most of this earnings season behind us, a theme that has emerged seems to be an increase in company management talking about the tariff situation. Of the 438 S&P 500 companies that held earnings calls between June 15 and Aug. 8, 124 cited the term “tariff,” according to FactSet. That’s up more than 40% from Q1, but well below the 162 in Q2 of last year. “It is interesting to note that the number of S&P 500 companies citing ‘tariffs’ had declined for three straight quarters until Q2 2019,” according to FactSet. “But, based on the numbers for Q2 2019, it appears concerns about tariffs may be back on the rise for S&P 500 companies.”

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