US, China Trade Concerns Appear To Mute Market Momentum

Even with the S&P 500 Index (SPX) near an all-time high, the U.S. economy humming along, inflation seemingly contained, and another strong corporate earnings season, investors apparently can’t totally shake off trade worries.

A focus this morning appears to be $16 billion in Chinese goods that will be subject to a 25 percent U.S. tariff starting later this month. China responded by announcing a 25 percent tariff of its own on the same amount of U.S. imports. It’s the latest tit-for-tat in a trade spat between the world’s two largest economies that has led some market watchers to worry that an escalation to a full blown trade war could dent global economic growth. 

The trade worries appear to have helped cause the market to lose some of the recent momentum that helped stocks continue higher Tuesday amid lighter-than-average summer volumes. All three major U.S. indices finished higher, while the S&P 500 Index (SPX) moved closer to its all-time high just above 2872 set back in January.

Before Wednesday morning, it had appeared that investors were continuing to trade on momentum from another bumper earnings season even as they let worries about international trade slip into the background. As Wednesday’s early pause in momentum showed, however, headlines about trade can move the market back and forth, especially when there is an absence of other news. 

Shades of 2017 in VIX

In one indication that worry was lower, the Cboe Volatility Index (VIX) dropped more than 3 percent to just under 11 on Tuesday. That’s its lowest point since January, around the time that the S&P 500 was hitting record highs. The VIX spent parts of 2017 under 10. Although it has risen some this morning, the VIX was still relatively subdued at around 11.

While a relatively low VIX could be one indication that the market is healthy, another could be the broad-based gains across multiple sectors. Over the course of the past year, only three of the 11 S&P 500 sectors are in the red, as of Tuesday’s close. The biggest gainer is information technology, despite a recent stumble in some tech names, with a near 30 percent rise from a year ago. That is followed by double-digit gains in the consumer discretionary, energy, health care and financial sectors.

While strong earnings appear to be helping stocks, so does a relatively healthy economy that is growing at a decent clip while inflation isn’t rising at an alarming pace. We’ll get another couple of readings on inflation later this week — first the Producer Price Index (PPI) Thursday, followed by the Consumer Price Index (CPI) Friday. 

On the Corporate Front...

One unexpected twist came Tuesday via Tesla Inc. TSLA. CEO Elon Musk tweeted that he was considering taking the electric car maker private at $420 per share, that funding was secured and that investor support was confirmed. The company’s shares ended nearly 11 percent higher, closing at $379.57, well under the premium indicated in Musk’s tweet.  

In earnings news, the Walt Disney Co. (DIS) after the bell Tuesday reported weaker-than-expected earnings and revenue. Adjusted earnings came in at $1.87 a share on revenue of $15.23 billion. For fiscal Q3, DIS had been expected to report adjusted EPS of $1.97 on revenue of $15.32 billion, according to third-party consensus analyst estimates. In the same quarter last year, adjusted EPS came in at $1.58 on revenue of $14.24 billion.

FIGURE 1: Hello, Again: As the S&P 500 (purple line) approaches highs last seen back in January, the VIX (candlestick) is revisiting levels it last reached earlier this year when the SPX was at its peak. Data Source: S&P Dow Jones Indices, Cboe. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results. 

Rising Rates And Stocks

Just because the Federal Reserve is in a rate tightening cycle, it doesn’t necessarily spell doom and gloom for the market to continue moving higher. Let’s turn to investment research firm CFRA for a brief history lesson. Including the one we’re in now, there have been 17 rate-tightening cycles since the one that began in 1946. Although the Dow Jones Industrial Average ($DJI) reacted negatively to rate hikes in the 1970s and 1980s, that benchmark rose an average of 7.8 percent during all those rate-tightening cycles and was higher more than half of the time, including during this tightening cycle. When you exclude the one-off rate hikes in 1971, 1984 and 1997, the benchmark rose at an average of 9.5 percent and was higher 71 percent of the time.

International Demand for Treasuries

There’s been lots of talk about whether the 10-year Treasury yield will meaningfully push above 3 percent anytime soon, whether it will stay above that psychologically important threshold and what that might mean for corporate borrowing and bank profits. The yield has hit 3 percent recently but now is just below that level. International demand could be one factor keeping the yield in check, according to Massud Ghaussy, Nasdaq IR Intelligence senior analyst. Gains in the U.S. dollar and tighter U.S. monetary policy even as the Bank of Japan and European Central Bank keep their policies more accommodative have made U.S. Treasury bonds more attractive to international investors, he said in written commentary. According to Ghaussy, that demand has helped push the yield on longer-dated Treasuries lower, contributing to the flattening of the yield curve, or the spread between shorter- and longer-dated Treasuries. That flattening may not be as worrisome as some market watchers may be fearing. “I do not see the flattening of the yield curve as a warning sign of a looming recession but yield-hungry global investors in an environment where rates elsewhere are zero to negative chasing higher returns in the U.S.” Ghaussy said.

Emerging Market Equities vs. Domestic Stocks

There are many decisions investors have to make when deciding where to put their money. One question an investor might want to consider is what percentage of stocks and bonds to hold. Of those stocks, the question arises of whether to hold emerging market stocks and if so what percentage. Based on the performance of the S&P 500 Index and the MSCI Emerging Market Index (MXEF), it appears that investors are preferring domestic stocks at the moment. Both hit highs in January, with the SPX setting a record and the MXEF hitting its highest point since 2007. The SPX is back within spitting distance of its record, but the MXEF has fallen more than 15 percent from its January peak. One reason could be the strengthening of the U.S. dollar, which can dampen demand for dollar-denominated commodities, often a staple of emerging market exports, by making them more expensive. Gains in the buck can also make it harder for emerging market countries to service dollar-denominated debt. A third reason a stronger dollar can hurt emerging markets is by making imports of U.S. goods more expensive. 

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.