Boeing, Caterpillar, Chipmakers Retreat After Trump Threats To Raise China Tariffs

Trade worries, which had been simmering, have returned to a boil after President Donald Trump surprised the market with a threat to increase tariffs on goods from China. 

U.S. shares appeared poised to open sharply lower following a rout in Asian stocks after Trump said in tweets Sunday that 10% duties on $200 billion on Chinese goods would increase to 25% on Friday. He added that $325 billion in Chinese goods that are untaxed would face a 25% tariff “shortly.” 

The tweets mark a sharp escalation in trade tensions between the world’s two largest economies just when Wall Street’s nerves about the dispute seemed to be relatively calm. In fact, part of the reason stocks have hit all-time highs recently has been because of optimism that a deal would get done soon.

But that worry reared its head again Monday, sending investors and traders concerned about the global economic fallout from an intensified trade war out of stocks and into so-called safe-haven assets. 

Wall Street’s main fear gauge, the Cboe Volatility Index (VIX), shot up nearly 40%, trading near 18 Monday morning after hitting its highest point since January. With nerves on edge, investors and traders flocked to assets perceived as safer, boosting the dollar and sending Treasury yields lower.

Meanwhile, stocks that have significant exposure to China were among the hardest hit. Caterpillar Inc CAT was down more than 3% while Boeing Co BA was off more than 2.6%. Both Dow Jones Industrial Average ($DJI) components derive a good portion of their revenue from the Asian nation. Chipmakers including Advanced Micro Devices, Inc. AMD and Nvidia Corporation NVDA were also lower, as was Chinese online retail giant Alibaba Group Holding Ltd. BABA.

As the market has been lured into relative calmness about the trade war given the optimism about a potential deal, it may have been easy to forget that trade issues between the United States and China have remained the biggest overhang to stocks. 

There may be a lot of noise on this front, but investors can still keep their wits about them and perhaps let the first bit of the day’s trading play out to see how things settle in. Also, it may be worth keeping in mind that Trump has a history of grandiose statements followed by something more practical. 

Further, the market has had a nice run, and some pullback might have been expected. Although it’s tough to put an exact percentage on that, it probably wouldn’t have been this large this fast.  

Jobs Jump 

Friday’s trade was dominated by strong economic data out of the United States. U.S. jobs growth surged in April, with 263,000 new positions created. Analysts had been expecting jobs growth of closer to 200,000. As job growth accelerated, the unemployment rate dropped to a near 50-year low of 3.6%.

Meanwhile, wages rose 3.2% year-over-year in April, the same as the previous month. Some investors came into the report worried that sharp wage gains might put more pressure on the Fed to tighten rates, but this data doesn’t show a big upsurge from previous months. 

Consumer discretionary shares turned in the best performance of the SPX’s 11 sectors, rising 1.4%. Presumably, some of that help came from the jobs report, which showed that wages have now grown 3% or more year-over-year for nine straight months. That may be a sign that workers are finally seeing some solid and reliable gains, which could help strengthen consumer demand. Consumer spending is the largest contributor to U.S. gross domestic product.

Friday’s jobs report seems to offer optimism that people will be shopping for things they want (consumer discretionary), not just things they need (consumer staples). Consumer discretionary stocks are generally cyclical, meaning they tend to do better when the economy is performing more strongly. 

The Consumer Discretionary sector also got a boost Friday as Amazon.com, Inc. AMZN gained more than 3% after Warren Buffett said in an interview with CNBC that Berkshire Hathaway has been buying shares of the online retailing giant. 

Data and Earnings Ahead

Compared to last week, this week is fairly light on economic data. Still, investors are likely to pay attention to data on producer and consumer prices. It could be interesting to see what these data tell us about inflation, especially after the jobs report on Friday showed inflationary pressures in the form of wages were relatively subdued. (See more below.)

On the corporate earnings calendar, Walt Disney Co DIS is scheduled to report this week. Avengers: Endgamehas now grossed more than $2 billion globally. Although this week’s quarterly results won’t include Endgame sales, it could be interesting to see whether management will discuss the blowout sales in their outlook for the current quarter. 

As of Friday, Refinitiv data showed that three-fourths of the 400 SPX companies that have reported this earnings season so far have beaten earnings expectations, Reuters reported, saying the better-than-forecast reports now have analysts expecting a nearly 1% gain in earnings for the quarter compared with a 2% decline that had been expected at the beginning of last month. 

True, this earnings season started off with very low expectations, so beating those might not have been too hard. But the optimism that has seeped into the market has helped boost stocks to record highs as it has essentially been icing on a two-layered cake of support from a dovish Fed and optimism about progress on the U.S.-China trade front.

However, that last bit of the cake seemed to be crumbling Monday morning after Trump’s tweets.

Figure 1: U.S. small cap stocks, as represented here by the Russell 2000 Index (RUT - purple line), have lagged the broader S&P 500 Index (SPX - candlestick). But if there's a significant setback in U.S.-China trade talks and if the U.S. economy continues to show strength, small caps might be able to do some catching up. (See more below.) Data Source: FTSE Russell Indexes, S&P Dow Jones Indices. Chart source: Thethinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.  

Doves Still in Flight: It’s looking like there is plenty of reinforcement supporting the Fed’s decision to be more dovish this year, a pivot that has pleased investors and traders who were worried the central bank might overzealously hike rates even with muted inflation. Last week, the Fed’s preferred inflation measure, core personal consumption expenditures, came in below expectations for March. And on Friday, government data showed lower-than-forecast average hourly wages for April. We’ll get our next readings on inflation this week with producer and consumer prices. Both the core producer price index and the core consumer price index are forecast to show a 0.2% rise in April, according to a Briefing.com consensus estimate. We’ll have to see whether the data continue to point to muted inflation even as the economy seems relatively healthy.

Small Caps and China: If this year’s optimism about a trade deal drains away and the wider market continues to suffer, one place to consider looking for better returns could be in U.S. small caps. With less exposure to China than big multinationals, they may not face as many headwinds if trade talks go south. They could also stand to do well if the U.S. economy does better than people have been expecting. Friday’s number on jobs growth and the unemployment figure “helped quell concerns that the economy was slowing and heading toward recession,” investment research firm CFRA said. Over the past year through Friday, as the SPX has risen more than 12%, the Russell 2000 Index (RUT) of U.S. small-caps has gained only around 4%. That means RUT could have some room to catch up if investors move some money out of big multinationals and into smaller U.S. stocks in the event the trade war lasts longer than expected and if the U.S. economy holds up better than its counterparts in China and Europe.  

Taking the Gold Out of Goldilocks: For argument’s sake, let’s say that Friday’s jobs number is a signal that the U.S. economy is returning to a Goldilocks scenario. If that’s the case, what might happen to gold prices? In a Goldilocks economy, economic growth is solid but isn’t enough to cause problematic inflation. Because gold is often considered a hedge against inflation, that could pressure the precious metal’s price. At the same time, increasing economic activity in the United States, especially if China and Europe continue to languish, could boost the dollar. That could also dim gold’s sheen. Because the precious metal is often traded in U.S. dollars, a rising greenback would make it more expensive for holders of other currencies, potentially dampening demand. Plus, because gold is an asset investors often turn to in times of lessened risk appetite, the warm fuzzies coming from a Goldilocks market scenario might pressure the metal further.

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