Geopolitical Action Helps Stocks For A Change

Range Maintained

The S&P 500’s range was maintained on Wednesday as it reversed the losses from Tuesday. The choppy action got choppier. You can see in the chart below how the market has moved nowhere ever since its decline in early August. This is an example of a sideways correction. You can debate that everything since January 2018 has been a sideways correction as the gains are putrid. The S&P 500 is up 2.26% since January 26th, 2019. A large portion of those gains in the past 19 months occurred on Wednesday as the S&P 500 was up 1.08% on the news that the Hong Kong tensions were alleviated. 

Geopolitical News

Specifically, Hong Kong’s leader Carrie Lam stated she will withdraw the extradition bill which was one of the protestors’ 5 demands. This bill was the original cause of the protests. Back in June, Lam suspended the bill, but that wasn’t enough. Protestors wanted it to be withdrawn so the government can’t slip it through quickly. Because Lam’s decision should quell the protests somewhat, the MSCI Hong Kong ETF was up 4.5% which was its biggest one day gain since September 8th, 2015.

There was also good news on Brexit. To be clear, good news for markets is either a soft Brexit or no Brexit. A delay pushes the government towards one of those options. A majority of legislators voted to take control of the government which could prevent the government from withdrawing the U.K. from Europe if there’s no deal by October 31st. Another vote will occur soon which could force the prime minister to extend the departure date from October 31st to January 31st, 2020. Politicians love to delay important decisions, so I fully expect another delay. Markets will like that.

The perfect situation for the market on the geopolitical front is a peaceful end to the Hong Kong protests, no Brexit, and a trade deal between America and China. If all those issues are solved, the S&P 500 will hit a new record high even though the economy is in a slowdown. Calling for a new record high isn’t exactly a huge deal as the market would only need to rally 3.2%. It just seems like a big deal because stocks have done nothing for about 5 weeks.

Specifics Of Wednesday’s Action

The Nasdaq increased 1.3% and the Russell 2000 increased 0.85% on Wednesday. The VIX cratered 2.33 to 17.33. One or two more up days for stocks will push the VIX to the low teens which would mean this correction is mostly over. As I have mentioned, when stocks are near the low end of this recent range, it seems like a correction and when they are in the middle or the high end, this seems like a range bound market.

The CNN fear and greed index finally got out of extreme fear as it increased 3 points to 28 which is fear. None of the components have recently changed their label. As I have mentioned recently, the utilities have been on a rampage recently. As you can see from the chart below, the XLU ETF is 3 standard deviations above its 50 day moving average which is rare. The index will probably come down in the next few weeks possibly because yields increase. It didn’t fall on Wednesday though as the sector was the second worst performer, but increased 15 basis points. It’s a great situation for the sector if it rallies slightly on up days and rallies significantly on down days for the overall market.

The best 2 sectors on the day were tech and communication services which were up 1.71% and 1.61%. The 2 biggest losers from Tuesday, which were tech and industrials, gained back their losses as the industrials sector was up 1.3%.

Fed Beige Book Reviewed

The Fed’s Beige Book sets up its September meeting which is in 13 days. The market sees a 100% chance of a cut and a 99.6% chance the cut is 25 basis points. The main source of uncertainty is about October and December’s decisions. The guidance from the September meeting will tell us if the Fed will cut again in October.

In the August Beige Book the Fed stated, “Although concerns regarding tariffs and trade policy uncertainty continued, the majority of businesses remained optimistic about the near-term outlook.” That’s an interesting take because sentiment surveys like the flash Markit PMI have been weak. I mentioned the Markit flash PMI because it came out on August 22nd and the cutoff date for the Beige Book was August 23rd. The latest surveys from August also have shown weakness.  

The Fed stated employment growth was “modest” which is “on par with the previous reporting period.” That’s consistent with jobless claims. Let’s see what the August BLS report shows this Friday. Regardless of whether the Fed may be ignoring some of the weakness in the economic data, the Fed is dovish. It is reacting as if the economy is taking a hit from tariffs. As you can see from the chart below, the diffusion index stayed low at -43. The Fed has been very dovish since the spring.

The chart below shows the use of the word “tariff’ actually fell from 37 to 29. That’s even though the trade war heated up in August. Trump’s latest tariffs were announced on August 23rd which means the Fed must have known about them when collecting information for the Beige Book. That being said, Trump’s announcement on the last day of the Beige Book didn’t affect businesses in time to show weakness caused by the new tariffs. I suspect that the use of the word “tariff” will increase in the next report. As the chart shows, the use of “tariffs” has predicted the use of any words with the root word “slow.” The use of tariffs and “slow” have been correlated when the use of “slow” is lagged by 2 months. In other words, the Fed should use “slow” less often in its October Beige Book.

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