Market Correction Catalyzed By Trade Worries

Market Correction - Stocks Crater On Trade Fears

Market Correction - In a previous article, I predicted that when China retaliated against America’s new 25% tariff rate on $200 billion worth of goods, the stock market would fall. On Monday, China stated it would tariff $60 billion worth of American goods. This sent the S&P 500 down 2.41%, the Nasdaq down 3.41%, and the Dow down 2.38%. 

Even though small caps aren’t as impacted by tariffs as big caps, the Russell 2000 fell 3.18% in true risk off fashion.

With the VIX up 28.12% to 20.55, the CNN fear and greed index fell from 44 to 32. If stocks fall for cyclical reasons, it’s easier to use sentiment indicators because the economy weakens in a somewhat orderly fashion. I’m not saying the economy is consistent and easily predictable, but it’s a lot more predictable than this trade war correction. Which could easily end by President Trump tweeting something positive.

It’s important to keep in mind how normal a decline of this size is. Since 1996, every year has had at least a 5% drawdown besides 2017. So far, the S&P 500 is down only 4.5% from its record high. If this ended up as the largest decline of the year, 2019 would be considered a placid year. I think there’s probably a little more room to the downside, but if there is a major intra-day drawdown of about 3%, I’d buy stocks.

Since 1928, there has been on average 17 2% declines per year. 

There have only been 3 of those this year. There are 7 3% declines per year and we’ve only had 1 in 2019. As you can see from the chart below, the average S&P 500 decline in the first 5 months of every year since 1995 is 8.5%. This decline of 4.5% would be below average if it is where stocks bottom.

Sector Performance

Market Correction - Companies that rely on China saw their stocks crater. For example, Apple stock fell 5.81% and Emerson Electric stock fell 3.44%. Furthermore, the SOXX semiconductor ETF fell 4.86%. This sent the tech sector down 3.11% as it was the worst performer on the day. Consumer discretionary and the financials were the 2nd and 3rd worst performers on Monday as they fell 2.95% and 2.87%. 

Uber and Lyft continued their devastating declines as they fell 10.86% and 5.75%. Uber hasn’t even reported its first quarter as a public company. While it was overvalued at its IPO, don’t expect it to keep falling at this rate. Every company has a value. That’s not a recommendation. It’s just a reminder.

The best sector on Monday was the utilities which increased 1.11%. As you can see from the chart below, in the past 15 years, there has only been one other time where the S&P 500 fell at least 2.4% and the utilities rose over 1%. That other point was October 24th, 2018. 

In the past 15 years, the gap between the utilities and the Nasdaq’s daily performance has only been wider on the negative side 8 times.

Market Correction - Bond Market

As you can see from the chart below, the difference between the 10 year yield and the 3 month yield went negative as that part of the curve inverted again. 

Bulls loved discussing how the March inversion may not have mattered because it was so quick. They aren’t happy now as the curve has been flattening lately. The difference between the 10 year yield and the 2 year yield isn’t nearly as flat, however. 10 year yield is at 2.41% and the 2 year yield is at 2.19%, making for a 22 basis point differential. This market would need to stop pricing in rate cuts to allow the 2 year yield to increase and invert that part of the curve.

However, the Fed funds futures market is very far away from expecting rates to stay the same. 

As you can see from the chart below, the market expects rates to end the year at 2.08% which is 30 basis points below the March 2019 dot plots. 

Market Correction - The difference is extremely high by the end of 2020 as the market expects rates to be at 1.82% and the Fed has guidance for rates at 2.63% as it expects one more hike this cycle. That’s an enormous 81 basis point difference. Fed funds futures market is highly inaccurate when making long run forecasts so I’ll stick with following the expectations for the next meeting. 

CME Group FedWatch tool shows there is a 10% chance of cut at the June 19th meeting. Even though economic data has weakened, I think it’s highly unlikely that the Fed cuts rates in June. At most, it will signal one cut is coming by the end of the year.

Market Correction - China Retaliates

China retaliated quickly on Monday as the tariff on $60 billion of U.S. goods will go into effect on June 1st. That makes sense because if a ship takes 21 days to sail from China to America, the U.S. tariffs effectively start on May 31st. China is going to tax more than 5,000 products at a 25% rate. 

Taxes on other goods will increased to 20% from either 10% or 5%. On the rest of the $325 billion in goods America imports from China, Trump stated, “We have the right to do [tariffs on] another $325 billion at 25% in additional tariffs. I have not made that decision yet.”

President Trump could have said America is going ahead with the tariffs, so this is moderately good news, but I don’t see any progress towards a deal. In terms of a timeline for a deal, Trump stated, “We’ll let you know in three or four weeks if it’s successful.” 

That’s coming from an administration that has said the trade deal was coming soon for a few months. I wouldn’t expect a trade deal by early June.

The two countries could get closer to an agreement or Trump could go through with the additional tariffs. It’s also possible nothing happens and the tariffs that have already been proposed go into effect. 

If negotiations head in the right direction, stocks could rise 3% in a couple days or even a few hours. If nothing happens, I think stocks will form a bottom, but won’t spike to new highs. However, if new tariffs are set, stocks could fall another 3% to 5%. 

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