Review Of Tuesday’s Stock Market
Tuesday was a continuation of the recent stock market trend which has seen largest caps underperform small caps. The Dow was down 1.15%, pushing it to the red for the year (it’s down 8 basis points). It is down 6 straight days which is its longest losing streak since March 2017. The S&P 500 was down 0.4% and the Russell 2000 was up 6 basis points to a new all-time high. The Russell 2000 is up 10.29% year to date. The CNN Fear and Greed index is now neutral as it is 54 out of 100.
I have been looking for a slight correction in the S&P 500 because it was overbought before this recent modest string of volatility. However, this isn’t the type of volatility I wanted because only the firms affected by a potential trade war are declining. It’s a sector rotation out of big cap industrials and into domestically oriented small caps. Since the mainstream media focuses so much on the Dow, this selloff looks bad, but there are 2000 companies in the Russell 2000 and only 30 in the Dow. Therefore, I would argue the Russell 2000 is more important than the Dow. I wanted to see a correction to wipe away the enthusiasm instead of just seeing it move to small caps.
The sector performance matches what you’d expect from a market impacted by tariffs. The industrials sector was down 2.14% which was the worst in the S&P 500. The domestically oriented utilities and telecom stocks were up 1.06% and 1.42%. They were the best performers.
Potential Trade War Has Escalated
As I mentioned, this selloff was caused by the potential for an escalated trade skirmish. Trump asked the U.S. Trade Representative to identify $200 billion worth of Chinese goods to be taxed at a 10% rate. China responded by saying "The United States has initiated a trade war that violates market laws and is not in accordance with current global development trends." This is a game of chicken which will eventually end in one side capitulating. Even though the overall market isn’t capitulating, as the trend has been to sell off in the morning and recover throughout the day, it is clearly pricing in the effects of high tariffs by rotating from large caps to small caps.
There have been interviews with a few billionaires such as Paul Todor Jones, Lloyd Blankfein, and Warren Buffett who all say this trade skirmish won’t end in a disaster because both sides benefit from trade. I think their motivation for saying this is the hope that the status quo remains. That sounds great, but if neither side capitulates, this will go on longer than they expect.
America has a 3.5% weighted average tariff compared to its trading partners which are at 6%. It seems reasonable to switch to matching tariffs, but Trump’s sweeping goal of eliminating trade deficits, makes me worried. Such high goals have put pressure on trade partners, causing them to respond with tariffs on America. I’m not anticipating a trade war which shuts down all trade, but the probability of higher taxes and lower trade in the next few years has increased.
Dollar, Treasuries, and Oil
As I have mentioned previously, the dollar is at an important technical range. If it breaks above the $95 level, it can continue this bull run. If not, it will be stuck in a range in the low $90s. The dollar index was up 0.27% to $95.01 on Tuesday. President Trump would like a weak dollar to help with his goal of lowering the trade deficit as exports would be cheaper for trade partners and imports would be more expensive. Unfortunately, the strong economy and rising rates in America are hurting emerging markets, pushing the dollar higher. Multinational firms are being hurt by the prospect of a trade war and the rising dollar.
The 10 year treasury yield fell 2 basis points to 2.9%. Early in the morning before trading, it was at 2.86% as the markets were extremely fearful of a potential trade war. The 2 year yield was flat which means there was another bout of curve flattening. The difference between the two treasury yields is down to only 35 basis points. I don’t think the President considers the yield curve when setting policy, but it should be looked at because flattening brings a recession quicker. There might need to be a strong economic effect from the tariffs which hurts America to make the President back down from them. Hopefully, the weakness isn’t irreversible.
Oil fell 1.2% to $65.07. I initially thought the OPEC meeting would be the most important catalyst for the oil market, but if China raises tariffs on American oil production, the price will fall sharply. Even though most of the big events will be over after the OPEC meeting as the central banks have met and the Trump-Kim meeting occurred, the trade tariffs can prevent the S&P 500 from breaking its January record. If there is a trade deal made, stocks, oil, and the treasury yield will rally.
Strong Empire State Manufacturing Survey
Once again, the Empire State Manufacturing index was strong. For June, the headline was 25 which beat the highest estimate which was 22.5. As you can see from the chart below, it was above the prior month’s report of 20.1. This is the 2nd best report since September 2014 as only the reading of 30.2 in October 2017 bested it. Factory orders continue to be strong as they are up at a double digit pace. However, the manufacturing numbers have shown stagnant growth.
One of the best parts of this report is the improvement in the 6 month expectations index. It was up 7.8 points to 38.9 as it recovers from its sharp tumble in April. Current new orders were up 5.3 points to 21.3 and shipments were up 4.4 points to 23.5. The number of employees index was up 10.3 points to 19 which makes sense because factory orders are doing well. Finally, the prices received index was up 0.3 to 23.3 and the prices paid index was down 1.3 to 52.7. Both are still running hot despite this stagnation.
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