Stocks Falter
Early in Fridays’ trading session it looked like the market was going to rebound or at least stabilize from the terrible selloff on Thursday. After 2PM, the selloff intensified as the S&P 500 closed down 2.10%. It looks like the only thing that stopped the S&P 500 from falling below the correction bottom was the closing bell. The S&P 500 is now just 7 points away from that level. The CNN Fear and Greed index is now at 7 out of 100 which signals extreme fear; it is below the point it hit earlier in the year. It’s at the lowest level since August 2015. The Dow is now below the February low as it has fallen into correction territory; it’s down 11.58% from the all-time closing high. The Nasdaq was hit hard on Friday as it was down 2.43%; it is down 4.8% in the past 2 days. Because the Nasdaq made a new all-time high in March, it is still about 3% above the February low.
The Russell 2000 is also about 3% above its February low because it’s thought that some small caps will be helped by the tariffs. Their costs will go up, so it’s still a net negative for the index as a whole. U.S. Steel has crashed 12.4% in the past 2 days because the steel tariffs have exemptions and because the Chinese retaliation is on U.S. steel pipes. Also, the retaliation means the current U.S. steel tariffs are less likely to stick in the long run. There’s also the fact that a trade war would slow down the economy and cause demand for steel to fall.
Other Markets Barely React
Bonds barely moved. Initially the 10 year yield was below the March 1st closing low, but it moved up 2 basis points from Thursdaynight. It is now less than a half of a basis point above the March 1st low. The 10 year treasury seems to be mimicking stocks in the opposite direction. This is a far cry from when investors claimed the near 3% yield caused stocks to fall in January. The curve steepened by 1.5 basis points. These are small movements compared to the volatility in stocks. The VIX was up 6.56% to 24.87. The dollar index also barley moved. It was down 0.37% to $89.48. This is another decline on a down day like Thursday. It is 89 cents from the low it made on February 15th. The CRB Commodities ETF was up 0.5% because oil was up 2.5%. Oil was helped by the Saudis discussing extending the output cuts until 2019.
Rate Hikes Could Be Taking Their Toll
I thought the rate hikes would start to hurt stocks next year, but the pain may be coming sooner than I thought. By some measurements, the Fed is near being hawkish. As the chances of rate hikes improve, they are being priced in the market. They are priced in way before they occur. The increased expectation for hikes in 2019 and 2020 are a killer because they will invert the yield curve for sure. The only way for the stock market to react to these hikes is to decline in the hopes that the Fed rescinds its guidance.
One important indicator that I’m looking at is the correlation between the expectation for hikes and the stock market. In the past few years, when stocks have fallen, there has been movement to expect fewer rate hikes. This is why the Fed critics claimed the Fed was dependent on the S&P 500. The Fed should care about the stock market because it is related to the economy, but it shouldn’t be dependent on near term moves. Even though stocks have fallen sharply in the past few days and are at the correction low, the odds for rate hikes in 2018 have stayed almost exactly the same.
It seems like only a decline in economic growth brought about by a trade war could stop the Fed from hiking rates according to its guidance. This isn’t a good scenario for stocks because either the economy falters or rates rise. Both are bad news. It appears Goldilocks has died early. The hope is that the economy improves in the rest of the year and the Fed only hikes 3 times. If those occur and the potential for a trade war ends stocks will make new highs. The other worry which will start to perk up soon is the 2018 mid term elections. The polls in the summer will garner a reaction from the market. I think the most likely scenario and the best scenario is the Dems taking the House and the GOP keeping the Senate. That would create gridlock which is usually great for stocks.
Tariff Speculation Increases
I obviously don’t know the exact cause of the decline on Friday. I can only speculate by looking at the political headlines, the economic news, and earnings announcements. When China announced it would retaliate with $3 billion worth of tariffs, I though that was a small amount. Specifically, the tariffs will be on wine, fruit, and steel pipes. However, some political advisors think President Xi will increase the tariffs sharply. The interview John Rutledge did on CNBC may have stoked the market’s fears. He is a former Bush advisor and has also advised government leaders in China. He stated because of Xi’s recent coalescence of power, he needs to show strength against these tariffs. Furthermore, Rutledge pointed out that the weak response was because China is uncertain about the specifics of President Trump’s tariffs. He said capital goods, technology, and agriculture are vulnerable to tariffs.
This is the worst case scenario for the market because slightly negative actions along with the uncertainty surrounding a potential escalation of the retaliation has cause a mini-panic. It’s all about how you interpret the news. In the beginning of the day, the market though that it had seen the end of this skirmish. By the end of the trading session, it worried that another shoe would drop in the next few weeks.
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