Trade Deal Outline in Place

Trade Deal - Stocks Creep Higher

Before getting into details about the potential trade deal, let's review the stock market. The stock market crept higher on Wednesday as it increased 0.18%. 

S&P 500 is now up 11.08% year to date. A question traders are asking is whether the market can maintain this momentum until it breaks the September record high. That would be very difficult because stocks are already overbought. 

S&P 500 is slightly less than 5% away from its record. But the CNN fear and greed index is at 70 which signals greed.

The 14 day RSI is at 70.18 which is an overbought signal. Even though almost every stock is above its 50 day moving average, the 50 day RSI is only at 54.5. 9 day RSI is at 76.66 which shows how the market has gone hyperbolic. 

Some claim that the amazing breadth means stocks will move higher. While that’s fair analysis based on historical trends, this move is highly unsustainable.

Trade Deal - Small Banks Rule The Market

Nasdaq was up just 3 basis points and Russell 2000 was up 0.46%. The Russell 2000 is up 17.29% year to date. VIX fell 5.78% to 14.02. 

It’s always the cheapest to buy protection when stocks are rallying sharply. I think it make sense to buy protection as I am very bearish on stocks in the short term. 

Best 2 sectors on Wednesday were the materials and financials which increased 1.69% to 0.58%. Two worst sectors of the year were real estate and healthcare which fell 0.66% and 0.13%.  

My long pick of the year was the KBW regional bank index. It has been an amazing play as it is up 20.26% year to date. 

Full disclosure, my short pick of the year has been a complete disaster as Yeti stock is up 43.23%. It has been very difficult to short stocks as even stocks that missed estimates only fell 0.4% after their reports on average. 

Firms which missed guidance are still up. Since Yeti is a small cap which raised guidance, it’s no surprise the stock is on a rampage.

One interesting new data point I found was that Wal-Mart only beats sales 41% of the time. That just adds to the impressive nature of its earnings report earlier this week. 

The consumer isn’t capitulating. I expect retail sales growth to be solid in February as consumer sentiment improved.    

Trade Deal - Trade Dispute Ending

Finally, China and America are outlining commitments in principle to form a trade deal. 

It’s sort of like a student that has procrastinated writing a paper for a few days finally writing something down. Even if the first sentences or outline of the paper aren’t good, it’s good to start because it forces the student to think. In this case, the procrastination was a game of chicken along with preemptive negotiations.

Trade Deal - There is no chance the two sides will get a specific deal done by March 1st. 

But they don’t have to anyway because President Trump softened his stance on raising tariffs if a deal isn’t done by then. 

Any rational negotiator would avoid having a hard deadline if progress is being made. Negotiators are drawing up 6 memorandums. 

They are on forced technology transfer and cyber theft, intellectual property rights, services, currency, agriculture, and non-tariff barriers to trade.

There are two points I want to highlight on this. Firstly, this isn’t a "Trump" issue. This is a U.S. and China issue that actually has bipartisan support in America. 

After Trump leaves office, this deal should still be in place if China keeps its promises. The second point is some investors are starting to get restless about stocks rallying on trade news because they feel like it happens every day. 

Don’t be a cynic. The trade negotiations are finally happening which is good news. Even though stocks have rallied on positive trade news, I still expect a modest rally when the parties get close to finalizing the agreement. This could help spark Chinese growth.

Trade Deal - Drivers Of Stocks In The Past Year

The chart below shows the drivers of stock returns in the past year. 

This is an opinion. There is no way of knowing what caused stocks to rise and fall. That doesn’t mean we shouldn’t try to figure it out. Knowing what drove stocks in the past helps us figure out what will drive them in the future. 

As you can see, the correction in Q4 was driven by trade tensions, the government shutdown, and global growth weakness. If that’s the case stocks should rally sharply as these trade negations head in a positive direction. 

The chart shows the rally this year is being caused by easing trade tensions, positive economic and earnings data, and the dovish Fed.

I somewhat disagree with the catalysts for the correction and wholeheartedly disagree with the catalysts for the rally this year. Many investors don’t think the government shutdown affected stocks much in December. 

Personally, I think the Fed’s hawkishness caused more selling than what’s listed here. Economic data caused some weakness and the trade tensions are overblown. It’s very weird to couple economic reports with earnings data. 

Trade Deal - It’s tough to see which variable is causing the changes.

The stock market rally isn’t being caused by earnings this year as estimates have crashed. The economic reports also haven’t been great as GDP forecasts for Q4 and Q1 have fallen. Maybe it’s fair to say there isn’t a fundamental justification for this rally instead of pretending earnings and economic reports were great.

Trade tensions have eased, the shutdown hasn’t helped stocks, and the global economy isn’t improving. I would argue the global economy has gotten worse this year. And I strongly disagree that the Fed has only modestly catalyzed this rally. 

The Fed has shifted from having the balance sheet on auto pilot and hiking rates 3 times in 2019 to ending the balance sheet unwind and hiking rates zero times this year. There has been a massive shift in guidance which will be shown when the Fed’s projections are updated in March. 

Spread the love