March & June High Broken
On Tuesday the stock market continued its rally as it looked like the tariffs were losing their ability to affect the market. However, after the close, President Trump issued another round of tariffs on China which may end this recent rally. I will review that later in this post. The S&P 500 closed up 0.35% at 2,793.84 which is about 79 points away from the record high in late January. Just like on Monday, the Dow outperformed the Russell 2000 by a wide margin. The Dow was up 58 basis points and the Russell 2000 was down 53 basis points. The financials were the only losing sector as they fell 37 basis points; their earnings results will start to pour in later this week. Consumer staples rebounded from Monday’s underperformance as they increased 1.26%. This was the best sector. The utilities and telecom also rebounded from Monday’s weakness as they rallied 0.98% and 1.13% respectively.
Treasuries Sell Off Again
U.S. treasuries sold off again on Tuesday as it was a ‘risk on’ day. However, they might rally on Wednesday because of the increase in trade war rhetoric which I will discuss in the next section. The 2 year yield increased about one basis point to 2.5693% which is just two basis points below the cycle high. Since the chances of future rate hikes increased, it’s not surprising to see the yield increase. It is near the end of its increase for this cycle, but I still think it will go up in the next 6 months because the Fed will stay hawkish until recessionary signs emerge.
The 10 year yield increased over one basis point to 2.8292%. I think the high set in May was the cycle peak because GDP growth likely won’t get higher than Q2 2018. The latest difference between the 2 yields is 28 basis points. The Fed’s meeting is in 3 weeks on August 1st. It seems like the difference will be below 20 basis points by then.
Trump Tariffs Come Back
Just as the market was getting accustomed to moderately increasing tariffs that would have a marginal effect on the economy, President Trump announced a tax on $200 billion of Chinese goods. As you can see from the chart below, the S&P 500 futures fell immediately after this announcement. The market usually recovers during the day if tariffs are announced the night before, but this time is different because the stock market had been shirking off worries about tariffs. The S&P 500 was slightly overbought on Tuesday because of this rally. The CNN Fear and Greed index was at 49 out of 100 which is neutral and the 14 day RSI was at 57.24. In addition to this decline, the Yen rallied versus the dollar and the iShares China Large Cap index fell 1.23%.
Specifically, the $200 billion worth of Chinese goods will receive a 10% tariff. This $200 billion list of goods is about 40% of the Chinese exports to America. It will be interesting to see the next level of rhetoric. It’s possible that all $500 billion of Chinese goods are taxed as Trump has warned after China retaliated with tariffs on American exports. The $200 billion in new tariffs will undergo a 2 month review and will have hearings from August 20th to August 23rd. Those hearings will undoubtedly be followed closely by investors. Some of the products on this list includes sectors in the Made in China 2025 plan. This plan aims to put China in the lead in key industries. It’s not surprising to see them added since many of Chinese imports are being taxed.
The U.S. Trade Representative to China, Robert Lighthizer, stated "For over a year, the Trump Administration has patiently urged China to stop its unfair practices, open its market, and engage in true market competition." The game of chicken has continued. It will soon get to the point where China will run out of American goods to tax. It seems like weakness in the Chinese economy is the most likely catalyst to end this game because the American economy looks strong. The Chinese economy is seeing weakness in rate of change terms and its stock market is still down 20.88% since January 26th despite its 3.43% rally in the past 3 days. As you can see from the chart below, the Chinese economic surprise index is at the lowest level in 2 years indicating results are missing expectations as its growth slows faster than expected.
To be clear, the weakness in the Chinese economy is not related to the tariffs yet, but they will amplify the weakness when they show up in the data. As you can see from the chart below, the global trade momentum is flashing a red warning signal for the first time since the middle of 2015. China is in a weak situation which means it might give in to America’s demands which include reforms which respect intellectual property rights.
America is in great shape to deal with this trade skirmish as the S&P 500 is near its all-time high and GDP growth is expected to be 3.9% according to the 11 models averaged by the CNBC GDP tracker. The chart below shows another example of strong American economic growth. As you can see, the coincident economic indicators index is at a record high and the diffusion index of leading indicators is near 100. The table below shows when the diffusion indicator is high, stock performance is better than when it’s low.
Conclusion
The stock market is declining after hours on Tuesday because of the latest round of tariffs the Trump administration put on Chinese exports. The larger they get, the more of an impact they will have on the economy. Even the $200 billion worth of goods tariffed at 10% won’t cause a recession, but the continued increase of rhetoric is worrisome. The best chance of a ceasefire to this trade skirmish is for China to give in to America’s demands since its economy is showing signs of weakness.
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