Are We Hitting The Point Of Maximum Trade War Concern?

PRESS IS IN THE EYEBALL BUSINESS

Financial networks and websites are in the eyeballs and click business; not that there is anything wrong with that.  The uncertainty related to a possible trade war between the United States and China is good for attracting eyeballs and generating clicks. Therefore, some of what has been written needs to be taken with a "what business are they in" grain of salt.

A PRUDENT LOOK AT BOTH ENDS OF THE TRADE SPECTRUM

Are there reasons to be concerned?  Yes

Are there reasons to believe the worst may be behind us?  Yes

CASE A:  WE ARE NEARING THE PEAK OF FEAR ON THIS TOPIC

A rational argument can be made that Trump's tariffs are nothing more than a negotiating tactic to increase leverage when discussions begin with China.  China's response to Trump's moves have basically the same "we will not be pushed around at the negotiating table " objective.  

Now listen to me. I am negotiating. Negotiation, this is what you do in business.
— George Costanza

A protracted trade war is not in either side's best interest. Tariffs, even the threat of tariffs, create numerous squeaky corporate wheels for Trump in the United States and for Xi Jinping in China. Nobody wants to deal with squeaky wheels for a protracted period; it can be very draining. 

Trump is most likely looking for some way to declare victory or show some progress on the China trade topic before midterm ballots are cast.  He has some specific objectives, including steel, aluminum, market access, and intellectual property; hence the need for proposing to enact several tariffs.  China has simply responded in kind to maintain a powerful posture.  Trump does not want this topic in the problem hopper when midterms arrive; China does not want to be perceived globally as anti-free trade. 

Trump was fairly silent on this topic for a few days that were marked by wild swings in the financial markets.  His April 4 tweet may mark the end of that silence and signify he wants to tone down the rhetoric and move closer to the negotiation/resolution phase.  If that is the case, which is still to be determined, it is possible today marked peak news-cycle-fear on the trade war topic. 

CASE B:  EGOS COME INTO PLAY

We would like to think the leaders of the United States and China can exercise the proper self control going forward, allowing for an eventual shift away from a ping-pong game of tariff announcements and toward the negotiation/resolution phase.

Unfortunately, when power, egos, and politics are involved, anything can happen, including an escalation from a trade battle to a full-blown trade war.  Therefore, while it is prudent to run through a few "what if" scenarios, we must remain flexible, disciplined, and open to all outcomes from an investment management perspective, which is exactly what we will do. 

Price Action YTD - What Can We Learn From History?

REFERENCE POINTS PROVIDE CONTEXT

β€œIn strategy it is important to see distant things as if they were close and to take a distanced view of close things.”
— Miyamoto Musashi, Legendary Japanese Swordsman

A December 2016 post highlighted similarities between late 2016/early 2017 and the 1994-1995 period.  The analogy proved useful in 2017 with stocks posting a rare low-volatility year that featured a strong bullish trend, which compared very favorably with the strong-gains/low-volatility year of 1995.

EASIER MARKETS AND HARDER MARKETS

Since we know easier markets are typically followed by harder markets, it is not particularly surprising 1996 was not as easy as 1995.  Nor is it particularly surprising 2018 has been harder than 2017.  Price action in 1996 featured several bullet points investors in 2018 should easily identify with:

  • 1996 started with a gain of 10.58%
  • Stocks then dropped 11.04% and went into negative territory YTD
  • The S&P 500 dropped below an upward-sloping 200-day moving average.
short-takes-1996-correction-stock-market-1.png

WHAT HAPPENED NEXT?

After dropping below the 200-day moving average and pushing into negative territory YTD, the S&P 500 resumed its primary trend by tacking on a gain of 25.78%.  After a rough period in the first half of the year,  patient investors were rewarded with a satisfying annual gain of 20.26%

short-takes-1996-correction-stock-market.png

HOW CAN IT HELP US IN 2018?

This knowledge helps us keep an open mind about all outcomes in 2018, including better than expected outcomes.  Just as 2017 followed its own path while sharing some key characteristics with 1995, it is within the realm of possibility 2018 could feature a "harder market" in the first few months of the year and still go on to post satisfying gains when the calendar hits December 31, 2018. 

LOW VOLATILITY IS NOT BEARISH

When volatility was low in 2017 we heard "this is not normal and is thus bearish".   In 2018 we are hearing "this is too much volatility and is thus bearish".  As calendar year 1995 proves, a low-volatility year, like 2017, is not necessarily bearish.  In fact, low volatility is a sign of strong bullish conviction.  When we view the increase in volatility that took place between 1995 and 1996, the shift between 2017 and 2018 does not seem particularly abnormal; in fact, it seems to fit the strong-bullish-trend script.  We covered these "don't be surprised if volatility picks up" concepts back on January 29, 2018.

short-takes-1996-correction-stock-market-3.png

HOW OFTEN DO STOCKS VIOLATE A 50-DAY MA? .... A 100-DAY MA? ...A 200-DAY MA?

If you have a pulse, you have probably noticed bearish articles covering "major trendline breaks" involving numerous "key" technical levels, including the 50, 100, and 200-day moving averages.  To put these "bearish" signals into some real-world context, this week's video reviews the frequency of "trendline breaks" within the context of a primary bullish trend.  After reviewing the facts, you can make your own call.

BEARS HAVE AN OPEN DOOR

Given the vast majority of industry-related articles have leaned bearish in recent weeks, it is fairly easy to keep an open mind about an ongoing correction and/or bear market.  As outlined on April 2, a sustained S&P 500 visit below 2,532 would give the bearish case a nice boost.  It is important under our approach to remain highly flexible and open to all outcomes from wildly bullish to wildly bearish.  The markets will guide us if we are willing to listen. 

Monday's Ugly Session

TESTING THE LOWER END OF THE RANGE

The S&P 500 is approaching the lower end of the recent range.  A sustained move below 2,532 would provide additional support for the bearish case.  Comments made on March 21st and in this week's video still apply.

short-takes-April 2 2018.png

BULL/BEAR INFLECTION POINT

The lower end of the range represents a possible inflection point.   As noted on February 6, reversals near a prior low can be sharp (see table below).  At these levels, there is a fine line between prudent patience and prudent capital preservation. 

short-takes-April 2 2018-table.png

GAME PLAN REMAINS THE SAME

As anticipated, with price near the lower end of the range, some additional deterioration has started to show up in the hard data tracked by the model.   Like the market, the data is near an important juncture where further weakness will most likely require some allocation shifts before the end of the week.  If the market can make a stand near current levels, we will most likely be able to sit tight.  The market and the hard data will make the call.