This was a volatile week. On Monday, the S&P 500 fell over 2% and dropped through its 200-day moving average early in the day as Tech resumed its selloff in the wake of another Trump tweet attacking Amazon over USPS finances and taxes. Stocks shrugged off the FAANG selloff to close higher on Tuesday, but that night, the Office of the US Trade Representative unveiled a list of proposed tariffs on $50bn of Chinese imports, on which an additional tariff of 25% will be imposed. China reacted immediately the following morning with counter-measures of the same scale and intensity, proposing a retaliatory tariff of 25% on $50bn of US imports including soybeans, autos, and aircraft. DOW Futures were down 500+ points premarket but surprisingly closed up ~230 points on Wednesday. Equities were positive again on Thursday as investors chalked up the impact of the announced trade policies as minor. Then on Thursday night, President Trump suggested that the US should consider sanctioning an additional $100bn of Chinese imports. Stocks were down a lot all day Friday, and the DOW closed down 572 pts. On the week, The S&P 500 and Dow Jones Industrial Average finished down -1.35% and -0.67%, respectively. Credit markets sold off as well, but to a lesser extent, driven in part by a lower weighting of the tech sector. The graph below shows the swings of the S&P 500 throughout the week.
Right now, all investors are assessing the probability and potential severity of a trade war. My view is that this is mostly posturing by the US Administration going into negotiations (similar to NAFTA). It’s important to remember that these tariffs are proposals, not policy. The actual policies are likely to be negotiated down. Even then, full implementation would reduce US and Chinese growth trivially. A 25% tariff on $50bn of imports is equivalent to only 0.1% of China GDP and 0.06% of US GDP. Retaliatory trade restrictions are also limited by the fact that the US only exports ~$150bn of goods to China but imports more than $500bn. However, China can retaliate in other ways (i.e. by reducing US Treasury bond holdings or restricting services trade and market access for US companies). Nonetheless, I think this recent $100bn suggestion/threat is just a negotiating tactic to get China to meet US demands. The demand list from the US will likely ask China to further reduce auto import tariffs, speed up the opening of the financial sector, and increase imports of semiconductors from the US. I’m sure there’ll be a number of “shocking” headlines that come out as negotiations unfold, but unless something drastically changes, I think a lot of it is just noise.
A few weeks ago, I thought the risk/reward relationship of US equities was skewed to the downside with the S&P 500 at 2,752 and harsh trade rhetoric coming out of the White House. I think the risk/reward is much better today as tech has come down a good bit and markets are pricing in a much higher probability of a trade war. The S&P 500 presently sits at 2,604, or 16.7x forward earnings. 16.7x isn’t too cheap from a historical standpoint, but fiscal stimulus and a strong global economic growth cycle are expected to grow earnings another 10% in 2019, from $156 to $172. Furthermore, I think there is a lot of near-term upside as investors shift their focus from trade frictions and tech regulatory risks to a 1Q earnings season that begins at the end of next week (April 13th). Consensus forecasts 1Q18 EPS growth of 17% y/y (10% organic when excluding tax cuts). Of course, the downside risk for 1Q sales and EPS misses is substantial. Furthermore, Friday’s payroll report suggests that the economy is not on the cusp of overheating and that the Fed is not behind the curve (Nonfarm payrolls rose 103k vs. 185k consensus and the previous two months’ prints were revised down by 50k). Although I try not to read too much into single data points, the report does ease concerns of upside surprises to inflation and/or a too hawkish fed. Rates are by far my number-one concern for risk assets this year, and the 10-Year Treasury yield closed at a relatively benign 2.77% on Friday. Overall, the risk/reward of US equities seems balanced. Fixed income, not so much, but that’s a topic for another post.
My Top 10 Reads of the Week:
On Monday, Jeff Gundlach, who is right a lot, tweeted: “I learned Dow Theory (and many other things) from the late great Richard Russell, probably the best investment newsletter writer of all time”. Perhaps somewhat embarrassingly, I hadn’t heard of Richard Russell and decided to check it out. This explains the disproportionate number of Dow Theory articles. Here’s a link to Richard Russell’s book Dow Theory Today if interested.
- Wikipedia: Dow Theory
- Dow Theory Letters: The History of the Dow Theory
- Dow Theory Letters: Rich Man, Poor Man
- The Grumpy Economist: Unraveling
- Barron’s: AI: Coming to a Portfolio Near You
- Dow Theory Letters: Acting
- Dow Theory Letters: Hope
- Dow Theory Letters: Time
- The Economist: A Trade War Between American and China Takes Shape
- WSJ: In the Oil Patch, Bigger is No Longer Better