Covenant’s Weekly Market Synopsis for April 6, 2018

April 9, 2018

Tariff tough-talk once again roiled financial markets last week, as uncertainty provoked volatility. The 5-day trading week included two daily declines of more than 2% in the S&P 500 and two days of 1%+ gains, netting to a weekly decrease of 1.4%. The Nasdaq Index did worse, down 2.1% as the treasured FANG (Facebook, Amazon, Netflix, Google/Alphabet) stocks no longer look unassailable. International stocks fared better for the most part, with regional indices in Europe and Japan recording gains of around 1%. Frontier markets also posted gains on the week, while emerging market equities fell modestly, dragged down by a -0.8% decline in China’s primary equity index. Fixed income investments did not prove to be a foil for equity declines, as interest rates rose on the week with a modest yield curve steepening bias. Precious metals offered some protection (Gold +0.6%, Silver +0.1%), but the energy commodity complex suffered with WTI Crude declining 4.4% to $62.06 per barrel.

For more detail on weekly, month-to-date and year-to-date asset class performance, please click here.

Razor’s Edge: Stocks are in a critical, if not precarious, position. The daily 1%+ moves both up and down this year (there have been 27 of them in 66 total trading days thus far this year) have resulted in the market traveling a great distance, yet not making any real progress in either direction. Currently, the S&P 500 Index is down 9.3% from its all-time high, on the cusp of a technical “correction” (defined as a 10% decline from its high) and testing its 200-day moving average for the fourth time already this month. Trade conflict with China is responsible for many of the recent large moves, but something equally as important looms soon – Q1 earnings season. Kicking off on April 13th, analysts’ consensus forecasts for the S&P 500 include a 17% jump in year-over-year earnings per share and a 10% increase in revenue (if realized, both would be the fastest growth since 2011). Much of this has been priced into the market so investors will be keen to see if their favorite corporates can deliver and support a bullish outlook for the rest of the year. In a period of high growth expectations, frayed nerves concerning trade, and a technically vulnerable stock market, the Q1 earnings season and associated forward guidance will set the stage for whether stocks end the year in the black or the red.

Change and Uncertainty: President Trump campaigned as an outsider that would “drain the swamp” and bring real change to America. While the question of whether he drained the swamp is debatable, the President is effecting change. The administration has cut taxes and reduced regulation. Some people like it, some people don’t, but it is change. And if one is to use the stock market, consumer confidence and business optimism as indicators, it has thus far been effective change. Currently, President Trump is trying to undo decades of trade pacts which he believes are disadvantageous to the U.S., and he is laser-focused on China. Of all his endeavors thus far, with the possible exception of his dealings with North Korea, the current situation with China is creating the most significant uncertainty. Stock markets don’t like uncertainty….and have reacted accordingly.

Change is messy. By its very nature change introduces uncertainty. Harkening back to North Korea, Trump’s approach was different than any President in recent memory. But with the help of China (ironically), Kim Jong-un has agreed to discuss the denuclearization of North Korea. Is President Trump’s current dealings with China regarding trade just another chapter in The Art of the Deal? It’s a high stakes game, and his approach is unorthodox until you recognize it for what it likely is… positioning for negotiation. Trump’s latest move to threaten trade tariffs on an additional $100B of Chinese imports is akin to a poker player forcing another with a smaller stack of chips to decide if he trusts his cards enough to go “all-in.” China has the “short stack” in this scenario because they don’t import enough products from the U.S. to be able to match the breadth of the total tariffs proposed on Chinese goods imported to the U.S.

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Source: The Daily Shot.

Sure, there are other levers the Chinese can pull (e.g., refusing to purchase U.S. Treasuries), but President Trump is trying to read China’s eyes about their confidence to go all in.

Engaging in a full-on trade war would be an irresponsible outcome for both U.S. and Chinese leaders. It would be disingenuous not to at least give them the benefit of the doubt that they know both countries are better together than apart on trade. Indeed, even as they increase their trade rhetoric, both sides are talking, and the timeline of the proposed U.S. tariffs invites negotiation:

  • May 15th – U.S. business interests will be allowed to air concerns publicly at the International Trade Commission.
  • May 22nd – Deadline for companies to object to proposed tariffs.
  • 180 days – Following the May 22nd deadline, the U.S. still has 180 days to decide if they will implement the tariffs.

Although the administration will hear companies’ opinions on tariffs, it doesn’t mean the administration will listen. It is doubtful the Trump Administration cares what lobbyists have to say about the tariffs. Rather, this extended comment period creates an intentional window for negotiation. And that’s already been taking place. According to the Wall Street Journal, Chinese economic envoy Liu He has recently been in dialogue with both U.S. Trade Representative Robert Lighthizer and Treasury Secretary Steven Mnuchin about a further opening of the Chinese market.

As the author of The Art of the Deal faces off against students of Sun Tzu’s The Art of War one would expect that, hard tactics aside, compromise is available and in the best interests of all involved. If not, the synchronous global expansion, already fraying at the edges, will unravel quickly. High stakes poker, indeed.

Be well,

Jp.