Wall Street Appears Calmer, but Trade Tensions Still Linger

Investor sentiment Tuesday morning seemed calmer than during the broad selloff the previous day, but trade tensions still appear to be weighing on the market.

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(Tuesday Market Open) Market sentiment Tuesday morning seemed calmer than during the broad selloff the previous day, but trade tensions still appeared to be weighing on the market.

Wall Street reeled on Monday over concerns that protectionist trade policies would dent economic growth in the U.S. and key trading partners China and Europe. But there also appeared to be mixed messages coming from Washington on the trade front.

This morning, General Electric (GE) shares offered a bright spot in pre-market trading. They were up more than 5% after the company said it would spin off its health care business and divest its stake in oilfield services company Baker Hughes (BHGE). The market was apparently cheering the conglomerate’s move to be more efficient.

Mixed Messages on Trade

The three major U.S. indices came under pressure Monday on reports that the Trump administration is planning to limit Chinese investment in U.S. technology firms. That’s on top of a tariff dispute that has many worried about growth in the world’s two largest economies.

During the trading session, Treasury Secretary Steven Mnuchin seemed to add fuel to the fire in a tweet saying that a “statement will be out not specific to China, but to all countries that are trying to steal our technology.” But then White House economic advisor Peter Navarro told CNBC the market was overreacting and the White House doesn’t have specific countries targeted in terms of limiting foreign investment. Still, the White House press secretary reiterated the Mnuchin statement.

Amid the trade fears, the Chinese yuan has been falling against the dollar. That makes goods the U.S. sells to China more expensive regardless of what is decided on tariffs and could provide another potential headwind for U.S.-based multinationals.

Tech Takes a Breather

The tech-heavy Nasdaq Composite (COMP) declined by the largest percentage of the big three U.S. indices Monday, with U.S.-based chipmakers Micron (MU) and Nvidia (NVDA) among the losers.

Keep in mind that these companies have been having a banner year. Even after Monday’s close, NVDA shares were up more than 23% year to date while MU’s were up nearly 30%. Also, the Nasdaq Composite was in record-high territory (see figure 1 below). So Monday’s declines could be a case where investors were using the headlines as an excuse to take some profits.

On Tariffs and Trade

Trade concerns weren’t limited to the U.S. and China, though. The Trump administration on Friday said it might target European Union-made automobiles with a 20% tariff, and President Trump on Sunday said the United States insists countries with “artificial trade barriers and tariffs” should remove them or face “reciprocity.”

EU tariffs on more than $3 billion dollars of U.S. goods, including motorcycles, went into effect Friday in retaliation for U.S tariffs on European steel and aluminum.

Shares of motorcycle manufacturer Harley-Davidson (HOG) fell nearly 6% Monday after it said it would move some production out of the United States to “alleviate the EU tariff burden” that could end up costing the company up to $100 million per year.

Meanwhile, the Cboe Volatility Index (VIX) rose sharply. Investors may come to expect higher volatility with the 10-year Treasury yield around 3%, and selloffs may be more prominent than they were last year as there could be more competition for yield. But just because trade is choppier doesn’t mean stocks can’t move higher, even as interest rates rise. (See more on that below). Plus, while professional traders love volatility, if you’re a longer term investor, ups and downs typically smooth out the longer your investment horizon.

Figure 1: Rough Week for Tech. After touching an all-time high last week, the Nasdaq Composite Index (COMP) has fallen back over 3%. Data source: Nasdaq. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.  

Rising Tide and Choppy Seas: Just because the waves get choppy doesn’t mean the tide isn’t rising. In other words, the market can still move higher over time despite heightened volatility. Investment research firm CFRA expects the S&P 500 this quarter will hit a milestone of the longest bull market since WWII and will hit 3000 within a year. That’s despite headwinds including slowing global economic and earnings per share growth expectations, trade issues, rising inflation expectations and increasing interest rates. Also, don’t forget it’s midterm election season, which generally is associated with increased uncertainty. “Even though the S&P 500 may end up posting a price increase in the coming quarter, it will also likely see a rise in volatility,” the research firm said. “Since WWII, the average daily price volatility during third quarters of midterm election years was 34% higher than in non-election years.”

Green is Good (Unless You’re Short): Shorts had plenty of fodder for making money on Monday, as the S&P 500 sectors were a sea of red. But there were two notable exceptions. Utilities and consumer staples were the only sectors in the green as investors apparently were attracted to their reputations as safer investments amid market volatility and selling. Both are considered defensive in nature because, let’s face it, we’re all going to need toilet paper and electricity no matter what’s happening with the economy. But investors may want to keep in mind that consumer staples and utilities stocks, which often pay dividends, can face headwinds as interest rates rise. (Utilities may do fine if interest rates rise gradually, but faster rate hikes could be problematic. And consumer staples may be more vulnerable to rate hikes regardless of their speed.) Both are also vulnerable to upward swings in commodities prices, which one could argue are more likely as the economy has been chugging along. Consumer staples companies are also facing competition from Amazon (AMZN) and can be vulnerable to a rising dollar, depending on how much business they do overseas. Also, as ironic as it may sound given the flight to safety on Monday because of the tariff tension, a full-blown trade war could be a headwind for consumer staples companies that sell to China and the European Union.

Delving into Durables: Tomorrow, the market will get a glimpse into the extent to which consumers and businesses are investing in long-term equipment and major appliances. This will come with durable goods data, which is an indicator of economic health. A consensus forecast from Briefing.com for the headline number doesn’t look too promising. Economists are expecting durable orders to have declined 1% in May. But stripping out transportation yields a stronger picture. In that case, economists are expecting a rise of 0.4%, which puts the number in line with other economic readings showing modest economic growth.

Good Trading, 

JJ

@TDAJJKinahan 

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