Caution Flag Waving: As Tariffs, Volatility Rise, Market Takes Another Swing Lower

Pressure is building on stocks early Friday after the U.S. raised tariffs on China. Industrials, Financials, and Info Tech could potentially be in for further weakness.

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6 min read

Key Takeaways

  • Tariffs rise to 25% on $200 billion in Chinese goods

  • Markets seem very sensitive now to presidential tweets
  • Consumer prices rose 0.3% in April, as inflation still muted

(Friday Market Open) If you happened to glance at stock futures early this morning after the U.S. raised tariffs on China just after midnight, you might have been surprised to see the market moving higher. 

It looks like some investors had hoped that with the Chinese delegation still in Washington, something could get quickly hashed out. There was also talk that China’s government was buying stocks, giving a boost to equities in Asia and perhaps raising hopes of a trade deal.

Those hopes quickly faded as the opening bell approached, with stocks taking a dive in pre-market trading as investors started preparing for what looks like a longer slog.

What’s the takeaway for traders and investors? Well, tariffs went up and the world didn’t end. Treasury prices are rising, which could be a headwind for Financial shares. Info Tech and Industrials could also find themselves under new pressure.

How you look at the situation depends on what type of investor you are. It’s arguable that as crazy as this week has been, it has something for everyone. For traders, this week has probably seemed like heaven with all the volatility. For investors, all the noise has been irritating, but it’s also offered a chance to find companies at lower prices after the long rally.

For anyone in the markets, it’s important to keep timeframes in mind. The longer your holding period, the more important it is to ignore this sort of noise. It’s also critical to keep an eye on earnings, because that’s what really drives the market over the long run.

It’s actually instructive that the tariffs went up the same day Uber (UBER) is scheduled to have its initial public offering (IPO). Just because it’s the first day of tariffs and the first day of Uber doesn’t mean you have to trade on the first day. There’s nothing wrong with letting things play out a little. There’s no award for being first.

Trump Tweets Monitored

Getting back to the tariff situation, something to consider is that the president often makes big pronouncements and then steps back. It’s possible that could be the case this morning.

For now, though, the U.S. has raised tariffs to 25% from 10% on $200 billion in Chinese goods, and it looks like China is probably going to retaliate. Most of the goods facing increased tariffs are things like circuit boards, microprocessors, vehicle parts and machinery, The Wall Street Journal reported. About $40 billion of consumer goods will also be hit. More than 5,000 different items are subject to the tariffs.

Even if a positive tweet comes out later today, it’s hard to imagine the market getting back into a major rally mode right away with this sort of negative overhang. Especially after weeks of looking like the two countries were about to strike a deal. It’s been a real whiplash these last few days.

One interesting note: The Cboe volatility index (VIX) was still under 20 early Friday despite the negative news on tariffs. Over the last week, the VIX has typically jumped over 20 when tariff fears are hot and fallen under 20 when fears cool off. The fact that it’s below 20 this morning could suggest some remaining hopes for a resolution.

However VIX is starting to creep back toward 20 as the morning continues. Volatility could pick up if more news starts to hit, so people trading the market today might want to consider entering and exiting with some extra caution.

Sectors Signal Trade Impact

This week’s trade-related pattern continued to show up in the sector rundown Thursday, with Materials and Info Tech—two of the sectors most exposed to China trade—having the worst performance. However, there’s been pretty widespread selling across most sectors these last few days, as it looks like few investors are willing to get out in front of possible bad news.

One thing to potentially keep in mind as the market gets slammed by negative trade news is how a possible trade war might affect earnings per share in Q2, and whether valuations might need to be reassessed for some companies and the market as a whole. Stocks weren’t necessarily “priced for perfection” across the board before trade barbs began to fly this week, but they weren’t really cheap either with a price-to-earnings ratio of near 17 vs. forward earnings estimates, up from around 14 back in December and slightly above the five-year average. If analysts think a trade war is likely to hurt Q2 and full-year 2019 earnings for many firms, the “E” aspect of those forward projections could start to fall, pulling the “P” part with it.

Looking away from the trade picture for a moment, today brought some fresh data with consumer prices for April rising 0.3%, according to the latest Consumer Price Index (CPI) reading. The cost of living increased 2% over the past 12 months, which is the highest rate of inflation in six months, yet still below the peak of 2.9% last year. Higher gas and rent prices drove much of the recent inflation increase.

Today is also expected to mark the debut of Uber (UBER) shares (see more below), as the IPO stampede of 2019 continues. That might help create a little excitement, though, as always, investors might want to consider taking caution about jumping into IPOs even if they like a company’s product.

Earnings’ Second Act

Almost all of the S&P 500 companies have reported, but a host of new earnings awaits investors next week, including Cisco (CSCO), Deere (DE), Walmart (WMT), and Nvidia (NVDA). The NVDA results and call could get close attention, mainly because semiconductor stocks have arguably taken the worst hit from this new China trade tension. Intel (INTC) has been one of the worst-performing big stocks of the week after the company’s analyst day appeared to disappoint Wall Street.

In another sign of investor caution this week, Treasury prices continued to move higher Thursday, pushing the 10-year yield down to 2.46%. At one point Thursday, the three-month yield briefly exceeded the 10-year yield, inverting for the first time since late March. That’s sometimes seen as a sign of pending economic weakness. By the end of the day, the inversion had ended. The 10-year yield dropped to 2.45% early Friday after tariffs went up, but remained two basis points above the three-month yield.

FIGURE 1: VIX ON TENTERHOOKS: After a month of calm the Cboe Volatility Index (VIX, represented here by the candlestick), has woken up amid uncertainty over tariffs. The VIX keeps swinging back and forth around the pivotal 20 area as investors’ moods go up and down this week. The rise in VIX has been accompanied by a big drop in the S&P 500 Index (purple line). Data Source: S&P Dow Jones Indices, Cboe. Chart source: The thinkorswim® platform from TD Ameritrade. For illustrative purposes only. Past performance does not guarantee future results.

IPO Stampede Resumes With Uber: Today’s expected debut of Uber (UBER) shares puts initial public offerings (IPOs) in the spotlight again. Recently, it’s been a crowded lane for IPOs, with more than 40 debuting so far this year, mostly in March and April after the government shutdown ended. Many of the big-name IPOs have rung up sharp gains, including some that rose more than 100%. This is a departure from typical IPO history, where data show average gains of 10% over the first five years after an IPO.

It’s unclear what sort of debut Uber’s $90 billion offering might have or what sort of traffic it might encounter as the stock begins trading after a less than stellar post-IPO market performance for competitor Lyft (LYFT). Some analysts have concerns about what they say looks like a relatively high valuation. On the other hand, you could argue that a company wouldn’t offer its shares publicly if it didn’t see demand from investors. We’ll have to see how it plays out, not just today, but in coming days and weeks. If the overall market continues to slump, that could mean fewer new offerings, as companies typically like to debut when things are going well on Wall Street.

Checking Your Emotions: When it comes to investing in IPOs, investors should consider keeping a cautious outlook. Many times in recent years, an IPO with a lot of publicity and hype cratered soon after its opening day. Sometimes investors confuse a company brand with its business. In other words, you may love the product, but that doesn’t necessarily mean you have to love the stock, too.

One problem with IPOs is that many investors rush in. It might be worth waiting to see what the stocks do. Or, if you do jump on an IPO, you might want to consider buying shares in partial increments rather than going all in at once. People can be excited to invest in these companies, but it’s good to keep the potential downside in mind.

Support Points? When stocks hit the skids, as they have this week, you sometimes hear people start talking about where support might be found. The S&P 500 Index (SPX) slid below its 50-day moving average near 2860 on Thursday before closing slightly above it, a possible sign of some strength. It remains well above the 200-day moving average of 2775. That’s right near the year-to-date moving average of 2778, perhaps making that level a particularly sensitive spot to consider watching.

Good Trading,
JJ
@TDAJJKinahan 

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Economic calendar for week of May 6. Source: Briefing.com
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Key Takeaways

  • Tariffs rise to 25% on $200 billion in Chinese goods

  • Markets seem very sensitive now to presidential tweets
  • Consumer prices rose 0.3% in April, as inflation still muted
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