Stocks Fall On Trade Worries

Stocks fell on Tuesday because of the negative news surrounding trade talks between America and China. News events on Tuesday have made the lead up to the trade negotiations almost as bad as it can be. Optimism about a deal has waned considerably. 

Investors, including myself, previously predicted a deal would occur this year. Now we must back off that expectation with the latest news. Traders should put little trust in statements by officials and reports. However, negative actions were taken; and I follow actions closer than words.

Near Worst Case Scenario For Trade Talks

It doesn’t seem like either side is getting ready to make a deal or agree to any concessions at the meetings later this week. Headlines couldn’t get any worse. Firstly, the US Department of Commerce added 28 new companies to its blacklist of Chinese firms banned from doing business in America. 

Firms on this list specialize in artificial intelligence, machine learning, and digital surveillance. One of the blacklisted companies is a video surveillance company called Hikvision. This firm is one of Ambarella’s customers. Ambarella’s stock fell 9.49% on this news. More importantly than impacting these 28 firms, this action makes it seem like a trade deal is much less likely.

China obviously didn’t react kindly to this action. A spokesperson from the Ministry of Commerce stated, “We strongly urge the U.S. to immediately… remove relevant Chinese entities from the list of entities as soon as possible.” The editor-in-chief of the Chinese and English editions of the Global Times tweeted, “I can feel that Chinese society has low expectation for real breakthrough in the new round of trade talks. Most people think alternate trade war/trade talks will be a normal thing between China & the US. Plus, people widely think the Trump administration can't honor its commitments.” 

It’s impossible to not have low expectations for these talks given the news that has come out in the past few days.

A 2nd action by America which has made me think a deal isn’t likely is it put visa restrictions on Chinese officials. Secretary of State Mike Pompeo stated the restrictions target officials, “who are believed to be responsible for, or complicit in, the detention and abuse of Uighurs, Kazakhs, or other members of Muslim minority groups.” 

As you can see, the disagreement with China has many layers. It is economic and political. The situation is dramatically worse than it was when President Trump delayed the tariffs by 2 weeks to October 15th. It doesn’t seem likely progress towards a trade deal will be made this week. At this rate, it’s surprising they are even meeting.

As if the two sides needed anything else to go wrong before the meetings, China is in a testy situation with the US NBA (National Basketball Association). Chinese businesses suspended ties with the Houston Rockets basketball team after the team’s GM tweeted support for the Hong Kong protests.

Tuesday’s Action In Markets

Stocks were down most of the day, but there was a brief rally after Powell stated the Fed will start expanding the balance sheet soon. That rally quickly ended which makes sense because this isn’t a stimulus. The goal is to fix the financial plumbing. Fed wants to avoid a spike in repo rates and the Fed funds rate. It’s good news the Fed is doing this, but it won’t improve economic growth. This balance sheet expansion won’t help stocks just like the balance sheet expansion before the financial crisis didn’t help them.

Specifically, the S&P 500 fell 1.56%, the Nasdaq fell 1.67%, and the Russell 2000 fell 1.68%. VIX was up 2.42 to 20.28. Just as predicted, the VIX is back above 20. It looks like the trade negotiations won’t go well, but we still need to wait for the rest of the news to come out. More bad news can send stocks even lower and the VIX to the mid-20s. CNN fear and greed index fell 1 point to 29 which is fear. It doesn’t matter if stocks are oversold; they will fall further if bad news on trade comes out.

Every sector fell on Tuesday. It was a broad-based decline. 3 worst sectors were the financials, technology, and healthcare. Tech stocks don’t like bad news on trade. Financials don’t like increasing rate cut odds. In yesterday’s article, I mentioned there was a 71% chance of a rate cut in October; now there is an 83.9% chance of a cut. I’m certain there will be a cut if the trade talks breakdown. 

A rate cut won’t be enough for stocks to avoid a correction. There is now a 44.6% chance the Fed cuts rates 2 more times this year. The 10-year yield is at 1.53% which is 10 basis points above its 2019 low. The 2-year yield is at 1.42%.

Every time healthcare stocks fall, it’s probably is related to Warren gaining in the polls. This is also partially why bank stocks have fallen. Latest Politico national poll that has Biden up by 12% showed a 1 point gain for Biden and no change for Warren. The latest Quinnipiac poll that has Warren up by 3% showed a 2 point gain for Warren and a 1 point gain for Biden. For the first time ever, Warren is leading in the average of recent polls. She’s up by 0.2%. 

S&P 500 Dividend Yield Higher Than Rates Is Bullish For Stocks

The chart below shows the S&P 500 compared with the S&P 500’s dividend yield minus the 10-year treasury yield. Because of the big decline in treasury yields, the S&P 500’s yield is much higher than it. Average 1-year and 3-year forward returns when the S&P 500’s dividend yield is this much higher than the 10-year Treasury yield are 13.6% and 11.7% per year. 

This situation is confusing because the 10-year yield has fallen because of weakening expectations for nominal GDP growth. Essentially, this suggests lower expectations for nominal growth mean higher stock prices. Clearly, this relationship isn’t guaranteed to continue, but it’s certainly worth watching.  

(Click on image to enlarge)