Analysis, Perspective, Trading Strategy
Trump’s Sunday Tariff Surprise May be a Game Changer for the Stock Market
By Joe Duarte on May 5, 2019
was reasonably positive on the stock market until mid-day Sunday based
on what seemed to be increasing upside momentum and subtle but hopeful changes
in the housing and restaurant sector which suggested consumers are resting
a bit easier at the moment. But after President Trump’s tariff threat against
China, we’ll have to see how things develop.
If there is a positive in all of this, especially if it turns out
that the rally is over after Trump’s remarks, the Federal Reserve is
not likely to raise interest rates this year, especially after the
recent purchasing managers and ISM data that show that the U.S. economy’s
growth rate is slowing, despite better than expected employment numbers.
This is especially important if the stock market enters a bearish phase
as it could mean that bonds become the momentum instrument of choice.
Of course, Mr. Powell might have been trying to herald his independence
and might have made his remarks bearish remarks after the Fed’s recent
meeting in response to President Trump and Vice President Pence’s call
for lower interest rates. Indeed, in hindsight, the remarks by the
president and the vice president seem a bit more loaded now after Sunday’s
announcement and the immediate sell off in the overnight futures. Moreover,
as the Fed and the White House sound off about monetary policy, the
real question for stock traders is whether there is still enough punch
in the bowl to keep bidding stocks up once the dust clears from this,
if it does.
The answer to what the Fed will do is yet unknown and thus much may
depend on what happens with the China trade talks in the next couple
of weeks, despite Trump’s remarks which could be a negotiating ploy,
as well as the general direction of upcoming economic data. Thus, if
after all is said and done, it is still plausible that if the White
House can come up with a credible enough deal with China, the market
rallies back, and the economy shows sign of stabilizing or picking
up slightly. In that scenario the Fed may have room to leave rates
unchanged and the headline reading algos would get the go ahead to
bid stocks higher.
However, if the China talks completely fail, which could happen as
early as this week since there are high level meetings scheduled later
in the week and the market continues to fall, investors would likely
look to the Fed for reassurances. This could be in the form of a statement
that the central bank will ease if needed, much as what we saw in late
2018 when the bear market reversed after the Fed made it clear that
its interest rate increases were on hold or even an outright, but highly
unlikely actual easing of rates. The down side is that if the Fed has
to come out to rescue the markets, they may be too late and the market
may not be listening anymore as everyone is rushing to the exits.
Hopeful Signs in Consumer Land
Given the tenuous macro landscape, it’s interesting to note that
up until Sunday, there were two market indicators that may be flashing
positive signals. Specifically, the action in the SPDR Homebuilders
ETF (NYSE: XHB) has been encouraging, behind better than expected news
from a smattering of homebuilders such as Lennar (LEN) and KB Homes
(KB), two homebuilder stocks near their 52 week highs.
Anyone who follows the housing market is familiar with the way the
sales figures and mortgage applications numbers have fluctuated in
response to interest rates over the past few years. Indeed, when rates
start to fall mortgage activity picks up, often with refinancing leading
the way. On the flip side, when rates rise, the housing market stalls
and refinancing dries up. Note the inverse correlation between the
U.S. Ten Year note yield (TNX) and XHB in the nearby charts. Perhaps
the most positive aspect of these charts is the failure of TNX to remain
above 2.5 percent this past week, and its subsequent reversal to the
down side. That suggests that the bond market is not worried about
inflation and considers the Federal Reserve as currently being all
Fundamentally, stock prices have responded positively
to better than expected corporate earnings and forward guidance of
late throughout the market. Specifically, consider the message from
the restaurant sector, an indirect measure of disposable income and
consumer confidence, where Ruth’s Hospitality Group (RUTH) recently
met its earnings expectations on rising revenues and the stock rallied
after a lengthy consolidation.
I recommended RUTH in February and the stock is
up nearly 15 percent since then. Accordingly, the key metric for RUTH
was a rise the amount of money spent per ticket by its customers. That’s
a sign that people are spending money with a bit less fear than in
the recent past. In fact, restaurant traffic in my neck of the woods,
Dallas has been very steady of late, which is something rare during
periods of rising gasoline prices which we’ve seen recently.
The Market’s Holy Trinity
So, here is why all this matters; consumers, because much their net
worth is now based on the fortunes of their 401(k) plans and the value
of their homes, are very much in tune to the daily changes in the stock
market and the effects on their investments when the Federal Reserve
acts. Moreover, it’s hard to ignore Trump’s tweets and the effects
they have on the markets and the general state of affairs.
The markets, and the algos up until Sunday, were in tune with this
dynamic and were betting that we are in an economic climate where consumers
are starting to feel fairly good about life and will continue to spend,
thus continuing the trend toward higher corporate revenues and earnings.
Because of this somewhat fragile connection between real life and
the financial markets, if the Fed turns hawkish and the bond and stock
markets hiccup, as they might after Trump’s Sunday surprise consumers
could get spooked, start to pull back on their spending, and set off
a negative chain reaction similar to what we saw in Q4 2018. That seems
to be less likely at the moment than the bears expect. But there are
no guarantees, so it pays to continue to monitor this situation.
Momentum was behind Stocks
The New York Stock Exchange Advance Decline line (NYAD) powered higher
to end last week, and remains the most accurate indicator of the stock
market’s trend since the 2016 presidential election. Unfortunately
the line moved outside its upper Bollinger Band on Friday which means
that momentum might have been getting unsustainable in the short term.
That one factor could mean that the down side risks, now that Trump
hit the skids on trade with China, might increase rapidly.
Meanwhile the S & P 500 (SPX) and the Nasdaq 100 (NDX) indexes
were within a hair’s breadth of their all time highs. This is likely
to change rapidly in the short term.
Internally, both indexes were sporting supportive
Accumulation Distribution (ADI), On Balance Volume (OBV) and ROC, which
measures momentum. The unifying feature is that all three oscillators
recovered from the prior week’s weakness, which was a hopeful sign
before the events on Sunday.
So for now, all we know is that last week was a good week but that
the new week will be very volatile.
Staying with the plan
The macro landscape might have changed and the stock market which
was being pushed higher by momentum trading algos based on the headlines
now looks set to take a fall, at least in the short term. The dips
were being bought. The market was making new highs. And the rally seemed
to have some legs. But now that may all have changed.
As a result, all we can do is to let the market get us out of positions
via our sell stops and wait to see what happens with the Holy Trinity.
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Joe Duarte has been an active trader and widely recognized stock
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