Analysis, Perspective, Trading Strategy
The U.S. - China Trade War and the 5G Dynamic Rallies Stocks and Sinks Bonds
By Joe Duarte on September 8, 2019
can talk ourselves into just about anything these days, but Wall Street
got a post Labor-Day jolt as the geopolitical situation eased some regarding
Hong Kong and Brexit while the U.S.-China trade talk shifted away from sanctions
with a bilateral promise of October talks. The upshot was a huge two day rally
in technology stocks coupled with a major selloff in the bond market and bond
proxies such as REITS, homebuilders, and dividend stocks. By Friday, however,
after the muted U.S. payroll number, traders paused, and by the weekend, Hong
Kong and Brexit were heating up again, so by the middle of the week, things
may be up in the air again.
Nevertheless as I noted over the last two weeks, the stock market
was due for a surprise move of some sort although the direction was
unknown. Certainly the action on 9/4 and 9/5/19 qualifies for, at least
the early part of that move being to the up side as the bears, overwhelmed
by algo fueled program buying in the futures market had to scramble
and cover their shorts. The big questions now are whether this rally
has any staying power and whether, or more likely how much the Fed
decides to lower interest rates at its upcoming FOMC meeting even in
the face of the stock market being within reach of its all time highs,
and whether China’s recent cut in reserve requirements will generate
Realistically speaking however, investors are caught between a market
where momentum may have returned, at least in the short to intermediate
term, and the reality that neither the U.S. nor China seem to be willing
to give in to the other’s demands on trade or anything else. So what
it all boils down to is that unless there is something much bigger
unfolding under the surface the odds of yet another disappointment
are higher than most would think.
Still it is possible that we may be seeing the early innings of a
sector rotation away from the defensive stocks and into aggressive
It’s Still about Bonds, the Fed, and MEL
Stock investors certainly got some good price moves despite, or perhaps
because of mixed U.S. economic data (PMI manufacturing and services)
but the Fed and the bond market are still in charge. So before making
big portfolio moves it’s important to consider what the effect of the
somewhat stabilizing but not highly encouraging global economic data
will be on the Fed’s next move and how the bond market responds. Moreover,
it’s all about how the whole thing is perceived by investors, how it
is reported by the media and how it affects the Markets-Economy-Life
system (MEL) as investors and consumers process the data and make decisions
about whether to spend their money or to keep their hands in their
Unfortunately housing has remained very subdued despite the record
low yield on the U.S. Ten Year note (TNX), the benchmark for 15 and
30 year mortgages. Thus, if there is a big backup in yields it’s not
likely that this sector will improve in the near future, and that could
be a further drag on the manufacturing economy.
Perhaps the most interesting event in the markets last week was the
rebound of German bond yields above
0.00% for the first time in months, although the bond selloff didn’t
last and by the end of the week yields were again falling. Nevertheless,
wouldn’t it be something to see if the Fed lowers interest rates and
the bond market sells off in a big way leading to higher market yields
which would negate the effects of the central bank rate cuts?
Chip Stocks Regain their Mojo but 5G and China Hold the Key
Long a casualty of the U.S.-China trade war, the semiconductor stocks
were languishing until the news of the renewal of trade talks hit the
wires and the sector got a bid. Moreover, regardless of where we are
in the cycle for the financial markets, one thing is crystal clear;
the stock market is in love with the idea that 5G is the next big money
maker. In fact, traders seem to dig the concept so much that any news
that suggests that somehow Huawei and the U.S. chip makers will be
back in business soon sends tech stocks rapidly higher.
As a result, two chip stocks in particular gathered momentum on 9/4
and 9/5, foundry giant KLA Corp. (KLAC) and Teradyne (TER) a leader
in semiconductor testing equipment. Certainly, both KLAC and Teradyne
produce and manage electronic components and processes which should
profit nicely from the deployment of 5G technology over the next few
years, if and when that comes to pass and to a certain degree whether
Huawei is involved or not. But algo sub routines, the what to do if
this happens parts of trading programs, are not known for their sophistication,
given their only two programming choices, 0 and 1. So anything that
sounds as if Huawei is out of the dog house sends tech stocks higher.
KLAC’s forte is providing equipment for quality controls, including
data analytics and inspection products to reduce errors in the chip
manufacturing process while also producing display related products
and water processing solutions, printed circuit boards and related
products, which gives the company a well diversified product portfolio
well suited to any upturn in the semiconductor cycle.
Teradyne shares, for their own have been consolidating
after a very upbeat earnings report released in July. And although
the stock got ahead of itself after the good news, shares look ready
to resume their uptrend barring the usual external event risk related
to the U.S.-China trade war if they can clear the current resistance
near the $56-$58 area.
Both KLAC and TER are banking on increased revenues and earnings
related to the expected 5G rollout over the next few years, which means
that if and when that dynamic really rolls, these stocks should respond
Indeed, what brings the two together is the global 5G rollout, which
of course, in the short term is highly dependent on the U.S.-China
trade war. And while Nokia (NOK) and Ericsson (ERIC) are Huawei’s competitors
in 5G, they don’t have the scale to compete in a major way. As a result,
any developments with regard to 5G will require an answer to what the
U.S. and to some degree the rest of the world decide with regard to
In other words, if and when the U.S. and China agree on their trade
issues, the next big shoe to drop is to what degree the alleged spying
issues involving Huawei are settled and whether Teradyne and KLAC can
resume their rapid pace of sales to them over the next few years. Otherwise,
much depends on how much of Huawei’s market share can be picked up
by Nokia, Ericsson and any new players that decide to jump into the
field and what type of sales they can generate from companies such
as KLAC and TER. Accordingly, the fact that both NOK and ERIC are essentially
in the penny stock price range these days suggests that the market
is making a big bet on Huawei coming out a winner in October.
I recommended both KLAC and TER in the late August-September time
frame, and suggest opening small positions with sell stops to guard
against trade war related volatility.
Market Breadth Regains Strength
The bright spot in the stock market is the New York Stock Exchange
Advance-Decline line (NYAD), the most accurate indicator of the general
market trend since the 2016 presidential election, which soared to
several new highs on the U.S.-China trade news.
Moreover, the Nasdaq 100 (NDX) and the S & P 500 (SPX) indexes
both rallied above their 50-day moving averages. Certainly, neither
index is too far from breaking out to new highs, which means that if
there is a breakout, money will likely flow in and extend the rally.
However, if the rally fails the likelihood of a rapid return to selling
However, Accumulation Distribution (ADI) and On Balance Volume (OBV)
for NDX rolled over by the end of the week while holding up better
on SPX, which suggests that tech traders are still cautious.
Trade Accordingly. Avoid the Kool-Aid
It’s hard to know if the U.S.-China talks in October will be meaningful
or not. It’s even harder to fathom what will happen between the U.S.
government and Huawei, as the former has alleged that the latter embeds
spyware into the chips its sells and hints at national security repercussions
from the practice.
What we do now is that stocks were poised for a big move and that
the action on 9/4 and 9/5 suggests that the move has started and that
its direction is to the up side, barring a litany of things that could
go wrong. In the end all we can do is trade accordingly without drinking
totally bullish or insanely bearish Kool-Aid.
Joe Duarte has been an active trader and widely recognized stock
market analyst since 1987. He is author of Trading
Options for Dummies, rated a TOP
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