I awoke early this morning (around 5am) to find the Dow Jones Industrials down more than 400 points with an hour of trading left. That’s not good. What’s going on?
I’ll let The Wall Street Journal explain:
‘U.S. stocks tumbled Monday, heading for their biggest one-day slide in months, as fresh escalations in the global trade conflict sent investors fleeing from some of the market’s most-beloved technology firms.
‘Fresh jabs between the White House and China exacerbated investor fears about a full-blown trade war. President Donald Trump is moving to bar Chinese companies from investing in U.S. tech firms and block additional tech exports to the country, in his latest effort to pressure Beijing. Chinese President Xi Jinping told a group of multinational chief executives that Beijing would “punch back”.’
Why are tech stocks immune from a global slowdown?
With the focus on tech stocks, the NASDAQ is under pressure, down nearly 2.5%. In recent months, tech stocks have been a safe haven amid concerns about a slowing global economy, exacerbated by the prospect of a trade war.
It’s not clear to me why tech stocks would be immune from a global slowdown, especially given the stretched valuations in the sector. But that’s how the market saw it and the NASDAQ went on to new highs in recent weeks while other markets struggled.
According to The Wall Street Journal, tech firms actually generate nearly 60% of their revenue from overseas, making them highly vulnerable to trade sanctions if the trade war does escalate.
This is where things start to get interesting.
I often say that narratives drive the market. A narrative is what everyone believes everyone believes. One of the narratives of the trade war is that Trump is bluffing. Everyone knows that everyone knows that Trump starts with a big outrageous claim to kick negotiations off, only to scale back demands to make the other party feel like they have ‘won’.
This narrative has ensured that the market hasn’t been too concerned about the impact of a trade war, coming at a time when the current US bull market is the second longest in history.
But…this narrative is now suffering a little fatigue. From the Financial Review:
‘Harley-Davidson said in a regulatory filing that it will shift some production overseas in order to limit the impact of the rising tit-for-tat tariffs triggered by the Trump administration that represent a threat to future sales.
‘It was a tweet the previous day from President Donald Trump that triggered a global bout of trade-war rhetoric rethinking.
‘In a morning post, Horizon Investments Greg Valliere said his earlier expectation was that the initial flurry of trade disputes would eventually get resolved, “that Trump was bluffing with extreme demands that eventually would lead to compromises. Now we’re not so sure.”
‘“Europe almost certainly will retaliate against auto tariffs, NAFTA is on very thin ice, and now a serious US-China trade war looms,” Mr Valliere said. “We still think some US trading partners will cry uncle, but that doesn’t look imminent.”’
What’s the real story behind the bull market?
There are a few things to note here.
First, the trade biffo is designed to preserve American jobs, not destroy them. The announcement to move some production offshore, by an iconic US brand like Harley Davidson, will not go down well for the ‘benign trade war’ narrative.
Second, the thoughts of Horizon Investments’ Greg Valliere sum up the change in mood. It doesn’t really matter than no one knows who he is. It represents a change in thinking. The trade war may have just turned from phony to real.
The reality of the situation is that Trump and his nationalist trade advisers want to reduce the US trade deficit. If they achieve this outcome, it will shrink global liquidity. The fact that it’s happening at a time when the Fed is also removing liquidity from the system makes it that much riskier.
And, as I mentioned, this bull market is the second longest in history. That tells you the upside from here comes with much more risk. The market narrative may be in the process of realising this now.
While you haven’t seen these risks priced in in US markets just yet (as I write, late buying took the Dow off its lows for the day) they are certainly showing up in the more sensitive emerging markets.
The chart below shows the ishares MSCI Emerging Markets ETF [AMEX:EEM] over the last two years. Last week, it broke below support at $45 to the lowest level since August last year. It now looks to be stuck in a downward trend.
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Emerging markets are in many ways the canary in the coalmine for the global economic cycle. They are a measure of global risk appetite. When times are good, capital flows into these markets looking for big returns.
But when the cycle turns, capital flows out, looking to escape the downside. Based on this chart, the global economic cycle peaked in late 2017/early 2018.
From here, it remains to be seen whether developed markets like the US and Australia will follow the leader lower.
Editor, Crisis & Opportunity