Stocks Anticipate China Trade Deal and Stronger GDP

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The stock market discounts future expectations. The roaring rally of the past 14 weeks cast aside recession ruminations and increasingly anticipates an economic rebound coincident with an important trade agreement with China. The benchmark S&P 500 Index of stocks just completed its best quarterly gain since 2009 and the best first quarter of a year since 1998. With 12 of the first 14 weeks of 2019 witnessing new weekly highs and no corrections beyond three percent traders are betting big on short volatility and higher stock prices as they did at the 2018 peak.

This frothy market may be so strong that investor sentiment is neutralized between buyers and skeptical investors that need a correction to open their wallets. Option traders are not increasing their optimistic call buying in recent weeks, small trader sentiment and fear gauges are also far from extreme euphoria. Is another climax peak in stocks imminent? The old adage is ‘buy the rumor and sell the news.’ Should this next leg pop above its record 2940’s peak in the S&P Index, there should be a longer and deeper correction to follow. Like the 2017 pattern, 2019 should exhibit the biggest equity appreciation prior to the realization of a global economic rebound in the second half of the year.

The closer stocks rise toward their 2018 highs, the stronger the magnetic pull ensuring prices will reach and exceed their previous records above 2941 on the SP 500 Index (26,951 basis the Dow). The minor pullback low the final week of March near 2800 SP is unlikely to be tested again, until the index tests its 2018 bull market peak. A break of this minor support just under S&P 2800 would turn the short-term trend lower.

The more narrow Dow Industrial Average lagged the tech heavy Nasdaq and broad based SP 500 Index, yet it also appears primed for a run to test its old highs near 27,000. While a break of minor support under 25,300 is unlikely before a major top arrives, a break of this level would turn the trend lower.

Tech has led the way in a bull market that has lacked the long expected rotation into industrial, cyclical and emerging markets. Tech-heavy Nasdaq is where the growth is as long as the bull market is healthy, and it will also be the most devastated when a recession arrives. Like the S&P and other major indices, the Nasdaq is drawn like a moth to the flame toward its 2018 record high. After such a record setting pace of stock appreciation in 2019, most will expect a strong pullback once the old highs above 7700 are tested. The unexpected would be for this climax rally phase to blow past the old highs before a serious five to 10+ percent correction kicks in.

We’ve eluded to a coming cyclical and emerging market shift for investment opportunities once the global lows were in and a China trade deal with the U.S. was imminent. Most emerging market indices are priced where they were in 2014 or 2013 while the U.S. and the world have soared higher. Being tethered to commodity markets such as agriculture and other commodities, emerging markets tasted some success in 2017 as synchronous global growth demand pulled them out of severe recessions. Emerging market stocks are still struggling but have lifted off their major 2018 lows thanks to the coattails of the U.S. and China market gains.

The real jackpot for Brazil, Mexico, China and others will be the end of tariff restrained global exports and renewed optimism for capital spending once an historic agreement with China is confirmed. While the U.S. and major country indices may have discounted much of the 2019 rebound already prior to a trade announcement, emerging markets and cyclical stocks should finally out perform in the aftermath.

While not a stock index, the bond market along with the dollar and oil have all played major roles in our record-setting stock market performance. When the Fed fell behind the curve of economic weakness and mistakenly ramped up the pace of current and expected rate hikes in late 2018, the 10-year note surged to 3.2 percent sending stocks into an overdue but heart pounding 20 percent dive. Since then the Fed has made clear its accommodative intentions until economic acceleration returned which allowed our 10-year yield to fall to 2.4 percent in late March. Our assumption is the economy will continue to rebound from a first and second quarter nadir and push interest rates higher (bond prices lower) for the remainder of 2019.

The hyper-focus on a U.S. trade agreement with China hints of renewed volatility once the rumor becomes verified news. The tea leaves we read indicate the long-awaited deal is weeks, not months away. Stocks should maintain a safe floor of two to four percent below each new high until Trump signs a trade deal. Like magnets, the closer indices are to their record peaks, the stronger the ferromagnetic attraction becomes. A test of record highs may arrive before an agreement is confirmed and a blow off to loftier levels may follow but look for a post-news five to 10 percent let-down within weeks after the ink is dry.

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