Pending Market Boom Held Hostage by Trade War Risk

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Originally posted at ExecSpec.net

The relentless 14-month rally in global stock markets that peaked in January 2018 has been followed by a 13% correction over the past 3 months that will remain static to lower until the trade tantrum on tariffs is resolved. We have seen first hand and globally the torrid pace of rising new order flows in manufacturing stagnate in March and April as business uncertainty grows over Trump’s trade policy. With today’s decision on potential tariffs on European and NAFTA partners delayed until June, we can assume economic growth will run in a lower gear for at least a couple more months. The longer this modest paralysis lingers, the more companies will lower guidance on next quarter of earnings reports due in July. The current earnings season has reached a record 80% of companies beating estimates. Such optimism will need tapering in the weeks ahead, putting stock market multiples at risk. With stocks stagnating despite great earnings, prices become vulnerable to weaker earnings surprises next quarter and even risk a short-term panic should any country fail to reach a compromise with US trade demands.

spx earnings surprises

Technically, the markets have behaved well in this correction with breadth, as measured by the advance-decline line, reaching new highs at each of the lower price peaks in the stock market. This positive underpinning to stocks is being dominated by a plethora of tech giants and smaller cloud- based software companies in the rapid adoption phase of their growth cycles.

spx advance decline line

Small investor sentiment in early April reached the most oversold level in almost a year and helped propel stocks higher in April. 

aaii investor sentiment

As we illustrate below, more deeply negative sentiment is typical during large double-digit corrections and are almost a certainty should the trade war escalate. Any break below the April lows in stock indices should send negative sentiment down to the “medium”-term oversold levels and a bargain entry for investors as the recession word will start to proliferate. Any move above the April high of Dow 24,859 would be a strong sign of a favorable trade negotiation and rebounding sentiment.

aaii bull bear spread

Caveat emptor: Failure to reach trade agreements with Europe and China this summer will send world stock markets to new multi-month lows. Risk is for the Dow to reach the 21,000 to 22,000 range and the S&P 500 to move into 2150 – 2400. This buyer beware warning label has a multiplier risk as a trade war resolution is required this summer to avoid a GOP defeat in the November elections and ensuing political/financial chaos. While many of the tech and banking stocks we favor have continued to test or reach new record highs in April, the odds of the major indices breaking below the recent 3 month corrective trading range are growing as any potential trade outcome is delayed yet another month. On the flip side, any trade resolution reached with global powers will trigger the economy to regain momentum and increase the odds of the GOP retaining political control. This higher odds outcome would be a shot of adrenaline for stocks that could send the Dow up to the 28,000 to 30,000 zone as the global economy reverses the building uncertainty.

dow weekly

The longer term backdrop for the economy and stocks are positive with exceptionally strong earnings, historic fiscal stimulus, 11-year record wage growth, unemployment at 17-year lows and enormous record sideline cash from financial firms seeking companies to purchase. The trade wars are the primary impediment increasingly weighing upon markets, stalling the pent up re-acceleration of the global economy and equity trends. We know Trump’s need for popularity favors a compromise and positive resolution over the portending trade wars well before the November election. The current correction to date is merely the pause that refreshes, but any Trumpian missteps will be costly for investors and a unique buying opportunity should Trump garner the perceived trade victory agreements he seeks.

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