3 Overlooked Points in the U.S.-China Trade Debate

Stocks fitfully gained ground Thursday in an exceptionally dull set of sessions boosted by pretty good earnings reports from Netflix (NFLX) and Morgan Stanley (MS) as well as a tentative Brexit deal.

This has to be one of the least interesting reporting seasons of all time as a toxic cloud of politics, impeachment, trade war, weak data and betrayal weighs on investors’ usual rapacity.

Around 15% of S&P 500 companies have reported results so far and numbers are mostly coming in ahead of analysts’ expectations. But it does not seem ready to move the dial, as some of the better earnings reporters are opening on a gap up and then backing off the rest of the session, with little follow-through.

Topping the new high list were:

• Home Depot (HD) …

• Nike (NKE) …

• Charter Comm (CHTR) …

• Dominion Energy (D) …

• Target (TGT) …

• Prologis (PLD) …

• Ross Stores (ROST) …

• Digital Realty Trust (DLR) …

• McKesson (MCK), and …

• PPG Industries (PPG), which is interesting as few other industrials are hitting the list.

It’s still a basket of cats and dogs, though it’s nice to see Home Depot and Nike providing some leadership.

Data from the U.S. Department of Commerce this week showed that retail sales slipped 0.3% in September, missing the expectations of economists.

This fueled fears about growth in the U.S. and overseas. The International Monetary Fund this week cut its global GDP forecast for 2019 to just 3% — its lowest level since the 2008 financial crisis — citing trade tensions and geopolitics. It projected 3.4% growth in 2020.

Parsimonious Participation

The S&P 500 is now within a stone’s throw of its all-time high, but relatively few stocks are participating in the advance. According to analyst Jason Goepfert of SentimenTrader.com, among all common stocks trading on the New York Stock Exchange, fewer than 50% have moved above their 200-day averages.

During a stretch when the S&P 500 has climbed to within 1% of a former high, this is an abnormally low figure. On average, 63% of NYSE stocks are in bull markets when the S&P nears an old high.

To discover what has happened next in similar conditions, Goepfert riffed his database to look at times when the S&P 500 is within 1% of a new high for the first time in three weeks and less than 50% of stocks are over their 200-day averages.

This has happened 10 times since 1994. On average, the following week was been flat. And so were the following month, and the two months after that.

The next three months averaged a 1.3% gain, the next six months a 4% gain and the next year a 2% gain, which is all pretty crummy.

Some bad news: The one-year results are brought down heavily by the serious forward weakness (-21% and -24.5%) of two horrible congruent instances: March 16, 2000, and Oct. 1, 2007. Both of those turned out to be highs just ahead of two-year bear markets.

As canine analyst Scooby-Doo would say: “Ruh-roh”.

3 Points Overlooked in the U.S.-China Trade Debate

On top of these troubling averages, the U.S.-China trade deal is still playing jump rope with the markets.

Over the course of the previous week, an announcement that some U.S. companies would be given permission to do business with Chinese telecom giant Huawei renewed investor’s spirits and saw the market rise. Meanwhile, news of the U.S. adding an additional 28 Chinese companies to their blacklist sent the markets spiraling.

Then, President Trump announced last Thursday that a “phase one” trade deal had been struck, giving hope that this rollercoaster would finally be over.

I received the latest client letter from Neil Shearing, chief economist at Capital Economics. It was insightful as always. And he noticed three critical points that were overlooked in the excitement of a potential end to the trade war.

First is the fact that, while President Trump announced a “phase one deal”, the terms of the agreement are unspecified.

General terms have been agreed to: China will step up its purchases of U.S. agricultural goods and the U.S. has agreed to postpone tariffs that were due to come into force this week.

But specifics were never agreed to. Questions remain now over how much China will have to buy, how many tariffs the U.S. must agree to lift and the time frame by which this first phase must be completed.

More fundamentally concerning is the fact is that this first phase only covers solving basic issues. Larger issues over IP ownership, technology transfers and daily concerns U.S. companies have doing business in China aren’t addressed. Worse, there’s no clear path to a “phase two” deal that would cover these.

Second, it should be noted that policymakers (and most economists) are probably overplaying the economic effects of the trade war so far.

Federal Reserve Chairman Jerome Powell made an oblique reference to the trade war in a speech last Tuesday. And it’s become increasingly common for central banks to cite it as a key drag on growth over the past six months.

While the trade war has clearly impeded economic growth, it is only one of several factors weighing on the global economy.

Third is that — despite what the headlines say — the dispute over trade and tariffs is actually something of a sideshow. In the background, a much bigger issue is playing out: China’s rapid rise is starting to destabilize the global order.

This is being felt in areas beyond just trade and tariffs. Last week saw:

• A decision by the U.S. Department of Commerce to blacklist several Chinese firms over human rights violations …

• A decision by the State Department to impose visa restrictions on several Chinese officials — a threat (later walked back) to limit the ability of Chinese firms to list in the U.S., and …

• A spat between the NBA and China over the Hong Kong protests.

By themselves, these are relatively minor issues. Which is why they haven’t gotten much attention as the trade debate. But taken together, they represent a slow and steady shift towards a more antagonistic relationship between the U.S. and China.

Shearing added this in the letter he sent to me:

One plausible outcome is that aspects of the global economy start to splinter into U.S.- and Chinese-led spheres.

While this will play out over years and decades rather than months and quarters, it has the potential to cause much greater damage to the global economy than the current trade dispute.

The U.S. still plans to impose new 15% tariffs on $156 billion in consumer goods starting Dec. 15, and it is unclear how that will affect negotiations going forward.

Add to that the uncertainty surrounding current central bank policies, and you have all the ingredient to make planning ahead a herculean task for companies and investors.

So for now, sit tight and stay vigilant.

Best wishes,

Jon D. Markman