Broker Check

New Trade War Anxieties Lead to Increased Volatility

August 12, 2019
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Monday Morning QB – Market Observations:

Volatility Returns to the Stock Market as a China/U.S. Trade Deal Takes a Major Hit
Monday’s Trade War Escalations from both the U.S. and China Lead to the First 3% plus Market Decline of 2019
Turnaround Tuesday takes Away Some Investor Pain
Currency Manipulation Becomes the New Battleground of the Trade War
If You Invest for Yield Better Buy Stocks

Monday Morning QB – Market Performance:

Volatility was the outcome of growing trade tensions between the world’s two most important economies. The major indexes suffered their worst day of the year at the beginning of the week as China let its currency fall below the key symbolic threshold of 7 Yuan to 1 U.S. dollar that has stood over the past decade.

In addition, the Chicago Board Options Exchange Volatility Index (VIX) hit its highest level since late last year. But a big turnaround on Tuesday and Thursday of almost 1,000 Dow points gave some hope that the storm had calmed.

The Dow Jones Industrial Average retreated 197 points, or -0.75%, to end the week at 26,287. The technology-heavy NASDAQ Composite fell to 7,959 or -0.6%.

By market cap, large caps fared the best with the S&P 500 giving up just 0.5%, while the S&P mid-cap 400 and small-cap Russell 2000 lost 0.7% and 1.3%, respectively.

Volatility Began with the China Driven Monday Sell Off – China Lets the Yuan Depreciate

The retaliation for the U.S. threat of additional tariffs of 10% on Chinese goods did not take long.

The Chinese will suspend purchases of all U.S. agricultural products as well as allow the Chinese currency (Yuan) to decline below a level against the dollar that has not been breached since the Financial Crisis (2008).

The “Red Line” was 7 Yuan to 1 Dollar. In the past, China had previously stepped in to support the currency before reaching the 7:1 level.

The reaction from the U.S. stock markets was immediate and swift.

  • Dow dropped 2.90% (767 points) – closed at 25,717
  • S&P 500 dropped 2.98% (87.31 points) – closed at 2,844
  • Nasdaq dropped 3.47% (278 points) – closed at 7,726

Adding to the Volatility, the U.S. Officially Labels China a “Currency Manipulator”

For the first time since 1994, the U.S. Government has officially labeled the Chinese as a “currency manipulator”.

The Trump Administration has long complained that the effect of the tariffs has been lessened by the Chinese lowering the value of the Yuan against the dollar. This action by the Chinese makes Chinese goods cheaper on the global markets.

The “currency manipulator” label does not mean much. It’s like calling a bully a “bully”. Being called a bully is not likely to change the behavior of the bully.

Being called a “currency manipulator,” from everything I have read, is a largely symbolic gesture but with the potential to aggravate the situation.

The expectation from the investment community going into Tuesday was, “Hold on. Things are about to get a lot worse!”

Volatility Continues on Turnaround Tuesday – China Instills a Sense of Calm about the Yuan, At Least for Now!

In the governmental game of chicken, it would be the Chinese who blinked first.

The Chinese Central Bankers gave the market a needed lift after Monday’s sell-off. China’s central bank chose to stop the Yuan from continuing to depreciate against the dollar.

The setting of the Yuan at a less aggressive level against the dollar was largely seen as a sign that the Chinese were trying to avoid further escalating the already contentious relationship with the U.S.

Well, at least for the rest of the week anyway.

The action by the Central Bank of China created an investment roll coaster ride for the week. We got on the ride Monday with an extreme drop, followed by a nice upswing Tuesday and Thursday. The S&P 500 finished the week down less than a half percent.

We got off the investment roller-coaster ride at almost the same place we started.

Volatility Returns Just in Time for the “Weak” Season

The back and forth jabs from both the U.S. and China threaten the very agreement that most of us assumed would occur.

The belief that a deal was inevitable helped markets advance to new highs in 2019. This past week’s action seemed to thwart even the best intentions of a deal.

With the guarantee of a deal all but faded, the markets will likely be swayed by whatever trade news dominates the day, especially since the next potential trade meeting will not occur until September.

Good news brings the market up and bad news sends it down.

August and September have a history of being volatile months, so hang on- it’s likely to be a bumpy ride.

The Yield Problem – How do Investors Create Income in the Current Volatile Investment Environment?

For investors whose priority is the yield (the income produced by an investment), a precarious dilemma has re-occurred after last week’s market action.

Yield investors typically buy bonds because they pay more interest than stocks. The riskier the bond is the higher the yield.

For the reason of safety, income-chasing investors prefer longer-term government bonds versus stocks or riskier higher-yielding bonds.

However, the yield on the 10-year Treasury note fell below the average yield of the stocks that make up the S&P 500.

I believe this has now occurred 8 times in the history of the stock market. That makes this a rare occurrence. Except it’s not!

All 8 times have occurred after the “Great Recession” of 2008-2009.

For those who argue that the Fed’s “Quantitative Easing” experiment has had little unintended consequences, they only need to look at this relatively new yield phenomenon. The effect on bond investors is potentially disastrous.

Bond investors are forced to give up the security of knowing that their investment dollars will be returned at the maturity of the bond against the potential of getting less money from a bad stock choice- a bad stock choice that still paid a good dividend.

The new term being floated to these bond investors is “Quality” stocks. Stocks are volatile no matter what the quality.

The cost of building wealth is volatility.

This is a lesson bond investors buying stocks should not forget. Enron was a “Quality” stock until it wasn’t!

(sources: all index return data from Yahoo Finance; Reuters, Barron’s, Wall St Journal, Bloomberg.com, ft.com, guggenheimpartners.com, zerohedge.com, ritholtz.com, markit.com, financialpost.com, Eurostat, Statistics Canada, Yahoo! Finance, www.stocksandnews.com, www.chaikinanalytics.com Chaikin Analytics, www.marketwatch.com, www.BBC.com, www.361capital.com, www.pensionpartners.com, www.cnbc.com, www.FactSet.com, W E Sherman & Co, LLC)
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