Are Trade War Fears A Ticking Time Bomb For The Market?
/Last week was anything but boring.
U.S. stocks fell nearly -6% as trade war fears swelled and the Federal Reserve ushered in a new chairman. The sell-off started following the decision by the Fed to raise short-term interest rates.
Interest rates rising: The Fed increased the Federal Funds rate from 1.50% to 1.75%. This is the target lending rate that banks use to borrow money from one another in short stints (emphasis on short-term). It is the sixth rate hike since the Fed started increasing them back in Dec. 2015.
This was the first Fed committee meeting led by new Chair Jerome Powell, who recently replaced Janet Yellen. I liked his communication style regarding Fed policy, as he was more direct and less academic than Yellen or her predecessor, Ben Bernanke. But it remains to be seen whether the Fed's current aggressive approach to raising rates is the wisest path. Powell indicated there will be three more interest rate hikes in 2018, which sounds unrealistic to me if the stock market remains volatile.
Trade war looming? Meanwhile, President Trump placed tariffs on certain Chinese imports as retaliation for what has been deemed intellectual property theft. This comes two weeks after he issued tariffs on steel and aluminum imports from certain countries. This has led to fears of a global trade war - particularly between the U.S. and China - the two largest economies by a wide margin. Here are the five biggest economies based on gross domestic product (per the International Monetary Fund):
- United States: $19.4 trillion GDP
- China - $11.9 trillion GDP
- Japan - $4.9 trillion GDP
- Germany - $3.7 trillion GDP
- France - $2.6 trillion GDP
(GDP = value of all goods and services produced annually)
Actual tariffs or smoke and mirrors? There is one detail worth pointing out... the tariffs on steel and aluminum won't actually go into effect on the countries that matter until May 1st. Also, the Chinese tariffs effectively have a two-week grace period while the Trump administration announces which Chinese exports will be affected. So a lot can, and likely will, change. Until the tariffs actually go into effect, I can't view this as much more than a power-play for trade negotiations or political purposes.
When Fed Chair Powell was asked about the impact of tariffs and a potential trade war, he seemed relatively unconcerned. Powell said that it would not impact current conditions but that some Fed members voiced concern about the future impact. Huh? That makes no sense, but then again, maybe he knows something we don't. Perhaps he does not expect the tariffs to happen. Nonetheless, the prospect of tariffs and trade wars would have widespread implications should they take hold.
In The Market...
The S&P 500 fell -5.9% this past week. Let's look under the hood:
(source: stockcharts.com)
There is not much to say about last week's sector performance, other than it was bad. As we would expect, growth sectors like Technology and Financials got hit much harder than the likes of Utilities. Last week looked very similar to the stretch in early February when U.S. stocks fell -10% in the matter of a 10 days. The overall market finds itself in a familiar spot, with the S&P 500 finishing at almost an identical low and sitting right above its 200-day moving average. Take a look:
(created in stockcharts.com)
Notice how similar the two points in time are. The 200-day moving average is a pivotal threshold today as it was in February. We want the S&P index to hold above that pink line. We figured it would be a bumpy ride, but if the S&P breaks below the 200-day moving average it would likely set off a wave of additional selling among investors.
Reasons for optimism: Stocks have fallen -7% in the past two weeks, but two weeks does not make a trend. Until that February price-low is broken, which coincidentally means falling below the 200-day moving average as well, benefit of the doubt goes to the bull market.
Reasons for concern: Some of the momentum indicators we use in tandem with price movements are weakening. Relative Strength, which is the smaller chart above the price chart above, has fallen back to 30.0 level that presents serious risk. Also, only half of the stock prices that comprise the S&P 500 index are above their respective 200-day moving average prices. It is the lowest ratio of companies trading above their 200-day averages since March 2016. As mentioned already, if that worsens much more the bottom could fall out pretty quickly.
In Our Portfolios...
In Financial Planning...
This may be a good time to remind everyone that situations like this present an opportunity to invest during a market dip, provided you have a long-term time horizon in mind. If you are of the mindset like I am, which is that the market will rise in the long run, then these situations offer a chance to do things such as:
- Increase your 401k contribution
- Invest excess savings
- Make a lump-sum contribution into a 529 college savings plan
- Max-out your IRA contribution for the year (if eligible)
You might have to sit through an uncomfortable period should the market decline further, but eventually it will pay off if 100+ years of market history provides any proof.
What's New With Us?
In light of the past few days, I spent much of the weekend digging into the market and prepping for the week ahead. That is, when I wasn't recovering from the food poisoning I got at an event we attended on Saturday. All better now though!
Have a great week,
Brian E Betz, CFP®
Principal