Divergence and Trade Wars: July Market Update

Divergence and Trade Wars: July Market Update


By: Guy Adami, Director, Advisor Advocacy
Published July 25, 2018

In the July market update call with Guy Adami, Dr. Alicia Levine of BNY Mellon Investment Management joined us to provide insightful market commentary. In her position as Head of Global Investment Strategies, she is an expert at synthesizing and translating concepts into actionable strategies and portfolio positioning decisions for all asset classes.

Looking back at early 2018, we remember seeing tremendous synchronous global growth, with equity markets at all time highs. Not only were emerging markets strong, Europe was strong and the U.S. market continued to move to new highs. There was an upward spiral for markets, economies, and consumers…but what happened? U.S. growth pulled ahead in front of every other economy and with that, the market cracked. In early February a jobs report from the Bureau of Labor Statistics contained a signal, albeit a false one, of higher wage growth. What that meant to the market was we were finally in a new world of higher growth with inflation. For six years the Fed could not get to its inflation target, and all of a sudden the markets saw inflation and the U.S. raising rates. This was when the market started cracking and diverging.

Divergence and Trade Policy Issues

While there may be some debate about whether the divergence trend continues on today, Dr. Levine would argue it does, at least for the short term. First, we have the U.S. raising rates, and secondly we have policy issues on trade. Trade disputes are hitting regions in different ways, but particularly vulnerable are China and emerging markets. Even Europe is more vulnerable than the U.S.

Speaking of trade policy issues, Guy asked a key question about trade deficits and the current administration. Without getting into all the politics, he asked about our administration’s perspective on trade deficits. Are they too focused? Are they in and of themselves a negative thing? While Guy speculates the president views trade deficits as a loss, whether justified or not, he sees trade deficits as a normal part of the cycle. Dr. Levine carried the thought one step further saying our current administration is embarking on what seems like a negotiation strategy, with the target being China. Looking back to 2015, the Chinese devalued their currency. We are seeing Chinese currencies trading lower over the last month, perhaps in a retaliatory mode not unlike three years ago. They don’t have as many billions of goods as the U.S. does to throw tariffs on, so they have to find other creative ways to inflict pain, hence devaluing their currency.

While the U.S. market has not reflected the full impact of a trade war just yet, the overall sentiments were that the market’s complacency is based on the fundamental strength of the U.S. economy. In the end, all the numbers are telling us the U.S. economy is in a great place; to use baseball analogies, it appears to be much earlier than the 8th inning! We are sitting at the five-year average on the S&P. Since the recovery after the Great Recession has been fairly shallow, there could be more room to grow. Confronting fears about another recession, a natural progression of a strengthening economy is rates going higher. It’s not necessarily a question of if the Fed will tighten us into a recession, but when. Dr. Levine’s estimate is that a recession isn’t likely in the next 12-18 months, but perhaps two years from now after several more rate hikes and when the benefits from fiscal stimulus (the tax cut) are no longer present.

The Yield Curve was also a topic of discussion as it continues to flatten at a rapid rate, but is this cause for concern? Perhaps not. Citing “Don’t Fear the Yield Curve,” both experts say there are so many variables affecting this yield; it’s simply not a reliable indicator for a recession. There are other considerations affecting the long end yield. In that case, do we have a narrow or a broad based rally at this time? Dr. Levine claims the trade issue is preventing it from being more broad based. However, stay tuned for what happens in the coming weeks regarding abolishing auto trade tariffs between the EU and U.S. when European Commission President Jean-Claude Juncker visits the White House. This could lead to a boost across several sectors, broadening the rally.

Guy Adami’s advice for the mindset of investors today? “Be looking for what can go wrong and what will go wrong. Basically, hope for the best and prepare for the worst. “ What does he mean by that? Stocks are simply not reacting to what’s happening in real life. Take Netflix, for example. They had nowhere near the growth they forecast for this last quarter. Yet, the Nasdaq closed UP the next day. It’s not a question of if it is healthy or not, but simply a caution to be aware of this “autopilot” mentality we face at this time.