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S&P 500: Investors Turn Defensive as Trade War Risk Bites

S&P 500: Investors Turn Defensive as Trade War Risk Bites

2019-05-22 17:30:00
Rich Dvorak, Junior Analyst
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S&P 500, US CHINA TRADE WAR, RISK APPETITE – TALKING POINTS

  • Stock market sentiment sours as trade war uncertainty bites
  • S&P 500 sector performance attribution could hint at further weakness despite stocks recovering from month-to-date lows
  • Equity traders may find solace in more liquid and ‘non-directional’ forex markets if tensions escalate further
  • Find out major differences between Trading Stocks and Forex

The S&P 500 has edged nearly 3 percent lower since President Trump tweeted earlier this month his intent to increase tariffs on China. Although the stock market has recovered slightly from the lows of its recent rout, market sentiment appears damaged still as suggested by relative sector performance.

S&P 500 RETURNS BY SECTOR – MAY 03 CLOSE TO MAY 22 INTRADAY (CHART 1)

S&P 500 Price Chart Return by Sector since Trump Tariff Tweet US China Trade War

According to SPDR ETF returns of the major S&P 500 sectors since the May 3rd close – the Friday preceding Trump’s trade war tweets on Sunday, May 5th – the technology sector (XLK) has significantly lagged the broader market. This is a stark contrast to year-to-date equity returns considering the sector has advanced roughly 20 percent which compares to the S&P 500’s overall 14 percent gain so far in 2019.

Seeing that tech stocks comprise the largest sector of the S&P 500 by far, further weakness in technology companies like Apple (AAPL), Microsoft (MSFT) and Google’s parent Alphabet (GOOG) threatens to exacerbate broader market weakness. This is due to the fact that performance of these ‘mega-cap’ tech darlings contributes significantly to the overall return of the market-cap weighted S&P 500 index.

S&P 500 RETURNS BY SECTOR – MAY 03 CLOSE TO MAY 22 INTRADAY (CHART 2)

S&P 500: Investors Turn Defensive as Trade War Risk Bites

With tech now widely underperforming the S&P 500, the “shifting winds” could indicate a change in investor sentiment as traders begin to favor defensive sectors like utilities (XLU), consumer staples (XLP) and healthcare (XLV). This is because companies in these non-cyclical sectors generally possess characteristics like stable cash flows and cheap valuations which tend to outperform during periods of elevated market uncertainty which leads to investor pessimism and risk-aversion.

Additional evidence of waning investor sentiment is provided by the AAII Sentiment Survey which shows that the Net Sentiment Index has dropped from 39.63 on May 2nd to 30.88 as of May 16th. Also, fading demand for comparably riskier high-beta stocks with unstable profitability like Tesla (TSLA) or new IPO listings like Lyft (LYFT) and Uber (UBER) could similarly signal shifting stock market sentiment to a less optimistic view. Moreover, the recent lack of risk appetite by investors is hinted at by the sharp drop in Treasury yields which has bolstered gold prices.

US China trade war tension risks further escalation as negative rhetoric endures following the breakdown in negotiations between the two countries earlier this month. Aside from tariffs, Chinese technology companies like Huawei are being targeted by the United States. If China decides to retaliate, supply chains and revenue sources of American tech companies could be in jeopardy.

Sell in May and Go Away Stock Market Anomaly: Should You Sell Stocks?

This possibility threatens a bearish knee-jerk reaction from US investors and has potential to snowball into a sharp selloff. That being said, the erosion of confidence in equities may continue even if the overall index holds should technology and other speculative sectors continue to flag.

Worth mentioning amid these concerns is the potential benefit equity traders may find from currency market liquidity and other advantages forex trading can offer such as its 24-hour session and natural ‘non-directional’ nature. The continuous forex market helps to significantly reduce the instances of large gaps that are frequent and sometimes extreme in equities as seen in the recent series of S&P 500 gaps to the downside in response to US China trade war headlines.

Another underappreciated aspect of FX relative to equities is the fact that there is always a ‘long leg’ and ‘short leg’ to any currency pair. For most participants in active stock trading, the predominant approach is to only pursue various long-only strategies which does not align well with return probabilities or volatility.

- Written by Rich Dvorak, Junior Analyst for DailyFX

- Follow @RichDvorakFX on Twitter

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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