S&P 500 and Dow Gap Lower as Trade Fears Grow, Recession and Dollar Worries Ahead
Risk Aversion Talking Points:
- Risk trends opened to another steep tumble with the S&P 500 leading with its biggest bearish gap in months
- Trade war headlines was top concern once again as Trump suggested a China deal could wait for the election and tensions with Europe rose
- Growth concerns are drawing market attention with the recently-popular US 10yr3mth yield spread dropping and US services report due
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US Indices Gap Lower a Product of Fear and Liquidity, But Trend As Well?
The souring of a comfortable retreat into seasonal year-end speculative climb continued this past session. The most pronounced stumble among the key risk benchmarks that I follow was once again the drop from US indices. Having pushed record highs this past month, these pacesetters have led the bullish speculative run - whether fueled through virtuous means or not - so they hold a loftier status among broader 'market' watchers. They also have the most premium to bleed. And bleed they did, with the S&P 500 posting its biggest bearish gap on Tuesday's open since August 14th. The two-day drop is the worst in two months and it has taken out more immediate technical structures to put bulls on edge and perk up bears to the possibility a more momentous trend. We have to remember that December is notorious for thinned trading conditions, a drain on volume that can snuff out meaningful trends before they can even start to breath. With the near entirety of 2019 a reflection of complacency habits familiar over previous years, it is not a small feat. Yet, thin volume does not negate volatility. It can actually amplify.
Given the shift of dependency from traditional growth measures to temporary factors like stimulus along with the enormous build up in leverage over time, there is an inordinately large risk to the financial system should conviction fail. Yet, fear has been beaten back multiple times before through the past decade, so it is important not to be lured by the appeal of overdue volatility. One point for a throttled sense of fear this past session was the lack of follow through after the US markets produced their unflattering gap. Further, there was a notable divergence in conviction to be noted across similarly put-upon market benchmarks. Global shares markets (rest-of-world VEU) initially dropped as well, but it recovered more of the smaller retreat. The EEM emerging market ETF and HYG junk bond ETF dropped but did not register nearly as significant a loss. There is still high correlation and heavy bias towards short-term risk aversion however, so the 'risks are tilted to the downside' as central bankers like to stay. If there were any break that I felt held significant potential for momentum, it would be a bearish one on sentiment.
US and China Escalate Their Trade Rhetoric, Europe and US Take Action
Risk trends are the end game and ultimate foundation for participation (liquidity) and conviction (momentum), but catalysts whip the speculative rank along the way. As for the prevailing fundamental theme at present, we are clearly following trade wars as a principal theme. This past session, the rhetoric between the United States and China intensified. In particular, the White House was on a blitz. Commerce Secretary Wilbur Ross repeated the line that no breakthrough will be found until a deal is written in black and white with signatures at the end. He would also ensure that the December 15th deadline for either some resolution or a painful escalation to the Chinese import tariff list was still on the menu. The most remarkable statement in my opinion was made by President Trump himself who suggested that it might indeed be better to hold off on a trade deal with China until after the 2020 election - a warning to its counterpart that the executive branch is willing to wait out the key political event just as readily as the Chinese government.
Chart of USDCNH with 200-Day Moving Average (Daily)
Chart Created with IG Charts
As remarkable as the trade headlines between the US and China were, headlines around the growing tensions between the US and Europe were of far greater concern - principally because they are currently founded on action rather than warning. Secretary Ross would weigh in on this front as well but insinuating that the Section 232 review on auto tariffs was indeed behind us for now, but by suggesting it could be considered again for the future. More tangible was the suggestion by the US Trade Representative's office that it should press ahead with its pressure on Europe in the wake of the rejection by the WTO of claims by the EU that it was no longer subsidizing Airbus to unfair advantage. Such a move is far more likely to provoke retaliation that is as-yet not under way. France may take the lead for the EU itself. Following Monday's ruling by the USTR that France's digital tax hurt the US disproportionately and that it was justified to tax its imports on $2.4 billion goods; President Macron's government said it was prepared to retaliate. I have had said before, if the world's two largest aggregate developed economies (open markets) were to engage in an outright trade war, the critical financial and economic implications would not be overlooked.
Chart of EURUSD (Daily)
Chart Created with IG Charts
Recession Fears Could Be a Tipping Point with the Wrong Outcome
Trade war fodder remains the most active fundamental headline at the moment, but a far more consistent fear could readily arise through fears around traditional economic pain. Back in August, fear of a recession peaked alongside the fixation on a typically-obscure signal: the US 10-year to 3-month Treasury yield spread. Inversions of this section of the curve is often used by economists as a warning that economic trouble is ahead, but it rarely finds its way to the Main Street investor...until then. This past session, the spread dropped sharply which accompanies renewed concern around global growth. On the economic front, the favorable global implications of a rumored $120 billion equivalent stimulus program from the Japanese government seemed to garner little traction. As for the Brazil besting of its 3Q GDP reading (0.6 versus 0.4 percent growth) and sharp miss from South Africa (-0.6 contraction versus 0.1 percent growth) wouldn't even register with a clean reading for local currency or capital market.
Chart of the US 10-Year to 3-Month Yield Spread with 50 and 200-Day Averages (Daily)
Chart Created with TradingView Platform
Ahead, I will keep my focus squarely on growth. This is not because it is an assured driver but rather its potential is far more extraordinary that nearly ever other known risk we are currently facing. Markets have outright ignored the moderation of expansion, and a true contraction could ultimately trigger substantial and overdue capitulation. There are a host of scheduled indicators that can tap into this theme, including global PMIs. That said, the service sector and composite readings are largely final reports. The Australian 3Q GDP update is more prominent but would struggle for global impact. The most remarkable listing will be the ISM's update on US service sector (non-manufacturing) activity for the past month. This accounts for the bulk of US output - and the country is the largest in the world.
Outside of trade wars and growth, there are a few highlights to look for in particular areas of the global market. In particular, I will be watching the Canadian Dollar particularly closely. This currency is due to absorb the Bank of Canada (BOC) rate decision. The Reserve Bank of Australia's (RBA) decision to hold with rhetoric that seemed to suggest a leveling of intent held nudge the Aussie Dollar higher. If the BOC decides to follow suit, there are some interesting crosses to monitor, but the clear USDCAD range is of particular interest to me.
Chart of USDCAD with 200-Day Moving Average (Daily)
Chart Created with IG Charts
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