Will The Chinese Retaliatory Tariffs Have An Effect On Stocks?
The major indices finished significantly lower on Friday, following one of the craziest sessions in recent memory, as the trade war between the U.S. and China entered a new phase. The Dow lost 623 or 2.4%, to 25,629, the Nasdaq was down 240, or 3.0%, to 7,752 while the S&P 500 declined by 76, or 2.6%, to 2,847. Decliners outnumbered advancing issues by an almost 9-to-1 ratio on the NYSE, where volume was well above average.
The President’s threat to actively curb the dollar’s approitiation could broaden the spectrum of the ongoing trade conflict, and the heightened uncertainty was behind the steep drop in stocks. A lot of things changed with regards to the likely outcome of the trade spat with China on Friday, since until now, the majority of analysts expected a deal, but the steep drop in risk assets shows that investors started to ‘price in’ the possibility of a prolonged conflict.
Reasons behind Friday’s plunge
Although before Friday’s plunge, the major indices showed remarkable stability in the face of the mixed global catalysts, stocks didn’t make much progress, and the benchmarks turned decisively lower on Friday. The FOMC meeting minutes were reassuring for bulls despite the two dissenting votes against the July rate cut, and even Fed Chair Jerome Powell’s speech at the Jackson Hole Symposium was dovish enough to support the rally in stocks. While the announcement of the Chinese retaliatory tariffs caused a brief spike lower in risk assets, it took President Trump’s swift and surprisingly vicious attack against the Fed and China to cause a full-blown risk-off shift on Friday.
Economic numbers took the backseat this week, as all eyes have been on the Federal Reserve, but investors still had to digest a few surprising releases. The Markit Manufacturing and Services PMIs both missed expectations, and the manufacturing measure dipped below 50, hitting its lowest level in a decade. The services sector is still in a better shape in comparison to the globally weak manufacturing sector, but according to the PMI, the economic slowdown in Europe and China is finally taking its toll on the resilient U.S. economy. On a positive note, the Eurozone PMIs surprised on the upside, which could mean that the weakest economies are already starting to recover from the cyclical slowdown. The housing market also gave something to cheer about for bulls, as existing home sales came in above the consensus estimate, even though new home sales were slightly below expected in July.
A technical analysis perspective
The technical picture remains mixed on Wall Street, and due to Friday’s steep drop, the short-term trend indicators are still clearly bearish. The S&P 500, the Nasdaq, and the Dow are still above their rising 200-day moving averages, but the indices closed the week well below their flat 50-day moving averages. Small-caps continue to be worryingly weak, and although the Russell 2000 had a couple of promising sessions this week, the index remains below both its 50- and 200-day moving averages. Before Friday, the Volatility Index (VIX) was showing a positive divergence in comparison to the major indices, but the ‘fear gauge’ surged back above the key 20 level on the last session of the week.
Market internals remained weak even before Friday’s sell-off, and due to the weakness in small-caps, most of the key measures remain negative at least from a short-term standpoint. The Advance/Decline line had a bullish week up until Friday, but decliners outnumbered advancing issues, by a 3-to-1 ratio on the NYSE, and by a 4-to-1 ratio on the Nasdaq. The average number of new 52-week highs increased on both exchanges, rising to 65 on the NYSE and 54 on the Nasdaq. The number of new lows declined in the meantime, falling to 120 on the NYSE and 142 on the Nasdaq. The percentage of stocks above the 200-day moving average bounced back as well, but on Friday it plunged below 45% again, closing the week near the 42% level.
Stock short interest
Short interest was flat at the end of the week, but the most-shorted issues were relatively strong compared to the broader market until Friday, and the total amount of bearish bets remains low historically. Our previous pick Mimedx Group (MDXG) edged higer this week, outperforming the major indices, and given its short interest of 61%,the stock could continue to push higher. Overstock.com (OSTK) has been among the most volatile stocks in recent months, but its up by more than a 100% since June, and since its short interest is still above 50% shorts could be in more trouble in the coming months. One of the most consistent stocks of 2019, Sempra Energy (SRE) had yet another bullish week, and since the stock still sports a very high days-to-cover (DTC) ratio of 16, it could be ready to hit new all-time highs again.
Chinese retaliatory tariffs hit stocks hard
In light of Friday’s developments, the aftermath of the announcement of the Chinese retaliatory tariffs will likely have the biggest impact on stocks next week. The fact that the President labeled China as an enemy and told U.S. companies to find alternatives to the country makes a trade deal highly unlikely ahead of next year’s elections. While another major plot twist is not out of the question, volatility will likely remain high and the firms most exposed to China could remain under pressure. As for economic releases, the durable goods report will be out on Monday, the CB consumer confidence number will be released on Tuesday, the second reading of the second quarter GDP will come out on Thursday, and Friday’s session will be highlighted by the Core PCE Price Index, so traders will likely be in for an action-packed week. Stay tuned!
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