Published October 11, 2019
The stock market has been going nowhere for four straight months as investors have hoped for a breakthrough in U.S. trade negotiations with China. Most days, stocks are reacting to rumors or vague official announcements regarding the outlook for those trade talks. However, there was one recent hard economic datapoint that caught investor attention. The most recent report of manufacturing activity in the U.S. showed a steep decline with export orders falling to a level not seen since the height of the financial crisis (see chart below).
For some analysis around that report, we found the following from Heritage Capital Research to be instructive (noting that none of the analysis below has any impact on the mechanical nature of our signals):
“Cutting to the chase here, the ISM Manufacturing Index slid 1.3 points in September to 47.8, which was (a) below the consensus estimate for a 1.0-point gain to a reading of 50.1, (b) below the all-important 50-line (the line of demarcation between growth and contraction) for a second straight month, (c) the sixth straight decline, and (d) the lowest level for the index seen since June 2009.
The Economics team at Ned Davis research summarized the report nicely by writing, “The decline in activity was widespread across industries, with 15 of the 18 ISM industries reporting contraction, and only three expanding. It was the smallest share of expanding industries since April 2009. Respondents’ comments reflected “a continuing decrease in business confidence” and singled out global trade as the most significant issue.
The key is that while this particular index is a survey and as such can be easily influenced by sentiment/news/headlines, the September reading was a surprise – and not a good one.
The bottom line is that when taken with the recent data from Europe as well as places like China, traders were forced to sit up and take notice. And instead of assuming everything would be hunky dory going forward, there was a sudden fear that economic conditions might get worse before they get better.
In other words, instead of seeing the market’s glass as at least half full and looking ahead to a post-trade war world, traders were somewhat forced to take a more pessimistic view. And in the blink of an eye, once the report was released, a triple-digit gain on the DJIA turned into a rout to the downside.
With world markets following suit overnight and another report suggesting that employment growth is slowing, it appears that the new game is to assume the worst and brace for a second straight Q4 debacle.
A more optimistic view of key assumptions here are as follows:
• The U.S. Consumer doesn’t panic – This keeps the U.S. economy moving ahead (albeit at a slower pace) and we avoid recession
• Washington remains deeply divided and votes along party lines – This means the chances of the President being removed from office for the first time in history are low
• BREXIT happens (or not) – and is a non-event for markets
• Central Bankers continue to ease rates around the world
• A trade deal is likely to get done – and sooner rather than later. This could easily turn economic sentiment on a dime
Finally, let’s keep in mind that according to Barron’s the manufacturing sector represents only 12% of US GDP. So, as long as Mom & Pop don’t pull in the spending reins, the economy and, in turn, corporate profits, can keep on keepin’ on.”
Investors rode through turbulent trade negotiation rumors this week, ultimately leading to an optimistic result. Monday brought a -0.4% slip as the day’s trade rumors were read negatively with concerns that Chinese negotiators were backing away from a broad deal. That negativism accelerated Tuesday with stocks tumbling -1.5% on news the Trump Administration was blacklisting several Chinese companies, a move which impacts some U.S. semiconductor firms. Wednesday brought a more positive spin on the week’s upcoming trade talks with reports that China was open to agreeing on a narrower trade pact. Stocks continued that bounce Thursday with a +0.6% move to bring the week back near breakeven ahead of Friday’s possible meeting between President Trump and Chinese Vice Premier Liu. Stocks ripped higher at the open Friday on news of a partial “Phase One” trade agreement between the U.S. and China that will avert a scheduled October 15th imposition of increased trade tariffs on some Chinese goods. Investors sold into the news leaving stocks to close at their lowest levels of the day, but still sporting a solid +1% gain.
Friday’s push higher left the S&P 500 (SPY) higher by +0.66% for the week. The Nasdaq 100 (QQQ) rose +1.22%. The Russell 2000 small-cap index (IWM) added +0.72%.
Warm wishes and until next week.