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RoboStreet – July 19, 2018
Market Volatility Will Rise as Earnings and Trade War Intensifies
Apparently, China’s President Xi Jinping has no interest in talking fair trade with the U.S. anytime soon. As per the latest reports on the tit-for-tat tariff dispute, U.S. and China trade officials have taken a pause on further negotiations, having hit an impasse. The Chinese central bank is manipulating the yuan lower to make its goods more attractive to other countries for export and to fatten profits for exporting companies while the U.S. Dollar Index (DXY) powers higher to a new 52-week high of 95.65 against the yuan and other major currencies.
Fed Chairman Jerome Powell gave a pretty upbeat report on the economy to Congress this week which is also contributing to the dollar strength while pressuring crude oil, copper, gold and other commodities. White House Chief Economic Advisor Larry Kudlow stated in an interview at this week’s Delivering Alpha Conference that while some low-ranking Chinese officials were prepared to reach a deal, President Xi was refusing to compromise over Beijing’s trade policies.
Kudlow said: “I don’t think President Xi at the moment has any intention of following through on the discussion we made and I think the president is so dissatisfied with China on these so-called talks that he is keeping the pressure on — and I support that.” President Trump has recently threatened to impose a new round of charges on $200 billion of Chinese products, unless the People’s Republic agrees to change its intellectual property practices and high-technology industrial subsidy plans.
Trump’s administration released a new list of tariffs on $200 billion of Chinese goods on July 10, as the president continues to broaden the scope of the trade war with Beijing. Trump’s new tariffs will not go into effect immediately but will undergo a two-month review process, with hearings Aug. 20-23. The list comes after warnings by Trump that he may implement tariffs on at least $500 billion, which is essentially most if not all Chinese made imported goods to the U.S.
Even though a trade war could culminate in new tariffs that exceed $700 billion on a global basis that the U.S. applies to imports, it pales in comparison to the $80 trillion global economy. It’s not even 1.0% of total global commerce, but could cause ripples and disruptions within the global supply chain, which is the larger risk to the stock market. News of regional manufacturing slowdowns because of supply shortages and bottlenecks will be a negative for investor sentiment.
Against this backdrop of what is a loud bark of trade rhetoric versus a small bite out of global growth, it shouldn’t make a big negative on GDP, but the noise level could get to a place where market volatility spikes in the next couple of months leading to the September deadline of when the $200 billion in additional tariffs on China would commence. In fact, my Tradespoon Seasonal Chart below of the Barclays Bank PLC iPath S&P 500 VIX Short-Term Futures ETN (VXX) forecasts a big spike in market volatility between now and early September, implying investors should look to hedge their portfolios or seek to trade from profits from the expected rise in volatility.
And remember we’re not talking about day-trading here. I’m looking for 50-100% gains inside of the next 3 months, so my weekly updates are timely enough for you to act.
Looking at the CBOE Volatility Index (VIX) that is the most widely followed measure of short-term market volatility, one could argue from a technical standpoint that this index is ripe for a big spike higher. The five-year chart below of the VIX shows the index soaring from 10 to 50 in the first week of this past February triggered by none other than widespread fear of a sudden slowdown China’s economy.
Since then, the VIX has tested the 12-level twice, putting in a double-bottom formation off of a weekly higher-low formation that is a strong set-up for a sharp move higher in the days and weeks ahead. The risk/reward proposition for getting long volatility in the form of either VXX shares or VIX call options is compelling. Once the FAAANG stocks and other market favorites report their second quarter results over the next week or two, there will likely be a void of significant catalysts to rally stocks higher thereafter.
Investors will be contending with the implementation of the next round of tariffs in the first week of September followed by the FOMC meeting scheduled for September 25-26 where bond traders are predicting an 86.1% probability the Fed will raise the Fed Funds Rate to 2.00-2.25%. (see chart) Short-term inflation data is there to support the next rate hike and that may cause the yield curve to flatten even further, threatening to invert.
U.S. inflation has consumer price inflation near 2.4%, enough to pull Personal Consumption Expenditures inflation, the Fed’s preferred gauge, near its 2% target. This gives me confidence the central bank will likely forge ahead with raising rates. I do not see inflation sailing far above 2%, but the risk of investor anxiety rising on inflation is there after years of deflation fears dominating. However, while the pick-up in U.S. inflation is keeping the Federal Reserve on track to raise rates, it is not high or sticky enough to reverse monetary easing in the eurozone or Japan, which will keep downward pressure on long-term rates.
High-profile earnings misses will also contribute to volatility. Shares of Netflix plunged 60 points from $402 to $342 when the company didn’t make their Q2 numbers. Traders that were short on the stock or long on the puts made a fortune. While those that were long stock or call options in W.W. Grainger also cashed in when the stock soared 38 points after beating analyst estimates this week. Next month is when 85% of all S&P 500 companies report their results and I intend to catch as many of the gap higher and gap lower moves as possible.
The other factor that investors have to consider is seasonality. The months of August and September are notoriously weak months for equity markets, and this year is setting up to follow that pattern. And while a spike in volatility might not repeat the scale of what took place in February, there is a good case for getting long on some volatility in late July.
To put it simply, the low-volatility environment has felt its first tremors of change in 2018. February’s spike in equity market volatility served as the first warning sign. The low volatility of 2017 was abnormal, even in the context of low-volatility periods we have seen since 1980. Steady, above-trend global growth is supportive of further low-volatility regimes, which in the past have tended to play out over many quarters. Yet I do see the potential for greater macroeconomic uncertainty with China’s economy, European credit, oil prices, and currency volatility.
So, while I expect the current low-volatility landscape to persist over time, I see potential for episodic spikes amid rising risk, which could occur as soon as the next month. To this end, I highly encourage all readers of this column register to attend my upcoming webinar on How to Rack Up 87% Gains from the Volatility Cash Rushscheduled for next Monday July 23 at 4:30 pm EST. It’s free and will be hugely informative for making decisive long and short trades on earnings releases and trading market swings. July 4thmight be Independence Day, but the real fireworks of Wall Street start next week and there’s a lot of money to be made if you’ve got the right trading system – and I do. Join me and let’s make some serious money!
And remember we’re not talking about day-trading here. I’m looking for 50-100% gains inside of the next 3 months, so my weekly updates are timely enough for you to act.
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