dow jones us-china trade war
The Dow fell 200 points, even after several reports that the US and China were close to a new trade war. The stock market bought the rumor – now it may finally be ready to sell the news. | Source: Shutterstock

There has been practically one story which has been driving headlines over the last few weeks, at least so far as the US stock market is concerned. A razor-sharp focus on incremental progress between the United States and China on trade has been a bullish fundamental for the Dow Jones and its sister indices.

As the Dow has now all but erased its sizeable dip in 2018, it seems a natural assumption that the market has effectively priced out the dangers of further tariffs. As is usually the case, this is an oversimplification.

dow jones industrial average, dji
The Dow Jones has all but erased the dip, but is the chart symmetry misleading? | Source: Yahoo Finance

Trade ‘Irritant’ not ‘War’

First of all, the announcement that there has been substantial progress made on trade with China is favorable for many reasons. Firstly, it shows warming of relations between the world’s two most important economies.

No one wins in a trade war where two economies are so interlinked as the US and China. What you get is a “best loser,” which traders clearly believed was the US as can be seen by the strength in the dollar and weakness in the yuan.

The dip in the Dow Jones and other major global stock indices was written off as overdone by many great traders, with Paul Tudor-Jones noting on CNBC that calling it a trade “war” was mere hyperbole,

“I would call it more of a trade irritant than a real trade problem. You have to put things in perspective, right? If we look at our four biggest trading partners they have a simple weighted average tariff of about 6 percent, we have one of 3½ percent. So there is a 2½ percent gap in unfairness.”

This is a Retail-Driven Rally

The eventual rally on warmer relations was accentuated by loosening of policy by Chinese regulators which helped further squash the CNY. There has been no question in China that stocks have loved the more favorable conditions.

Hao Hong, head of research and chief strategist at Bank of Communications International, spoke to CNBC about Chinese markets on Monday, stating:

“I think momentum is … very, very strong. It’s very difficult to stop a runaway train. Most people are piling money into the stock market, especially the retail investors. It’s very difficult to argue against such a strong trend,”

That’s more than a bit concerning. Powerful headlines like “Trade War Risks Ease” are often the kind of catchy title that captures public attention. History has demonstrated that retail investors are usually at significant risk of being on the wrong end of market moves during periods of elevated volatility. Retail-driven rallies are usually among the most vulnerable. Remember that things had to get worse before they got better in trade talks.

Global Growth Fears Weigh on Outlook

So at best the fundamentals should dictate that the outlook for trade is back to neutral while earnings have faltered. If you are buying the Dow Jones for immediate improvements in the US economy, perhaps you should take a look at recent signs of slowing productivity. This point of view has started to permeate analyst reports, as Barron’s noted in a recent report with this quote from Neal Shearing at Capital Economics:

“While the dampening down of trade tensions between the world’s two largest economies would clearly be a positive development, it is unlikely to provide much of a boost to global growth this year, Meanwhile, it seems that most of the good news on trade is now priced into asset markets.”

So this is a point to consider. Better US relations with China are a good thing for market confidence. Watching the performance of the Dow Jones on Monday, we can assume that smart money now believes it is an excellent time to cut a little risk. It appears that fresh buyers were vulnerable after a strong start in the futures markets. The deal with China also needs to go through. Xi must make some concessions, and it must be confirmed. Beyond that, the grants must be quantifiably enforced.

Dow Jones Struggles to Start the Week

dow jones industrial average, dji
Even after a later afternoon rally, the Dow is firmly in the red on Monday. | Source: Yahoo Finance

If you believe that the China storyline receding will open up an empty highway for bulls, it is also worth considering that Trump may turn his attention towards European trade. The most attractive thing about US stocks has been impressive earnings, but as the sugar rush from Trump’s handouts fades, companies are struggling to outdo expectations.

Perhaps buying appetite and a need for yield outdoes fundamentals in the current cheap-money environment. This would allow you to maintain a bullish outlook on dips, as the US is both a haven and a world leader in productivity. However, if you are buying solely based on trade war optimism, then you need to make sure you feel confident that the orange is as juicy as the global media establishment has made it look.

Already, the Dow has lost more than 200 points after analysts predicted that bullish trade deal sentiment would buoy the markets on Monday.

Looks like it’s decision time.

Disclaimer: The views expressed in the article are solely those of the author and do not represent those of, nor should they be attributed to, CCN.

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