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Dow Clings to Rally but Economist Exposes Trade Deal’s 5 Gaping Holes

Last Updated September 23, 2020 1:24 PM
Josiah Wilmoth
Last Updated September 23, 2020 1:24 PM
  • The Dow clung to record highs but failed to extend its rally much further.
  • One economist unveiled a sobering assessment of what the trade deal really means for the stock market.
  • China’s plan to increase US imports may end up hurting the Hong Kong economy.

The Dow struggled to extend its record-setting rally on Tuesday, as fragility in its heaviest stock continued to fester.

Investors remain optimistic about the market impact of the US-China trade deal, but economist Mohamed El-Erian published a sobering critique that proves the trade war cease-fire might not last for long.

Dow Hesitates After Reaching New Zenith

The Dow Jones Industrial Average closed at a record high on Monday, but the index sharply pared its gains during the afternoon session. That weakness carried over into Tuesday.

Shortly after the open, the Dow had dipped another 5.94 points or 0.02% to 28,229.95.

dow jones industrial average chart
The Dow slid into Monday’s close, and the index didn’t do much to recoup those losses on Tuesday. | Source: Yahoo Finance 

The S&P 500 managed slight gains, rising 2.39 points or 0.07% to 3,193.84.

The Nasdaq fared similarly, edging 6.59 points or 0.07% higher to 8,820.82.

Boeing Stock Vulnerable After First 737 Production Halt in 20 Years

The immediate catalyst for the Dow’s pullback was the stunning announcement that Boeing, the heaviest component among the DJIA’s 30 stocks, would suspend production of 737 Max.

It marks the first 737 production halt in more than two decades , and one columnist analogized it to McDonald’s suddenly scrapping the Big Mac  from its menu.

“Imagine if Toyota Motor Corp. stopped making Corollas, or Coca-Cola Co. stopped making Diet Coke, or McDonald’s Corp. stopped serving Big Macs,” David Fickling wrote. “That’s the best way of looking at reports that Boeing Co. is considering halting production of its troubled 737 Max single-aisle jet.”

BA shares had plunged on Monday in the expectation of the 737 Max suspension, and the slide extended into Tuesday after Boeing made the news official.

El-Erian: 5 Reasons Why the Trade Truce Won’t Last Long

Delayed euphoria over the “phase one” trade deal empowered the Dow to resist the gravity from Boeing stock on Monday. But Allianz Chief Economic Adviser Mohamed El-Erian warns that the agreement is little more than a Band-Aid  that will protect the US and Chinese markets from further damage while the two countries reload for the next offensive in their ongoing economic war.

Writing in an op-ed this morning, El-Erian lists five reasons that the trade deal will only provide the Dow and broader stock market with short-term relief:

  • The trade deal doesn’t even attempt to address structural disputes between the trading partners.
  • The agreement’s narrow terms won’t stem the tide in Congress of growing bipartisan hostility toward China.
  • The deal doesn’t have clear and straightforward enforcement mechanisms.
  • It’s likely that Donald Trump and Xi Jinping will outsource the signing ceremony to their underlings.
  • One of the biggest US-China flashpoints – technology policies – continues to simmer, regardless of the tariff rollbacks.

There’s nothing wrong with a short-term truce, El-Erian says, except for this: The stock market is pricing in a long-term resolution to US-China tensions.

mohamed el-erian, stock market, trade deal, dow jones
Mohamed El-Erian warns that the trade deal is a short-term solution, but investors are treating it like a long-term resolution. | Source: REUTERS/Jason Reed/Files

He writes:

Judging from the price moves, the fixed income and currency markets seem to understand this better than the stock market. Specifically, the first two have been much more guarded in translating short-term relief into a longer-term lifting of the uncertainties facing global growth.

Not so for stocks, where the beneficial impact on valuation (higher) and volatility (lower) has turbo-charged that of the extremely accommodating financial conditions imposed by ultra-stimulative Federal Reserve and European Central Bank measures.

El-Erian recommends that investors take advantage of the stock market rally to rotate into defensive stocks with “resilient balance sheets and high cash generation.” This could help them fortify their portfolios against the inevitable breakdown of the tariff truce.

China’s Strategy to Increase US Imports May Pinch Hong Kong

hong kong protest
The Hong Kong economy has struggled amid the months-long protest movement, and Beijing may add further pressure by re-routing shipments directly to the Chinese mainland. | Anthony WALLACE / AFP

Meanwhile, details about China’s strategy to “increase” US imports have begun to emerge , and they suggest that Beijing plans to employ some clever logistical and accounting tactics to reduce its actual obligations.

According to Bloomberg sources, China may begin re-routing trade directly to mainland ports rather than having it pass through Hong Kong first.

Because the US does not tabulate shipments to Hong Kong as part of its balance of trade with China, re-routing these orders directly to the mainland would allow Beijing to nominally increase its importation of US goods without having to place any new orders. It’s estimated that this strategy could “raise” US exports to China by $10 billion annually.

This fancy footwork would also batter an already-fragile Hong Kong economy. The White House may be inclined to look the other way to avoid inflaming tensions, but Congress has betrayed no such scruples about taking Beijing to task for its behavior toward Hong Kong amid the months-long protest movement.