V-SHAPED RECOVERY TO PAUSE

Stocks gapped down at the open for the second day in a row following the revelation that US and Chinese negotiators are still very far apart on a potential trade deal. At the moment, the Dow is down 270 pts and the SPX is down .65%. Ten of eleven major market sectors are in the red, led by energy (-2%), financials (-1.1%), and materials (-.8%). The VIX Index jumped back up to 17.3; that’s probably a much more muted reaction than traders were expecting. European stock markets will also close lower for the second consecutive session. The easy culprit for the change in market direction is tenuous trade negotiations. But the fact is that after such a strong January, we’re due for some consolidation. After a growth scare that produced a 20% correction in stock prices, one cannot expect the recovery to be as sharp as it has been since Christmas Eve. Commodities are mixed today. Oil prices roughly unchanged around $52.50/barrel. Copper is also unchanged after rising 8% so far this year. Gold is up very slightly today (+2% on the year). Fixed income markets are mostly higher in price with the notable exception of junk bonds. The 10-year Treasury yield has fallen back to 2.64%. That’s a long way from 3.2% just three months ago.

Investors are weighing the possibility that the 90-day deadline to reach a US-China trade deal may expire next month without any kind of resolution. In fact, White House economic advisor Larry Kudlow said yesterday that he sees a “pretty sizable distance to go” before a deal can be reached. Traders, of course, are all over this prophesying that the stock market will revert to playing defense until a deal is reached. We know it is not that simple. There are a lot of “crosscurrents” affecting asset prices, as the Fed points out. As I said, stocks are ripe for some near-term consolidation. Goldman Sacks (GS) analysts say “There seems to be a moderate number of investors waiting for a correction in order to add positions, which contrarily usually means that the dips will be brief.” Economic data hasn’t deteriorated as sharply as many expected several months ago. The Citigroup Economic Surprise Index has improved to +17 from -22 since the beginning of the year. And earnings season is thus far proving that Corporate America isn’t falling apart. Finally, it does look like both the Federal Reserve and European Central Bank (ECB) won’t be hiking interest rates anytime soon.

The Eurozone economy, on the other hand, is losing altitude. According to Bloomberg, German business expectations fell to a six-year low in January. Private research firm Markit Economics just released its Eurozone PMI for January, showing business activity has basically flat-lined (i.e. zero growth). Some of this weakness is a direct result of trade tensions between the US and China (i.e. corporate purchasing managers delaying orders in hopes that a deal may be reached soon). But remember, they’re dealing with a messy Brexit and economic recession in Italy. The Eurozone’s Citigroup Economic Surprise Index has fallen to -80. This is why the ECB can’t raise rates. Last year’s narrative of globally synchronized monetary tightening has flipped.


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