What to Think About Market Volatility

Jeff Remsburg

Market Tanks After Trump Escalates War of Words With Fed and China

It’s an action-packed Friday …

It began when we learned that China will implement new tariffs on an additional $75 billion worth of U.S. goods. The tariffs will range between 5% and 10%, implemented in two batches — Sept. 1 and Dec. 15, respectively.

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Then we had Fed Chair Jerome Powell’s remarks from Jackson Hole. While he didn’t explicitly call for another rate-reduction, he clearly tried to assure the market that the Fed will cut rates if needed.

Unfortunately, that wasn’t enough for Trump.

In the wake of China and Powell, Trump blasted a series of tweets, first attacking Powell for not signaling a rate-cut …

… and then ripping into China, ordering U.S. companies to begin looking for alternatives to doing business with Chinese companies.

Trump then promised a response to the Chinese tariffs sometime the afternoon. At the time of this writing, we haven’t received indication yet what this is.

Nevertheless, Trump’s tweets have rattled the markets. As I write early afternoon Friday, the Dow is down over 500 points, or 2%. The S&P 500 and Nasdaq have slid 2% and 2.4%, respectively.

***Stepping back, did anything truly “new” happen today?

As of the time of this writing, we don’t know what Trump’s response will be to China’s tariffs. So, that could be new. But for now, while the additional tariffs from China are “technically” new, they’re really just a continuation in the ongoing trade war. So, nothing all that earth-shattering there.

What about Powell’s speech?

He said that the U.S. economy is in a favorable place but it faces “significant risks.” These included the trade tensions between the U.S. and China, Brexit, and the dissolution of the Italian government.

The discussion of Italy was interesting, and it’s something to watch as it could lead to bigger issues in Europe. But besides that, no, nothing all that substantive.

Nevertheless, following Trump’s tweets, investors rotated into safe haven assets. Stocks sold off while bonds and gold rallied. Gold is surging nearly 2%. And the yield on 10-year Treasuries has fallen to 1.513%, which has now triggered another inversion with the 2-year Treasury note. This is the third such inversion in less than two weeks.

***So, what are we to make of today’s fireworks?

Well, it’s increasingly bringing “sentiment” into the equation. And that could present challenges.

You see, while many analysts agree that the underpinnings of our economy are still largely healthy, a growing, progressively-louder voice is calling that health into question — and that could prove problematic.

Neil George recently wrote on this topic to his Profitable Investing subscribers:

… what I do see as a risk beyond near-term volatility is the proliferation of political spin on business and economic news.

For example, leading newspapers are running an increasing number of front-page stories arguing that U.S. consumers are set to pull back on spending, businesses are frightened about the economy and that recession is on the horizon.

At the same time, a recent survey by the National Association for Business Economics (NABE) showed that 34% of its members thought that the U.S. economy could slow into a recession in 2021.

The risk here is that the negative spin on economic news could begin to make consumers wary and, in turn, slow the economy and damage the stock market.

Here’s how we described this dynamic in our Digest on Tuesday:

… consumer fear when it comes to our economy is different — far more threatening.

It’s often a self-reinforcing loop. Regardless of what economic conditions actually are, if consumers perceive things are deteriorating, they’ll hold tighter to their money. This, in turn, will have a very real impact on exact economic fundamentals many consumers are watching, which will only reinforce the fearful sentiment, leading to even less spending, which further damages the economy, and so on.

***I just scanned a few financial media websites — it took me all of about 90 seconds to find the following headlines

From the Wall Street Journal:

From the New York Times:

From Yahoo! Finance:

From Bloomberg:

From CNBC:

As we mentioned in Tuesday’s Digest, keep such media headlines on your radar. The usual “wall of worry” headlines related to the stock market are one thing, but an increasing volume of headlines suggesting a deteriorating economy and anxious consumers could help give us an idea of how close we are to a true inflection point in the markets.

***So, what does this mean for the market in the short/medium term?

For what to look for, let’s turn to John Jagerson of Strategic Trader. Regular Digest readers recognize John as the author of many of our past, featured markets studies. As a quant investor, John analyzes historical market data to identify patterns and trends. Then he uses that information to help make well-informed predictions as to what might happen in the markets going forward.

As the markets pull back, what are the key support levels we should be watching for the major indexes?

For the S&P 500, John points toward $2,850. This is where the market stalled in March. As I write, it’s trading at $2,864.

But we might get greater insight into market direction by looking at the Russell 2000. Earlier in the week, John sent me the following:

One of my biggest concerns during the June-July rally was lagging small caps. Normally, if bulls are very confident the gains in the Russell 2000 would have been expected to outpace the gains in the slower-moving large-cap indexes (like the S&P 500). A reliable sign of weakness and risk is when small caps lag like they did this summer …

What I believe is most helpful about a study of the small-cap index is as an early warning signal if support is broken.

The specific support level John is watching is $1,463. As I write, the Russell is trading at $1,467. I just reached out to John for his latest thoughts.

From John:

I think the Russell is at a make or break point for the market in the short-term. I still don’t think that breaking support will result in a bear market, but a deeper correction is definitely possible.

At this point I suggest traders make two contingency plans. If the Russell breaks $1,463, they should add some portfolio protection (e.g. protective puts or call selling strategies) to reduce the potential downside.

The other contingency would be to build a list of strong, large-cap, consumer stocks at support that could be added to a portfolio if the market whipsaws back up within two or three trading days of a break. I think this is wise because the market is being pushed around by external issues (trade wars, etc.) that can shift sentiment very quickly in either direction.

Keep your eyes on the Russell 2000 level of $1,463. And over the coming weeks/months, watch for the volume of headlines related to consumer fear.

We’ll continue to keep you up to speed.

Have a good evening,

Jeff Remsburg

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