FeaturedMarket Outlook

The Trade War is still the main problem in the market

By October 3, 2019 No Comments

In what has felt like a reoccurring theme for the last six months, the stock market is again selling off. There have now been three drops of 5% or more in the S&P 500 in the last six months. All of these drops have occurred shortly after the S&P 500 approached or made new record highs. That is the most frustrating part: when it looks like the market might finally sustain a new advance, it doesn’t. The concern here is that the S&P 500 is now going on 20 months of no gains amid the Trade War between the US & China.

Even though the S&P 500 is still up 15% year-to-date, it is flat since January 2018. That’s not an arbitrary month either, It was in January 2018, that President Trump first launched his trade war on China, slapping tariffs on solar panels and washing machines. Prior to that point, the stock market had enjoyed a strong rally to new record highs. The S&P 500 closed January 26, 2018, at a then-record high of 2872. As of this writing, the S&P 500 is at 2881.

The evidence suggests the Trade War is the problem

We can never know for certain what is moving the market on a week-to-week basis. However, we can make educated guesses. The beginning of the trade war is the one major event that changed global economic dynamics in January 2018. We would argue that the Trade War has been the main driver of volatility over the last 20 months. For evidence, here is a chart of the VIX-index, the most common measurement of volatility in the market:

VIX chart since Trade War

2017 was a very calm year for volatility, and the S&P 500 returned 21.80%. Notice from our chart above the VIX spiked beginning in January 2018. That coincides with the very beginning of the Trade War. Volatility and stock market returns are historically inversely correlated. When volatility rises, stocks fall, and when volatility declines, stocks rise. As such, stocks have had a hard time rising consistently over the last 20 months due to increased volatility. You can see the inverse correlation between volatility and the S&P 500 in the chart below:

VIX inverse correlation with S&P 500

Until the Trade War ends, expect continued volatility

All of this is to say that volatility has increased ever since President Trump started his Trade War with China. This increased volatility has been bad news for stocks, as we would expect it to be. Therefore, we think the best chance for a decrease in volatility is for an end to the Trade War. Or at least an easing of tensions between the two nations. The problem is that we’re not sure that is likely.

Even if President Trump wants to get a deal done with China, the recent impeachment proceedings will likely distract him in the near-term. The President would get a big boost from a trade deal, but do you think democrats want to give him that just before the election? Furthermore, do you think the President will be focused on anything but defending himself against impeachment in the near-term? If his recent Twitter rants are any indication, the answer is no.

The impeachment drama isn’t helping

Therefore, the best chances of the Trade War ending, or at least easing, is for the impeachment process to unfold quickly. Even if the rhetoric surrounding impeachment is damaging politically, it is unlikely to have an effect on the market unless it gets dragged out. Of course, if the President were actually forced out, that would be a different story. But as of now, we believe Donald Trump will still be the incumbent President at this time next year.

In summary, the market was doing very well until January 2018. Since then, the S&P 500 is more or less flat. The most obvious catalyst to point to is the start of the Trade War between the US and China. This has resulted in volatility shocks over the last 20 months and has made it hard for stocks to go up consistently. Until the Trade War is resolved, or at least trends in a positive direction, the road for stocks will be bumpy.

Don’t want to miss anything?

Subscribe to our monthly newsletter for market insights.

Leave a Reply