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STA Weekly Report – How Bad Could a Trade War Get?

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INSIDE THIS EDITION:
S&P 500 Crosses Above It’s 200-Day Average
Industrial Sector Clears December High
401k Plan Manager*Updated on 12/31/2018

This week is an important week on the U.S.-China trade dispute front. Senior Chinese and U.S. officials are meeting again in Beijing this week to continue trade talks and try to resolve their trade dispute ahead of the March 1st deadline. When Donald Trump met Chinese President Xi Jinping on December 1, they agreed to a 90-day trade truce to give negotiators time to hammer out an accord. That truce extended the deadline for an escalation in U.S. trade tariffs from January 1 to March 2.

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The trade fight has rattled financial markets and threatened world economic growth for months now. It remains a focus for investors as the outcome of the talks could play an important role in determining the direction of markets.

So how costly is a trade war if a bilateral agreement cannot be reached?

There are surely more losers than winners, in an ever-integrated global economy. If 25% tariffs are imposed on all bilateral trade between China and the United States, China’s GDP growth is expected to be dragged down as much as one full percent, according to estimates by OECD (The Organization for Economic Co-operation and Development). More damage can be done if the negative impact of related uncertainty is factored into the equation. The U.S. is not in a better position, either. A full-fledged trade war could cause a 1% slowdown in US GDP growth by 2021.

Bloomberg Economics holds a more pessimistic view. According to its calculation, the increase of tariff on $200 billion of imports from China from 10% to 25% alone could shave 0.9% off growth. The 25% tariff on all imported Chinese goods will cost as much as 1.5% of Chinese GDP growth. 

A trade war would likely shock the global economy more if it is transmitted through a country or region of great importance to global trade. This is certainly the case for U.S. and China, because both countries stand at the center of global trade. See chart: the size of the circles represents total trade. The thickness of the lines represents the volume of trade flows. Grey circles represent other countries.

Because of the interdependence in global trade, the damage will likely go beyond the borders of U.S. and China. For example, a hit on China’s exports can pass on to other economies through at least two channels. The first is the supply chain, because China imports parts from other countries to be processed and exported to the rest of the world. The second is domestic demand if weaker exports hit income of Chinese consumers. According to Bloomberg analytics, Asia’s smaller economies, such as Taiwan, Malaysia, and Korea will be hit hard if China’s exports fall 10% (damage ripples through supply chain channel) or imports fall 10% (damage ripples through domestic demand channel).

Although the impact on other regions is likely to be modest, some countries, especially, commodities exporters that have high exposure to China can be significantly impacted with China’s dominant role in global commodity markets.

As for this week’s trade negotiations, will we get a big agreement to settle the trade dispute? Probably not. The negotiations so far seem to have focused on the easiest part, where China agrees to narrow the trade imbalance by buying more American products. But negotiators haven’t made much progress on tougher issues such as industrial subsidies for state-owned enterprises and intellectual property. In addition, we haven’t seen any clear path of enforcement if any deal would be made.

We hope both sides can at least make meaningful progress before March 1st and agree on postponing the tariff escalation beyond March 1st.  So, the recent uptrend momentum of the markets will not get disrupted. We expect the ongoing negotiation will last much longer and will get harder when tougher issues kick in. The new U.S.-Mexico-Canada Agreement replaced NAFTA in a relatively short period because exports to the US from either country are a big component of the national economy. China certainly feels the drag of tariffs on its economy, but it can also sustain that pain for much longer.     

S&P 500 Crosses Above It’s 200-Day Average

Until this week, the Dow Industrials was the only major stock index to trade above their 200-day average. The S&P 500 closed marginally above its 200-day line on Tuesday.

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Chart 2 shows the SPX extending that gain over its red line today. That leaves their early December highs as the next resistance barrier to be challenged. Both indexes remain somewhat over-extended after their strong 2019 rebound. The upper box in Chart 1 shows the Dow’s 9-day RSI line moving into overbought territory over 70 for the second time this month. The second move over 70 is usually the more troublesome and bears close watching for any sign of failure. Chart 3 shows the Nasdaq Composite in the process of testing its red line and its early-December intra-day peak at 74.86. This week’s upside crossings of 200-day lines is a positive sign for stocks. It’s important, however, that they end the week on top of the those lines. Several sector SPDRs have also crossed over their red lines which include cyclicals and industrials.

Industrial Sector Clears December High

Chart 4 shows the Consumer Discretionary Sector SPDR (XLY)trading over its 200-day line and nearing a test of its December high. Chart 5 shows the Industrial Sector SPDR (XLI)already clearing its early-December peak. [The only other sector ETF to do that is Real Estate (XLRE) which is trading at a record high]. The XLI has been drawing strength from rising transportation stocks, and rails in particular. Chart 6 shows the Dow Jones US Railroad Index reaching the highest level since early November. Its biggest gainers include CSX, Norfolk Southern (NSC), and Union Pacific (UNP). Building materials, industrial suppliers and machinery have also been industrial leaders. Other sector SPDRS that are trading above their 200-day lines include staples (XLP), healthcare (XLV), utilities (XLP) and Real Estate (XLRE). That shows that investors aren’t abandoning defensive stock sectors while buying into more economically-sensitive groups.

If you have any questions, please feel free to email me at luke@stawealth.com.

Luke

STA Investment Committee

Luke Patterson, CEO & Chief Investment Officer

Mike Smith, President

Andrei Costas, Senior Investment Analyst (Equity Strategies)

Nan Lu, Senior Investment Analyst (Fixed Income Strategies)

Maximizing Opportunities in Today’s Trade Market

Event Date:  February 26, 2019

To attend, click link to Register Now

If you are a business owner or executive that is looking to learn how to maximize import/export trade in today’s global markets, this event is for you.  STA is proud to co-sponsor this event and breakfast discussion where a panel of trade experts will further explore the current trends and opportunities happening globally and ideas to optimize your global trade business activity.

Important Disclosure:
Please remember that past performance may not be indicative of future results.  Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by STA Wealth Management, LLC (“STA”), or any non-investment related content, made reference to directly or indirectly in this article / newsletter will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful.  Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this article / newsletter serves as the receipt of, or as a substitute for, personalized investment advice from STA.  To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing.  STA is neither a law firm nor a certified public accounting firm and no portion of the article / newsletter content should be construed as legal or accounting advice.  A copy of the STA’s current written disclosure Brochure discussing our advisory services and fees is available upon request. Please Note: If you are a STA client, please remember to contact STA, in writing, if there are any changes in your personal/financial situation or investment objectives for the purpose of reviewing/evaluating/revising our previous recommendations and/or services, or if you would like to impose, add, or to modify any reasonable restrictions to our investment advisory services. STA shall continue to rely on the accuracy of information that you have provided.

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