US stock indices head lower

US stock index futures gave up early gains and traded lower ahead of the official open. Overnight brought the release of a clutch of weaker-than-expected Chinese data. Industrial Production rose 4.8% year-on-year, down from +6.3% just one month ago. This was its lowest reading since the first quarter of 2009. Retail Sales were up 7.6% from the same time last year, but this was well below last month’s reading of +9.8%.Fixed Asset Investment rose 5.7% year-on-year which again was down from +5.8% last month. Rounding things off, Factory Output fell to its lowest level in seventeen years. Earlier on, the People’s Bank of China fixed its US dollar/ Chinese yuan reference rate above 7.0 for the fifth consecutive session, but at a stronger yuan level than yesterday. However, the Chinese currency lost ground after the data was released.

Tariff delay

Yesterday global equity markets fell sharply in early trade as investors fretted about the falling yuan, unrest in Hong Kong, rising geopolitical tensions between India and Pakistan over Kashmir, and what appears to be a wide-ranging global economic slowdown. However, equities suddenly roared higher soon after the US open. This move was triggered by an announcement from the United States Trade Representative’s office saying that a number of products were being removed from the Chinese tariff list due to kick in at the beginning of September. In addition, tariffs on products such as mobile phones, laptop computers, computer monitors, video game consoles, some toys, and certain items of footwear and clothing will now be delayed until 15th December. The news helped to offset investor concerns over the growing civil unrest in Hong Kong. Flights were once again cancelled at the Hong Kong International Airport as thousands of protesters disrupted operations. There are rising fears that the Chinese authorities will not allow such widespread disruption to continue for much longer and that they could employ the military to crush the demonstrations. After appearing to take the situation to the brink yesterday, protestors backed off this morning and the airport has reopened.

Other trade issues

There are other trade issues emerging across the Asian Pacific region. Less than a fortnight ago Japan removed South Korea from its list of "white nations" considered safe enough to export strategic materials. The South Korean economy is already struggling to cope with the US/China trade war. Now South Korea has moved to downgrade Japan from its list of most trusted trading partners while also seeking talks to end a months-long spat that has hurt economic ties between the two countries.

Flattening yield curve

But while yesterday’s US/China trade news brought some relief for equity investors, the US Treasury bond market continues to wave a big red flag. The yield curve has flattened further and earlier this morning the yield on the US 10-year Treasury was less than 1 basis point above the 2-year yield – the narrowest gap since May 2007. This suggests that investors are getting increasingly concerned about the economic outlook and fear that a recession may be on the cards. 

S&P charts

The S&P has recovered well since hitting a two-month low at the beginning of last week. That sell-off saw the index slice below the 200-day Exponential Moving Average (EMA) although it quickly bounced back above it. Once again, traders were quick to follow the lesson learnt over the last ten years and rushed in to ‘buy the dip’. However, as we can see in the first chart, the S&P is now running into resistance at the 50-day EMA which currently comes in around 2,935. The bulls need to push the index above here to boost confidence and retest last month’s record close.

However, this is the middle of August when institutional business is at its quietest and typically trading volumes are low. But there are exceptions as we saw yesterday when the index flew higher on huge volume following the apparent easing of US tariffs on Chinese goods. But this in itself highlights a big danger for traders at this time of year. Sometimes markets overreact to news headlines which don’t do justice to the underlying facts of the matter. After all, does yesterday’s news really mean that a US/China trade deal is in sight? Another ‘August’ feature is that lower liquidity can lead to raised volatility. As we can see in this chart of the VIX (a measure of volatility in the S&P 500) volatility remains elevated, despite pulling back from last week’s spike. This is, along with the flattening of the US Treasury yield curve, a warning that the ‘all clear’ has yet to be sounded. Traders should continue to be exceptionally cautious over the next three weeks or so.

 

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