Last week, I said on Monday that it could be a pivotal week for stocks as the market was approaching a significant technical level, with several things that had been driving stocks for some time coming to a head. Those things came and went, mostly with no real resolution, and we start this week poised in much the same way.
The S&P 500 is hovering around 2800, just below the 2815 high during November’s retracement and, most significantly of all, the market is still awaiting a resolution of some kind to the ongoing trade talks with China.
Traders, therefore, are once again left asking: Deal or no deal?
That question took on a more urgent tone last week, when President Trump walked away from the talks with North Korea empty-handed. Until then, the logical assumption was that because of domestic political need and a stated admiration for the North Korean dictator, Kim Jong Un, a deal of some sort would be reached in Vietnam. Trump’s willingness to take no deal over a bad deal there has some questioning whether the same will be true when it comes to the trade talks with China.
The other way of looking at it is that now Trump will be even more desperate for something that could be called a “win,” making a deal of some kind more likely than it was last week. That more widespread view has led to a renewed focus on not just whether a deal is agreed at all, but also the substance of any agreement. Lifting or reducing the existing tariffs would be welcome of course, but if we end up worse off than before this “crisis” was created, the market is likely to react negatively.
It would suit both sides to do away with, or at least significantly reduce existing tariffs, but there is another sticking point to negotiations, one where one side will emerge a clear winner.
Traders are increasingly focused on changes to the way American companies are required to do business in China. In the past, they were required to enter into some kind of joint venture or give access to their intellectual property (IP) in some other way, and the hope is that those restrictions will be removed, allowing better access to the massive Chinese market. The problem, however, is that those rules are not really about economics.
As China embraces a “free” market economy, it is increasingly easy to forget that it is still a one-party state and a totalitarian regime. To most American commentators, the benefits to consumers of access to U.S. products are so clear that denying them seems ridiculous, but in China, everything has to be seen in terms of how it benefits or harms the Party and their hold on power. The benefit to Chinese companies of gaining access to the secrets of U.S. corporations may be worth trading for increased inward investment, but the benefit to the Chinese government is much more valuable.
There are indications that Trump, aware of that and desperate for a deal, has already conceded on that point. If you Google “Trump China intellectual property” you get links to several statements made on the subject in October and November, but nothing since. A deal on trade with China that doesn’t address that issue would be seen by the market as a disappointment ... and that is looking increasingly likely.
There is still a chance, however slight, that Trump will once again walk away from negotiations with nothing, and even if a deal is reached, there is a good chance that it will disappoint.
When you add in the “buy the rumor, sell the fact” effect that is always possible after a runup as strong as we have seen in stocks since Christmas, trading in expectation of a good deal and a positive reaction looks extremely risky.
With earnings season over and Jerome Powell’s testimony to Congress restating the Fed’s intent to be cautious about rate hikes moving forward, trade is now the only one of the big three worries that drove the drop at the end of last year remaining (the third being the government shutdown).
Traders and investors will therefore be focused on that subject and increasingly asking questions that go beyond deal or no deal. Good deal or bad deal is now looking like a more relevant question and while the initial reaction to any announced deal would undoubtedly be positive, the devil will be in the details.
There is just too much chance of disappointment in those details, so from a risk/reward perspective, betting against a deal, or at least delaying any new long positions, makes the most sense for investors at this point.