Should Stock Investors Trust the Bounce?

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Yesterday, stocks had their second-best day of the year. The Dow gained over 500 points and the Nasdaq nearly 200, or around 2 and 2.5% respectively, and early signs this morning are for more of the same, with futures indicating that the Dow will open up another 150 points or so. For investors, that is very welcome after a month of declines, but the obvious question is which is real, the drop or the bounce?

In order to answer that, we must look at the probable reasons for both.

There are several reasons why stocks have fallen over the last month or so, but the trade situation is foremost among them. There is increasing evidence that the tariffs are impacting China negatively, which is presumably the idea, but the market is beginning to realize that that isn’t necessarily a win for U.S. corporations, given it effect on global growth. Add in the threat of tariffs on Mexico that are a more blatant example of politicking and have nothing to do with economics, and the pessimism is understandable.

The existing tariffs and the threat of others is also partly responsible for the other reason stocks have been falling: weaker U.S. data. The housing market, for example, is slowing even as rates are falling, suggesting an uncertainty among consumers, and manufacturing PMI last month hit its lowest level in a decade.

The bounce seems to also be based on multiple things. It started when there were conciliatory comments from the Chinese government about trade, then gained pace yesterday when the Fed Chair Jerome Powell suggested in a speech that rate cuts may be coming in the near future. It has also been fueled by reports that a large number of Senate Republicans are opposed to tariffs on Mexico.

The problem is that while all those things offer hope, none actually change the situation.

The Chinese government has swung from belligerence to conciliation several times during this dispute, which only highlights the fact that they are reacting, not leading the issue. This is a trade war started and controlled by Donald Trump and he will ultimately decide when it ends. The bad news for investors is that for as long as his base supports him and ignores the downside, a resolution doesn’t make political sense.

Powell’s comments, that the Fed would “...act as appropriate to sustain the expansion” have the capacity to offer more long-term support for stocks, but there is a problem there too. I have said on many occasions that low rates can drive stocks higher, and that while they remain low, equities are the best place to be. The key word, though, is “remain.”

It is one thing to leave rates where they are to support economic expansion, but quite another to cut them in anticipation of weakness. The first drives stocks ever higher as they look attractive relative to bonds, the second is a warning.

Expecting a good resolution to the Mexico tariffs issue based on the words of a few Senators is simply a triumph of hope over experience. When Trump promised this week that they would be imposed, he seemed confident of that despite what Senators were saying. Based on the evidence so far, he is right to be.

Firstly, while several Republicans have uttered concerned words at various points during this Presidency, a rebellion against Trump has been conspicuous by its absence. Secondly, while the constitution clearly gives Congress alone the power to levy tariffs, that power was ceded to the executive branch a long time ago. There is a chance that they will be avoided, but if so, it will probably be because Mexico makes, or at least promises to make, the changes Trump is demanding.

It is, I suppose, understandable that stocks have bounced so hard in the last couple of days. There has been a confluence of news stories that shed a more positive light on the main things that have caused stocks to drop, but so far, they offer only hope, not substance. At some point, the issues will be resolved and there is more chance of that today than there was as this week began, but until they are, traders and investors should brace themselves for a return to the downward trend.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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Martin Tillier

Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.

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