Don’t look down!

Don’t look down!  Equity markets climbed yesterday, some indices scaling to some new heights while others were content to put in a solid day’s climb.  Equity markets started the session poised to follow on the prior day’s rally as traders began to contemplate the positive effects of the good earnings season ahead.  With the President traveling and little time to log into twitter traders were able to push aside trade fears and talk of geopolitics.  The S&P500 traded in a relatively small range but managed to close just above a fairly strong resistance level of 2791 further adding to a constructive formation (see chart 4 in my chartbook).  The S&P will encounter more resistance at the round 2800 and will use its 2774 Fibonacci line as support.  The Dow Jones Industrial Average also had a very positive close above its strong resistance line of 24858 closing just below its high of the day (see chart 6 in my chartbook).  The Dow’s trading range will be 24567 support through 25000 resistance.  Despite two very positive sessions the DJI chart is not yet constructive.  The small cap Russell 2000 had an interesting session showing its colors as an independent.  The index, unlike its larger-cap cohorts traded up to its 1708 resistance line and high before giving up gains and closing down for the session (see chart 7 in my chartbook).  With a short term rally that started last week, traders took profits out of the small caps and placed bets on larger cap names.  This could indicate that traders are digesting the trade challenges that have been hampering markets.  Speaking of challenges, the job of the Federal reserve got a bit tougher yesterday in a small technical way.  It has been a while since I discussed the shape of the yield curve, which was very much on the minds of the Fed governors according to the FOMC meeting minutes release last week.  Recall that an inverted yield curve has been one of the best indicators for an upcoming recession.  The Federal Reserve has very firm control over shorter maturities and, in fact directly manipulated them with its monetary policy tools.  The Fed’s raising rates brings the front end of the yield curve up.  The longer maturities are controlled more directly by investors, and a recent rally in 10 year maturities pushes longer yields down causing a further flattening of the yield curve.  While the Fed does have some tools to address this, the longer end of the curve tends to be more vagrant.  Remember that the Fed is in the process of unwinding its large balance sheet which is part of the process known as normalization.  All of this fancy stuff means that the Fed is holding on to a lot of longer maturity bonds which were purchased as part of the quantitative easing process and that they are selling them back into the market.  They can, and most likely will, speed up the selling to put pressure on longer maturity prices in order to push the longer end of the curve up in order to accommodate the 1 or 2 rate hikes it expects to put in place in the later half of the year.  Chart 18 in my chartbook graphically depicts the rapid flattening of the yield curve, which was further accentuated yesterday by a less-than-orderly 3 year treasury note auction.  The 2/10 swap starts today’s session at 27.51 basis points just above its recent low of 26.5.

The Fed’s challenges with the slope of the yield curve are just the beginning.  As one might expect, the FOMC spent a good amount of  time in their policy meeting discussing the effects of a trade war on our late cycle economy.  While it is clear that the effects of tariffs will ultimately drag on GDP, which is the ultimate gauge of our domestic economy’s output, it is not so clear on when, how, and how much.  But one thing is clear, there will be effects and those effects may be quite interesting.  A few weeks ago I talked about the sinking price of soybeans in response to China’s at-the-time proposal to place tariffs on US soybean exports.  China represents the largest export market for soybeans.  Interestingly, anticipating the enactment of the tariffs, soybean farmers rushed record shipments overseas in order to get the product on-shore in order to beat the tariff.  The one time spike in exports is expected to actually have a significant positive impact on the GDP of the quarter.  As of last Friday, the tariffs actually did take effect and they will affect future sales and, of course, the GDP in future quarters.  For some strange reason, many analysts are reluctant to label the ongoing trade dispute as a “trade war”. My regular readers know that I have no reluctance to do so.  Many investors and traders alike are betting that the Trump administration is using the threat of a trade war as a negotiating tactic and that once our goals are achieved all sanctions will be lifted.  Unfortunately, many actual wars begin with the same thesis and most escalate beyond the opening shot across the bow as parties become reluctant to back down in fear of losing public support.  WHILE YOU SLEPT the Trump administration announced plans to levy an additional $200 Billion dollars in tariffs on Chinese imports.  This one hits closer to the bone and affects more consumer-oriented products from electronics and sports equipment to durables such as wash machines.  Don’t worry, your smart phone is safe as they have been “strategically” exempted - we can’t live without those.  If I haven’t said it enough, I will say it again: tariffs and trade wars are bad.  With this latest pronouncement, the Chinese quickly responded with an in-kind threat of retaliation (what a shocker) which will leave traders, recently coming down off of yesterday’s sugar-high rally scratching their heads today.  Expect some volatility in today’s session!  Higher elevations are typically much cooler than lower ones and icy patches tend to develop often causing climbers to slip, lose ground, and even get injured in their quest to reach the peak. Please call me if you have any questions.

daily cheat rag 2018-07-11