foxex: Slowing in China Worries Traders

Chart Advisor | INVESTOPEDIA

Focus on the Price

By John Jagerson, CFA, CMT

Monday, January 28, 2019

1. Slowing exports are an issue for US GDP

2. Reaction to bad news surprisingly benign in EM stocks

3. Shutdown uncertainty isn't over

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Major Moves

Something that is often lost in the discussion around the US trade deficit is that the trade balance is comprised of both imports and exports. While it is true that imports greatly outpace exports, the US (as of the latest trade data) is still the world's second-largest exporter. The US is second to China and is running ahead of the third largest, Germany. This matters because exports from the US to both developed and emerging economies, like China, is a critical component of overall economic growth. We learned a little bit more about the cracks in that part of the GDP picture today.

Both Nvidia (NVDA) and Caterpillar (CAT) reported earnings today with disappointing results largely due to slowing growth in China. In both cases, the charts look very similar to an example I used last week in the Chart Advisor newsletter. As you can see in the following chart, Caterpillar was bumping up against its long-term pivot at $135 per share. We've seen this many times before this season: a company bids higher on an improving outlook, then sells off at resistance levels following a disappointing earnings report or guidance statement from management.

S&P 500

This back-and-forth puts the broader S&P 500 index in a tough spot as it continues to struggle against its own resistance/pivot level near $2,640. If cyclical stocks (companies that are sensitive to short-term economic cycles,) like CAT and NVDA continue to fail at their respective resistance levels, investor sentiment may shift in a much more negative direction on a macro level. However, in my view, investors shouldn't see the bad news as terminal for the current rally, as long as services and financial stocks are performing better-than-average. Currently, even on a bad day like this, financials were near breakeven and services were well above average.

Read more:

Balance of Trade

A History of Bear Markets
Understanding the Manufacturing Indexes

Risk Indicators

From a risk perspective, most of the important indicators (high-yield bonds, currencies, and volatility indexes,) remained relatively sanguine today. It's a good sign that we're not seeing any early warning signs from the typical markets. Normally, news from CAT would have led me to expect a sizeable retracement in Chinese stocks which would have helped quantify the overall level of stress in the market even if we didn't see much selling in the US.

Instead, however, Chinese indexes have been surprisingly stable all session. For example, in the following chart of the Hang Seng index (Hong Kong stock index), you can see that the double bottom breakout from Friday's session is still intact. Today's "counterattack" candlestick pattern isn't ideal, but I wouldn't consider it to be a validated bearish signal until we have another negative close through 27,200. What this seems to indicate is that investors have pre-priced slowing in China and therefore another break higher is possible barring additional material and unexpected bad news.

Read more:

What is the Hang Seng Index?

How Double Bottom Patterns Work

How China's Slowdown is Hurting US Earnings

Bottom line: Shutdown worries are ongoing

According to Factset, 71% of the companies in the S&P 500 that have reported earnings so far have exceeded estimates. Although, it is true that expectations have been reduced significantly over the last 90 days, that surprise ratio is in line with the average over the last five years. If the trend continues, the forward P/E ratio (currently 15.4) would be below the average of the last five years, which creates less of a valuation headwind for more gains in 2019.

While I think the evidence is still in favor of additional growth (at least through the second quarter of 2019) the key short-term X factor that needs to be monitored as the remaining 75% of the S&P 500 report their results is how much damage has the government shutdown actually caused the US economy?

Estimates provided by the Congressional Budget Office puts the shutdown costs at -$3 billion in the fourth quarter and another -$8 billion in the first quarter which would reduce GDP by -0.2%. In my experience, the bigger issue is the damage to expectations if further shutdowns are threatened when budget negotiations in Congress are unsuccessful in three weeks. Until we have more information about how those negotiations are proceeding, the major indexes may remain stuck at this pivot level in the short-term.

What is an Earnings Surprise?

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