foxex: Trade Rally Fades on Rising Uncertainty

Chart Advisor | Focus on the Price

By John Jagerson, CFA, CMT

Monday, February 25, 2019

1. Tariff deadline postponed... to some future date

2. Oil markets reveal risk bias

3. Looking for a dovish Fed chair on Tuesday and Wednesday

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Major Moves

After President Trump postponed the tariffs that US importers would have had to pay on $200 billion of Chinese goods beginning on March 2nd, the S&P 500 hit a new short-term high today. However, a new tariff deadline or a schedule for meetings with Chinese President Xi were not provided by President Trump via his Twitter feed.

The initial rally in US equities faded through the rest of the day as interest rate sensitive sectors like utilities and real estate declined. However, Chinese stock indexes continued to have the best day since 2015 following the trade news. As you can see in the following chart, the Shanghai Composite index reached its full price projection based on the depth of the double bottom pattern formed in January.

S&P 500

The worst performing sectors and stocks in the S&P 500 included just about anything paying a larger than average dividend yield like consumer staples, utilities, and real estate investment trusts (REITs). I would have expected concentrated selling amongst income stocks to be triggered by rising interest rates. Like bond payments, dividend income is less valuable when interest rates rise; that's because the price of stocks that pay a dividend fall.

However, long-term interest rates were only slightly lower for the day, which makes the selling in income sectors look like the first part of a short-term whipsaw. Unless the outlook for interest rates shift, I would expect these same stocks to pop back up over the next two trading sessions.

As you can see in the following chart, the S&P 500 is still struggling against the short-term resistance level I pointed out in Friday's issue of the Chart Advisor newsletter. If we see more definitive news about a timeline when the US/China trade deal will be settled, I would expect the major stock indexes to break resistance.

How Does a Tariff War Work?

3 Sectors Fueling The 2019 Stock Market Rally

Risk Indicators - Oil prices are too high?

From a risk perspective, the outperformance of technology and industrial stocks in the US is a positive sign for the market. However, there appears to be a bias to the downside in oil which could become more of a concern in the short-term if prices continue to fall.

Along with comments on his Twitter feed about the US/China trade deal, President Trump seems to have triggered the selloff in oil early Monday morning by writing "Oil prices getting too high. OPEC, please relax and take it easy. World cannot take a price hike -- fragile!" to his Twitter followers and the media. It's not unexpected for statements by any US president to have an impact on the market, but West Texas Intermediate (WTI) oil prices dropped a surprising 3.3%.

I believe investors should be concerned about the magnitude of the reaction to President Trump's tweet. This reminds me of a similar tweet on November 12th, 2018 when prices were already in decline. The losses accelerated with prices of WTI bottoming out near $42 per barrel.

Lower commodity prices can be a good thing for the economy, but there can be unexpected consequences as well. The energy sector is a significant percentage of the non-consumption portion of the US economy. The "earnings recession" of 2015 was largely driven by a collapse in oil prices that began in 2014.

Besides the complicated relationship oil prices have with the US economy, what today's reaction tells me is that investors have a bias towards taking some of the short-term gains off the table in the energy sector. That is useful information for portfolio and trade planning if we can make estimates about the sectors most likely to surprise to the downside.

As you can see in the following chart, WTI oil futures have recently completed an inverted head and shoulders pattern that today's decline is threatening to invalidate. In my opinion, the pattern is still intact if the price can break back above the neckline of the pattern without forming a new short-term low.

What is an Inverse Head and Shoulders Pattern?

Why Retail Stocks Are The New Big Short

Bottom line: Looking for dovish confirmation

I expect that we will continue to see some news about the US/China trade negotiations this week that could increase volatility. Additionally, traders will be watching the Fed's chair, Jerome Powell, on Tuesday and Wednesday as he provides testimony and answers questions to both houses of Congress. Today's somewhat outsized move in income sectors indicates that investors are nervous about the outlook for interest rates and will be seeking confirmation that Powell's Fed does not plan to raise rates again in the short-term.

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