Last week was not great for investors, and the market mayhem continued Monday. As the China trade talks broke down Friday, investors were scurrying to figure out what it all meant. In this post, we will discuss the cause of this recent turmoil, what we might expect in the near term, and take a brief look at the U.S. economy.
Last Week in Review
Stock prices declined last week by 2.12% (DJIA closing levels from May 3rd to May 10th). Why did the market react so negatively? Investors assumed a trade deal would be reached, which was priced into the market. The expectation of an agreement has been one factor propelling stocks higher. When an agreement seemed in doubt, selling pressure rose and stock prices fell. I believe there will be an agreement at some point. China’s economy is heavily dependent on exports and needs a deal more than the U.S needs it.
To illustrate, the four components of U.S. GDP are consumer spending, business spending, government spending and net exports. The following chart shows how much each has contributed to total GDP (SAAR) from June 30, 1947, through March 31, 2018. Note that consumer spending is easily the most important while net exports are the least. Therefore, it is this authors opinion that a trade deal, though important, is not as important as the U.S. markets seem to indicate. Conversely, the Chinese economy relies heavily on exports. In fact, in 2018, Chinese exports declined 2.7% and the Chinese economy experienced its weakest GDP growth rate in 28 years.
What caused the initial and ongoing turmoil?
Sunday afternoon, May 5 – in advance of the May 10 trade meeting with Chinese officials – President Trump went on the offensive (which may have been a bit offensive to China). In a tweet, he stated he would increase tariffs from 10% to 25% on $200 billion of Chinese exports. He further stated he would impose a 25% tariff on an additional $325 billion in Chinese exports “shortly.” Understandably, investors became nervous. The following chart shows the market’s reaction. In it, we find the daily movement of the Dow Jones Industrial Average from Friday, May 3 to early Thursday morning, May 9. Notice where it opened and closed each day.
Because of the Trump tweet, the DJIA opened 465 points lower on Monday than it had closed the previous Friday (A). While Chinese stocks fell about 5.0% Monday, the DJIA rebounded, losing only 66 points or 0.2%. That was a very good sign. The following morning (Tuesday), the DJIA opened lower, but to a lesser extent. Unlike Monday when it rallied, stock prices fell sharply throughout the day. Wednesday’s opening was about the same as Tuesday’s close (another good sign). Thursday morning stocks opened lower than Wednesday’s close (C). Thursdays close to Friday’s opening was not much different (not shown) and this morning’s opening was significantly lower than last Friday’s close, as stocks continue to tumble.
While I believe this is a lot of noise, I still believe the negative reaction is overrated and we will look back at this as another bump in the long and winding road. I do not believe the road will wash out! Perhaps the difficulty lies with U.S. companies that have deals in place with China to provide various goods. Depending on the terms of these agreements, it could lead to higher consumer prices. This is a primary concern.
To understand why the president would tweet as he did, we must understand the strategy behind it.