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Stocks Soar as China Gives Trade Peace a Chance

By John Persinos on April 10, 2018

Make trade peace, not war. That was the message from China today. Stocks jumped on the news.

In a speech Tuesday to business leaders in China, Chinese President Xi Jinping considerably softened his country’s stance on trade. Xi promised to slash import tariffs, open China’s economy to outside investment, and protect the intellectual property of foreign firms. Specifically, Xi said his government would “significantly lower” tariffs on vehicle imports this year.

Perhaps Mr. Xi had dusted off his old John Lennon albums and was inspired by “Give Peace a Chance.” Regardless, the main indices soared today in a relief rally that saw stocks rise in all sectors. Technology and energy shares led the advance.

But it would be a mistake to interpret Xi’s remarks as capitulation. By no means did Beijing blink.

Keep in mind that many of the measures Xi mentioned on Tuesday are ones China already has proposed. It appears that Xi’s real goal was to calm jittery financial markets, not appease President Trump. This is the “Year of the Dog” in China. But the dog didn’t roll over.

Marxist-Lennonism…

That said, investors were quite content with Red China’s ostensible olive branch. The latest inflation data also provided encouragement. The Labor Department reported today that its producer price index (PPI) for final demand rose 0.3% in March after increasing 0.2% in February. That boosted the PPI’s year-over-year increase to 3.0% from 2.8% in February.

Investors interpreted the latest PPI report as positive. The numbers showed that inflation, while rising, isn’t hot enough to force the Federal Reserve’s hand into raising interest rates more aggressively than planned.

Oil prices also shot higher today, as investors expected economic growth to stoke energy demand. The U.S. benchmark West Texas Intermediate rose 3.67% to close at $65.75 per barrel. Brent North Sea crude, on which international oils are based, rose 2.49% to close at $71.14/bbl. The benchmark Energy Select Sector SPDR ETF (XLE) spiked 3.31%, reaching its highest level since November 2016.

As this chart shows, oil prices have rallied over the past 12 months (the data is from the U.S. Energy Information Administration):

Production cuts have pushed up oil prices, lifting energy equities. The Saudi Arabia-brokered deal between OPEC and non-OPEC energy giant Russia is holding firm.

Oil and gas prices seem to have found a bottom, which should prove a stabilizing force for the broader markets.

Don’t tug on Shiller’s CAPE…

In today’s “post-truth” political environment, conventional rules and facts don’t seem to apply. But the spin doctors and misinformation gurus can’t repeal the laws of finance.

Even after the 10% correction we witnessed in the first quarter, stocks remain pricey by almost every standard valuation measure. My preferred yardstick is the cyclically adjusted price-to-earnings ratio (CAPE). This time-proven metric is flashing a warning sign.

Devised by Robert Shiller of Yale University, CAPE averages corporate profits over 10 years. The ratio determines whether a stock is undervalued or overvalued by comparing its current market price to its inflation adjusted historical earnings record.

The CAPE ratio is a more accurate valuation indicator than the traditional price-to-earnings ratio (P/E) because it eliminates fluctuations of the ratio caused by variations of profit margins during business cycles.

The CAPE ratio for the S&P 500 now stands at 31.06, which is 85% higher than the historical mean of 16.8. It’s also higher than the reading of 30, which occurred immediately before the market crash of 1929 that ushered in the Great Depression.

The CAPE metric gained popular use during the dot.com bubble in the late 1990s, when Shiller correctly warned that tech stocks were absurdly overvalued and poised for collapse.

The most likely trigger for another steep decline right now is headline risk. We got a bitter taste of headline risk yesterday, when news broke that the FBI had raided the offices and hotel room of President Trump’s lawyer Michael Cohen.

The bombshell report about the FBI raids broke on Monday at about 3:15 p.m. The major indices, which had been soaring, promptly went into free fall. At its session high, the Dow Jones Industrial Average had been up by as much as 440 points. By the closing bell, the Dow was up by only 46.34 points. That’s a dizzying fall in a short amount of time.

The lesson here is that the stock market remains extraordinarily vulnerable to splashy news headlines, of which there is no shortage.

Consider taking profits from your portfolio’s growth stocks that have run up in price and which are now overvalued compared to their fundamentals. Keep the cash handy, for bargain hunting when the next massive sell-off hits. Volatility is unnerving, but it also provides opportunities for value investors. Peace out.

Tuesday Market Wrap

  • DJIA: +1.79% or +428.90 points to close at 24,408.00
  • S&P 500: +1.67% or +43.71 points to close at 2,656.87
  • Nasdaq: +2.07% or +143.96 points to close at 7,094.30

Tuesday’s Big Gainers

Payment solutions firm targeted for acquisition.

Analysts bullish on drug maker.

Financial data firm rises on easing of trade tensions.

Tuesday’s Big Decliners

Biotech’s Alzheimer’s drug flunks late-stage clinical study.

Biotech hit by subdued earnings estimates from analysts.

Kitchenware maker lowers quarterly guidance.

Letters to the Editor

“How do trade tensions affect small-cap stocks?” — Dave F.

Trump’s “America First” protectionist policies, which pose a threat to export-dependent giants, would actually benefit U.S. small caps. The majority of small caps derive the bulk of their sales domestically, which means that trade wars tend to hurt them less.

Another advantage for small companies is the Trump administration’s determination to lessen regulations against the financial services sector. That in turn makes it easier for regional banks to give loans to small companies.

Got questions about global trade anxieties and how they could affect your portfolio? Drop me a line: mailbag@investingdaily.com

John Persinos is managing editor of Personal Finance and chief investment strategist of Breakthrough Tech Profits.

 


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