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Stocks Pull U-Turn, Careen Lower on Trade Turmoil

Wall Street today pulled a screeching 180 degree turn and crashed.

On Wednesday morning, the major stock averages jumped sharply higher, as the White House softened its threats to restrict Chinese investments in U.S. technology firms.

However, in the afternoon, the indices abruptly changed course and gains rapidly evaporated, as investors were confronted with new and mixed messages on trade. The Dow Jones Industrial Average, S&P 500 and Nasdaq all closed deeply in the red. The tech sector fell the hardest today.

At its session high today, the Dow was up by 280 points. The index finished 165.52 points lower. The CBOE Volatility Index (VIX) jumped 13.07%.

When the Trump team first threatened technology export controls Monday, the stock market tanked. In response to the backlash, the administration backpedaled today, saying that it would use a “strengthened security review process” for all countries, instead of imposing specific restrictions on China.

Investors at first cheered the news today, but the mood soured when President Trump called on Congress to restrict Chinese investment in the U.S. Making matters worse, trade advisor Peter Navarro (a trade hawk) sent signals that conflicted with those of U.S. Treasury Secretary Steve Mnuchin (a trade moderate).

Every new day serves up a big helping of headline risk.

On Wednesday, the Shanghai Composite Index fell 1.10%, underscoring the increasing strain on the world’s number two economy from the trade conflict. Chinese equities are now 20% below their recent high in January, putting them in bear market territory.

China’s Ministry of Commerce vowed Wednesday that attempts to restrict Chinese investment in technology would be met with swift retaliation.

Further evidence that the trade war is damaging the economy arrived today, in the latest numbers for durable goods orders.

The U.S. Census Bureau reported Wednesday that orders for durable goods fell 0.6% in May following a revised 1% decline in April. Durable goods are products made to last at least three years. Driving the decline was the largest drop in new orders for cars and trucks since 2015.

Analysts speculate that the fall in demand for durable goods largely stemmed from uncertainties and canceled orders caused by trade conflict.

The high stakes for tech…

Technology stocks face high stakes in the trade war. The broader market’s reliance on tech stocks for upside momentum magnifies the risk for all investors.

The technology sector now accounts for more than a quarter of the total market capitalization of the S&P 500 index, the largest percentage since the peak of the dotcom bubble in 1999, when tech represented more than 30% of the index.

The bull market’s increasing reliance on technology stocks, combined with high valuations of tech shares, raises the possibility that we’re facing another tech bubble.

And yet, despite a few speed bumps along the way, the tech sector has enjoyed a long period of market-beating performance. Tech stocks outperformed in 2017 and they continue to outpace all other sectors year-to-date (see chart, compiled with Bloomberg data):

Here’s the good news: Technology benefits from several tailwinds that help offset trade protectionism.

The 2017 Trump tax cut bill allows cash hoards repatriated from overseas to get taxed domestically at a lower rate. The tax windfall already is prompting tech firms to initiate share repurchase programs and mergers.

Corporate earnings as a whole are expected to remain strong this quarter, which should boost spending on information technology.

For the second quarter of 2018, the estimated year-over-year earnings growth rate for the S&P 500 is 19%, according to research firm FactSet. If 19% is the actual growth rate for the quarter, it will mark the second highest earnings growth since the first quarter of 2011, when it came in at 19.5%.

At the sector level, analysts are most optimistic about technology (59%), followed by health care (59%) and energy (59%). The three sectors have the highest percentages of “buy” ratings.

Rising interest rates threaten the broader bull market, but here again, tech stocks have an advantage.

According to Evercore ISI Research, tech sector relative performance has had a 36% correlation with 10-year Treasury yields, the highest of any sector. In other words, as yields move higher, tech has demonstrated a greater tendency to beat the market than any other sector.

The takeaway: Stay invested in technology, but pare back your stakes in the overvalued mega-caps. Smart bets now are small- and mid-cap tech stocks with reasonable valuations and less overseas exposure. Trade chaos won’t end anytime soon.

One final piece of advice: Don’t be swayed by the sensationalism of financial news channels. They only care about ratings and advertising dollars, not your portfolio. They exist to entertain, not inform. In particular, on the subject of trade, their level of misinformation has been astounding. Better yet, just turn them off.

Wednesday Market Wrap

  • DJIA: -0.68% or -165.52 points to close at 24,117.59
  • S&P 500: -0.86% or -23.43 points to close at 2,699.63
  • Nasdaq: -1.54% or -116.54 points to close at 7,445.08

Wednesday’s Big Gainers 

  • Global Blood Therapeutics (NSDQ: GBT) +16.53%

Bargain hunters snap up biotech after its sell-off.

  • Ensco (NYSE: ESV) +8.46%

Offshore oil and gas driller expands operations. 

  • Vaalco Energy (NYSE: EGY) +6.18%

Energy producer reduces debt, boosts output.

Wednesday’s Big Decliners

  • China Southern Airlines (NYSE: ZNH) -10.13%

Trade war weighs on country’s airline industry.

  • WageWorks (NYSE: WAGE) -7.80%

Benefits administrator bedeviled by financial scandal.

  • Conagra Brands (NYSE: CAG) -7.35%

Wall Street looks askance at food producer’s merger deal.

Letters to the Editor

“What is a good hedge and what does it hedge against?” — Richard E.

Prepare for inflation and higher interest rates by considering these three moves:

1) Diversify into precious metals (e.g., gold and silver) and commodities such as agriculture-linked investments.

2) Allocate a portion of your portfolio to Treasury Inflation-Protected Securities (TIPS).

3) Park at least 20% of your portfolio in cash and take partial gains from your biggest growth stock winners.

Questions about hedges? Drop me a line: mailbag@investingdaily.com

 John Persinos is managing editor at Investing Daily.

 


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