This week the markets shrugged off the prospect of a trade war with some our best friends as Trump announced tariffs on steel and aluminum with Canada, The EU, China, Japan and Mexico.
The Russell 2000 ( IWM) and the NASDQ100 ( QQQ) both closed up over 1% by the close on Friday, with the Dow Industrials closing down-.63%. The Wall Street Journal , prominent investors and business owners have been completely confused as to the purpose of such actions since the victims of the tariffs and a possible trade war are domestic companies, and the jobs tariffs were supposed to protect.
So the logical questions to ask is what is Mr. Market thinking, or why did it shrug off the prospect of a trade war. Well, when trading the markets politics come in second after economics so unless the Fed dramatically hikes rates to preempt a big rise in commodities prices due the to the tariffs, stocks will likely rise until they don’t. This type of situation usually culminates with massive inflation, and or a full out trade war. The end result is much lower global trade which crushes earnings and stock prices.
On the other hand, if the Fed raises rates faster than current expectations it would mark the end of a 30 year downtrend in rates and put more immediate pressure on equities.
The highlights of this week’s market action are the following:
- Long term rates dropped easing pressure on equities for the moment
- Volatility remains at a higher level from last week even after the move to new highs in the IWM which means at the this very moment the volatility indicator is not convinced that the move up will last
- Three of our five Risk on indicators recovered nicely after being pummeled early in the week
- Junk debt versus US government debt is still indicating Risk Off and could be the canary in the coal mine
- Emerging markets are worth watching and might have found support as it is sitting on long term support on a relative basis to US Equities.
The final takeaway is that in the short term markets respond based on human behavior and longer term ( looking forward about 10 years) to valuation metrics, so with that being said, we would not be surprised to see a blow off top in the near future and eventually, a very nasty selloff from a party that has lasted way to long.