President Donald Trump’s ever-rising Twitter diplomacy on the China trade war front may be eroding confidence in the market outlook so much so, that the brutal December 2018 lows for stocks could be back in play before year end.
“Oh absolutely [president’s Trump’s tweets on trade are eroding market confidence],” said Diamond Hill Capital Management strategist John McClain on Yahoo Finance’s The First Trade. McClain believes there is rising risk of a U.S. recession happening in early 2020, calling out weakening macroeconomic data across the globe as an important driver. The specter of an escalating trade war — as seen on Friday with the U.S. and China hitting each other with fresh tariffs — therefore only raises the possibility of a deep market correction.
McClain thinks that correction — which would be needed to adjust valuations for slowing global growth and the inability of the Federal Reserve to immediately jumpstart growth — may bring investors back to the Dec. 24, 2018 lows.
“It’s a time not to lose money. You can see a repeat of the fourth quarter last year, say a 15% to 20% draw-down [later this year],” McClain thinks.
Signs of investors losing confidence in the earnings power of Corporate America amidst the trade war are everywhere in these markets. Hedge funds and mutual funds have rotated out of stocks with oversized China sales exposure. That cash has instead been parked into perceived safe havens such as health care stocks and U.S. Treasuries (see recent yield curve inversion).
The small-cap Russell 2000 (^RUT) — often viewed as the de-facto measurement of the health of U.S. centric companies — has lagged the Dow and S&P 500 since mid October 2018. Meanwhile, the Dow Jones Transportation Average (^DJT) has underperformed the broader stock benchmarks going back to early June.
What to expect in the coming months
“It is fears about where the trade war is going that will now weigh even more heavily on financial markets and business investment in the coming months — and that is where the real damage to the US economy will be done,” writes Capital Economics Chief U.S. Economist Paul Ashworth.
Not everyone subscribes to the view the December 2018 lows are in play. But the collective tone on Wall Street is that September — historically never that great for stocks —could be choppy, especially if Trump’s Twitter feed stays crazy active with trade comments.
“I don’t think the December lows are likely in play. The reason being is that we had a global tightening cycle last year and I think people are much more hedged already,” says SunTrust Chief Markets Strategist Keith Lerner. “Could you have a 10% to 15% correction? Sure. But I think it’s unlikely we will go and retest the December lows.”