US/China tariff news spurs equity rally

By David Morrison  |  11/12/2018 15:40

The Dow reversed a 500-point drop to end yesterday’s session in positive territory. The buying continued this morning after China indicated it would cut auto tariffs

Global stock indices appeared to be in melt-down yesterday afternoon in a move which saw the S&P 500 hit its lowest intra-day low since early April this year. The benchmark US index broke below 2,600 with many traders forecasting a retest of the lows seen in February. But by the close all the US majors had made back earlier losses to end in the black in a dramatic short-covering rally led by the tech sector. Some analysts had warned previously that equities were oversold, if not technically, then from the point of view of professional positioning. This showed up in data courtesy of Nomura’s Charlie McElligott (h/t Zero Hedge) which showed that Commodity Trading Advisors (basically professionals who run money) were effectively “maximum short” of every major global stock index except the NASDAQ 100 and Brazil’s Bovespa. This meant that there was a strong probability that given a bit of a trigger, equities could bounce and set off a surge of short-covering. That indeed happened as stories emerged of a thawing in US/China trade tensions. The buying accelerated once the S&P broke back above 2,600 and there has been a continuation of the move today.

China auto tariff cut

Stories of a US/China trade thaw followed news of a call between Chinese Vice Premier Liu He, US Treasury Secretary Mnuchin and Trade Representative Lighthizer to discuss a “road map” on trade talks. Then came a report this morning saying that China was preparing to reduce tariffs on vehicle imports back to 15% from 40%. While all this sounds incredibly positive, it’s worth putting it in some perspective. Firstly, the US negotiating team were very quick to boast of ‘Chinese concessions’, including a cut on auto tariffs straight after the G20 meeting in Argentina a few weeks ago. But China failed to confirm this and suddenly observers were pondering if anything had been formally agreed. Then came a breakdown in relations when it was revealed that, as Presidents Trump and Xi Jinping were sitting down to dinner, Huawei CFO Meng Wanzhou was being arrested in Canada on a US warrant linked to Iranian sanctions-busting. Huawei is a very politically-sensitive company given its vast reach and amid cybersecurity fears, and Ms Wanzhou has not yet been bailed. So, while a little tariff tempering may be enough to trigger a short-covering equity market rally, it doesn’t mean that US and China’s trade disagreements are settled. Trump has promised to hold off from hiking tariffs to 25% from 10% until 1^st March next year. But if issues over intellectual property theft and cybersecurity aren’t resolved, those tariffs will go ahead. In the meantime, US and European stock indices are rallying.

The technical picture

If we look at the S&P 500, there are a few important levels to keep an eye on. Firstly, yesterday’s break below and subsequent bounce above 2,620 means that this remains a crucial level of support. What the bears need to see to raise the probability of a bigger sell-off is the index falling and then consolidating below here. There’s also an obvious area of resistance around 2,800 which has been tested and rejected three times since October. But before reaching here, the S&P will have to break and hold above a band of resistance which has formed through the convergence of the 50,100 and 200-day moving averages. In this chart I’ve used the exponential moving average which means a band between 2,735 and 2,775, but this can change depending on which moving average you use. Nevertheless, adding to the bearish technical picture is the fact that the 50-day has crossed below both the 100 and 200. If the 100 were to also cross below the 200, then that would be a fair indication that the bullish trend that we’ve enjoyed for so many years has turned bearish. Such changes in trend take time to work themselves out. But in the meantime, the Relative Strength Indicator suggests that the market is neither oversold nor overbought, no matter what long-short professional positioning tells us.
 
 
 
 
 
 
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