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Trade War Truce: You Might Want to ‘Sell the News’

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Trade war truce

After meeting with President Jinping, President Trump put more tariffs on hold for now. Technically, President Trump could impose tariffs on another $300 billion worth of Chinese goods. Markets celebrated the news about the trade war truce on July 1. The S&P 500 (SPY) gained 0.77%. The S&P 500 had its best first half in many years.

Easing Huawei sanctions also helped propel chipmaker stocks. Broadcom (AVGO), Qualcomm (QCOM), Micron (MU), Intel (INTC), and NVIDIA (NVDA) gained 4.3%, 1.9%, 3.9%, 0.38%, and 1.2%, respectively, on July 1. According to a CNBC report, Qualcomm, Micron, NVIDIA, Broadcom, and Intel have a 67%, 66%, 53%, 49%, and 42%, respectively, revenue exposure to China.

Economic data

While the markets were trading sharply higher in early hours on July 1, they pared the gains as the day progressed. As we noted in Soft Economic Data Could Derail Sentiments after G20 Bonhomie, the manufacturing PMI data on July 1 showed a deepening slowdown across the globe. The data released by IHS Markit showed a contraction in Chinese manufacturing activity. The Eurozone’s manufacturing PMI was worse than what the flash reading showed. While the US manufacturing PMI was better than what the flash reading showed, it was the second-lowest reading since September 2009. Chris Williamson, a chief business economist at IHS Markit, noted in the PMI release that “US manufacturers reported business conditions to have remained the toughest for nearly a decade in June. The past two months have seen the lowest readings since the height of the global financial crisis in 2009.”

Earnings

While the noise about US-China trade relations has been driving markets for the last two months, investors also need to pay attention to corporate earnings. According to a FactSet report, S&P 500 companies are expected to report a 2.6% YoY (year-over-year) decline in their second-quarter earnings. The S&P 500’s earnings fell YoY in the first quarter. If the earnings fall YoY in the second quarter, it would be the first time since 2016 that the S&P 500’s earnings fall for two consecutive quarters. The report also said, “For Q2 2019, 87 S&P 500 companies have issued negative EPS guidance and 26 S&P 500 companies have issued positive EPS guidance.” From a valuation standpoint, markets don’t look cheap either. The S&P 500 is trading at a forward PE ratio of 16.6x. The ratio is above the five-year and ten-year average. To compound the valuation concerns, corporate earnings growth has slowed down.

Would the trade war truce help?

The trade war truce helps clear some anxiety from the markets. However, the markets partially priced in a trade war truce last month after President Trump and President Jinping’s phone conference. After the call, President Trump confirmed that the two leaders would be meeting at the G20 summit. There have been two pauses in the US-China trade war. In May 2018, the two sides decided to put the trade war on hold. In December, the two countries decided on a truce to make way for the trade talks. While the May truce only lasted a few days, the December truce lasted for about five months. Eventually, President Trump increased tariffs on Chinese goods. He accused China of reneging its previous commitments.

The trade war truce wouldn’t offset the current economic slowdown. An old adage says that “buy the rumor, sell the news.” Regarding the US-China trade war truce, it might be the time to “sell the news.” However, markets might not make a major reversal from here. The upside looks capped from here with more downside risk than upside potential. Moving forward, the baton lies with corporate earnings.

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