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Don't Buy Into Dip, Stocks Will Plunge Even Lower

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Thursday, 11 October 2018 08:26 AM Current | Bio | Archive

U.S. equity markets seem to be finally waking up to some of the likely effects of the U.S. trade tariffs that are in effect and are coming.

Taxing trade with tariffs will always hurt equities more than it will hurt the economy.

Now, around about 80 percent of global trade is conducted by multinational corporations, meaning listed companies, generally speaking.

However, the so-called Buffet Indictor, as of today October 11, shows that U.S. total market cap of the Wilshire stands at about 147 percent of U.S. GDP, which is unsurprisingly qualified as significantly overvalued.  

Besides that, it’s also a fact that a bit less than half of S&P earnings come from outside the United States.

All this and of course a lot of other things is why the performance of the U.S. equity market is a very, very different thing from the performance of the U.S. economy.

Putting tariffs on trade or taxing trade does matter to equities more than it matters to the economy at large. Taxing or threatening to tax U.S. firms that use Chinese technology’s inputs is also likely to have a very focused negative effect on U.S. technology companies, and the U.S. equity markets are disproportionally focused on technology.

There is evidence that U.S. companies are feeling the effects of earlier tariffs on trade.

For example, when about a month ago President Donald Trump threatened to impose tariffs on practically all Chinese imports, an impressive list of important U.S. companies commented negatively on the news, saying for example:

  • Dell Technologies said the proposed tariffs will increase costs of vital parts and components for its U.S. services and manufacturing operations.
  • Dell added that the tariffs on desktops/servers, computer parts, network switches could result in “serious damage” to the company and its employees.
  • Intel Corp said proposed tariffs would negatively affect U.S. businesses and “stifle advancements” in telecom infrastructure, including next generation technologies like 5G.

The company said the tariffs will raise costs for U.S.-based technology companies that manufacture ICT products such as desktop computers, laptops and servers.

Trump Says the Fed is Going Loco

President Trump slammed the Federal Reserve as “going loco” for its interest-rate increases this year in comments hours after the worst U.S. stock market sell-off since February.

Trump said in a telephone interview on Fox News late Wednesday night the market plunge wasn’t because of his trade conflict with China: “That wasn’t it. The problem I have is with the Fed,” he said. “The Fed is going wild. They’re raising interest rates and it’s ridiculous,” he said.

“That’s not the problem,” he said about the trade standoff. “The problem in my opinion is the Fed. The Fed is going loco.”

About the decline in U.S. stocks Mr. Trump also said: “I think it’s good. Actually, it’s a correction that we’ve been waiting for a long time. But I really disagree with what the Fed is doing."

Treasury Secretary Steven Mnuchin echoed those sentiments in an interview in Bali, Indonesia earlier today, saying markets can overshoot in either direction and the slump is not particularly surprising. Markets are not efficient, and markets move in both directions and at times they overshoot in both directions. The fundamentals of the U.S. economy continue to be extremely strong, I think that’s why the stock market has performed as well as it has. The fact that there’s somewhat of a correction given how much the market has gone up is not particularly surprising.”

That is of course one interpretation.

Another interpretation is that the Federal Reserve is perfectly sane and is currently running with a ‘real’ Fed funds rate that is ‘barely’ positive. The economy is at full employment and has had a deficit financed tax cut. It’s somewhere between extremely difficult and impossible to suggest that there is anything wrong with the Fed’s policy so far.

It is worth remembering that the Federal Reserve is unlikely to be too concerned by equity markets moves. A very large number of Americans do not own equity and most of those that do own equity do not own very much.

While market moves are confined to reacting to the trade dispute with China, the Fed is likely to be OK with the situation.

Volatility is likely to continue, but the underlying economic fundamentals are likely to remain relatively good.

As an investor, not a trader, I personally wouldn’t buy the dip yet. I’m convinced there is still much more to come.

Etienne "Hans" Parisis is a bank economist who has advised investors on financial markets and international investments.

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Volatility is likely to continue, but the underlying economic fundamentals are likely to remain relatively good.
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Thursday, 11 October 2018 08:26 AM
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