The Zigmont Report (Recap for 5/13/19)

Mike Zigmont

Mike Zigmont, author of the Zigmont Report, is a partner at New York-based Harvest Volatility Management, a hedge fund with over $10B AUM, offering volatility management solutions to its investor base worldwide.  Mike has been publishing his daily newsletter (Monday-Friday) privately for the firm’s investors and his personal contacts in the investment business since 2008, sending it daily shortly after the market close.

The opinions expressed below are my own and do not necessarily represent those of Harvest Volatility Management, LLC.

Retaliation.  China announced their response to the increased US tariffs.  They will implement higher tariffs too.  The tit-for-tat escalation of punitive actions should not surprise us.  Why it surprised the market is a mystery to me – but it did.  Overseas markets fell about a percent and our market fell more than two.  The intraday low was pretty nasty with the S&P dropping 80 handles (2.8%).  The bounce off the low was helped by encouraging tweets from President Trump and comments by Treasury Secretary Mnuchin.  Capital flow was heavy at 126% but not as heavy as I would have expected.  Something like today should’ve sent flow above 150%.  Maybe that’s a sign that while the price action is nasty the investing population isn’t as panicked as it may appear?

Let’s talk big picture.

The world isn’t that different than Friday.  China retaliated, as we all expected.  The retaliation involves increasing tariffs to 25% on products that have existing tariffs in the 5-10% range.  The universe of goods taxed is $60 billion per year.  The higher tariffs go into effect June 1.

Let’s review.  There are two major takeaways.

  1. This is a smaller than what the US did.
    1. Due to the trade imbalance, China simply cannot match our tariffs
    2. Despite this technical constraint, there is almost certainly a constructive signal here too
  2. The response still has to go into effect
    1. This suggests patience and a willingness to come to an agreement while needing to save face

Who knows how long it takes for the US and China to reach a full and constructive agreement but the response from China, seems encouraging to me.  I think that the trade war rhetoric is more a function of the press plus investor fear than the actual events unfolding.

That said, I don’t think dip-buyers should be jumping in on the hopes of a 100-plus point rally because of a surprise agreement.

Like last week, while trade is the front-and-center issue of the market, the underlying reality is the market’s repricing of risk.  Even if trade with China is settled quickly and cleanly, the valuations of the market are still lofty and there are macro considerations which need to be respected.  A US/China trade agreement may take some recession risk off the table and may even boost GDP expectations for both countries but the earnings growth outlooks aren’t rosy enough to justify expanding valuations.

My point is simply that the US/China trade issue is a Pandora’s Box for the market.  Risk-awareness escaped  the box.  We are not in a market where trade is the one-and-only issue.  There are lots of issues.  The market ignored them all 2-plus weeks ago.  Now it does not.  That won’t change.

Obviously a pop higher on trade progress lies ahead but I do not think new highs lie ahead.  We were way too optimistic about *everything* last month.  With renewed attention on risk, we will not go back to a Pollyannish mindset.

What should we do?

Prepare for swings but don’t project a trend.  Emotions are at work because worldviews are in flux.  There’s no obvious valuation that we *should* head towards so investors are probably going to turn to technicals.  Moving averages suggest a range of 2750 to 2860.

Seems like a respectable range for the next week.  I think playing the range makes sense.

See you tomorrow.