Trade talks put focus on pullback
02/22/19

●S&P 500 is in the vicinity of its October-December highs

●Working deadline for US-China trade deal is a week away


 

Funny how things work out sometimes. With the clock ticking down on the current March 1 deadline for a US-China trade deal, the US stock market’s current rally recently brought the major indexes fairly close to the resistance implied by their fall 2018 highs.

Technicals, say hello to fundamentals.

Take a look at the following chart of the S&P 500 (SPX), which yesterday made a lower low for only the second time in the past eight trading days:

S&P 500 (SPX), 7/30/18–2/21/19. S&P 500 (SPX) price chart. Getting close.

Source: Power E*TRADE


Even after yesterday’s dip, the SPX was less than 2% from reaching the resistance level (around 2,815) implied by the top of its October–December trading range. Will the market turn lower at this psychological barrier, or push past it?

There are a few moving parts to consider. First, because resistance and support levels represent general zones rather than precise price points, some traders may consider Wednesday’s rally to around 2,790 as close enough to the December 3 high of 2,800 (the last of the three swing highs defining the resistance level) to qualify as a test. Those traders may see yesterday’s mild weakness as the beginning of a possible pullback. Others may expect to see prices push a little closer to (or even above) those October and November highs around 2,815 before any pullback occurs.

Investors tend to get nervous when the market rallies as forcefully as it has over the past couple of months—you know, the whole “climbing a wall of worry” thing. The SPX is pushing a 20% gain off its December 24 low, with only three relatively minor pullbacks or pauses since. Hence the recent chatter about the “need” for the market to pull back,1 or reports the market may be too optimistic about the trade-war situation.2 But let’s break down the likely near-term outcomes:

1. The current trade negotiations fall apart.

2. No deal is reached by the March 1 deadline, but both sides agree to future talks and delay any immediate punitive (tariff) measures.

3. The US and China announce a comprehensive deal.

In the first case, it’s not difficult to imagine a sharp market downturn, although no one can guess how deep or long-lasting it would be. After all, a failure of the current negotiations is unlikely to be the end of the story—future negotiations would likely be proposed after the initial finger-pointing.

In the second case…who knows? But it would be a stretch to call it a “positive,” given how tired of the issue the markets have become. Perhaps a pullback similar to the ones that have unfolded over the past couple of months?

But the third outcome doesn’t necessarily imply a rally, or at least a significant one.

Because at least some of the recent rally has been widely attributed to expectations of a comprehensive trade deal, traders have to consider how much of that bullishness has already been priced into the stock market. While the announcement of a trade deal could certainly be expected to trigger a jump in equities, the question is, how big will it be and how long will it last?

S&P 500 (SPX), 12/17/18–2/21/19. S&P 500 (SPX) price chart. Pullback possibility.

Source: Power E*TRADE


Given all three of the possible outcomes appear to carry at least some risk of a stock pullback, some traders are likely mapping out their game plans. The chart above shows the previous pullback bottomed right around the level of the preceding (January 18) swing high; a similar downturn from current levels would imply the possibility of a move to at least the February 5 high around 2,739.

Beyond that will likely be a matter of how the upcoming trade deadlines read. Either way, a volatility uptick could be in the cards.

Today’s earnings include: AutoNation (AN), Cabot Oil & Gas (COG), Royal Bank of Canada (RY), Wayfair (W).

 

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1 MarketWatch. A 5% to 10% correction is vital for this stock market, warns Jefferies strategist. 2/21/19.

2 Bloomberg.com. Markets Are Too Complacent About Trade War, Morgan Stanley Wealth Says 2/21/19.

3 CNBC.com. US and China are sketching the outlines of a deal to end the trade war. 2/21/19.