Sell In May, should’ve stayed away.

Stocks continued their slide following Trump’s weekend comments and the moves against Huawei which effectively mean U.S. software makers cannot supply Huawei.  Thus, the technology sector was battered with the Nasdaq 100 down 1.7%.

Component makers were the hardest hit. This action is believed to possibly slow China’s ambitions of establishing a 5G network. Thus, global supply chains are being hit or are expected to be hit. Trump was quite buoyant in his interview as he said that the trade war was going well, and that China would not become a top superpower under his watch.

There appears to be some disparity of views between the U.S. and China about the trade talks. China is unaware of the Agreement that Trump talked about recently on Fox. Lu Kang (Chinese Foreign Ministry spokesman) suggested that the U.S. demands were extravagant and would not work.

The restrictions on Huawei mean that Google won’t provide access to proprietary apps and Lumentum, a mobile phone parts manufacturer, won’t supply phone parts. In addition,  Intel, Qualcomm, Xilinx, and Broadcomm won’t supply chips. Not surprisingly, the Philadelphia Semiconductor Index fell 4%. Shares in Apple slumped 3.1%.

The slide in semiconductors pulled the Stoxx 600 down and equities fell in China and Hong Kong.
The uncertainty is starting to make a number of major equity investors rethink strategy with concerns that the Trade War will drag on for some time. The S&P 500 is on track to provide its worst monthly decline since December 2018 and is trading almost 4% below the high. Volumes were light on the day with only 6.4 bio shares trading on the U.S. exchanges.

Small caps have not escaped the selloff. Rising tariffs are expected to hit the bottom line. And with less of a financial buffer than the bigger multinationals, these small caps are expected to suffer. In a risk off environment, small caps tend to perform poorly. For many small caps, the problem is that they have not been able to build inventory to shield themselves from the trade war. First-quarter earnings per share are expected to decline by 18%, followed by a 9% second quarter decline. This would be the worst result since 2009 and traces its way back to Trump’s tariffs.

The day was a little strange for bond investors. The market was choppy and traded in narrow ranges. and volume was light on the day. The market appeared to be more preoccupied with the looming Memorial Day long weekend starting Friday. In addition, there is scant economic data due this week. James Bullard, the St Louis Fed President, said positive things about the economy today.  He suggested that the trade war would need to continue for some time before it impacted on the U.S. economy.

The highlight of the week will be the Fed minutes. Some economists are pointing to continuing weak retail sales as a contradiction to Powell’s assertion that the weak consumption data was temporary. The New York Federal Reserve’s yield-curve model implies the probability of a recession mid 2020 at 28-29% based up the current 3-month and 10-year spread. The implied probability of recession 12 -months earlier before the last three downturns was 38% (2008), 26% (2001) and 31% (1990).

Fed funds futures are now fully pricing in a 25bp cut. The IMF has cut its growth forecasts for advanced economies by 0.2% since January. Commodity prices appear to be stalling on concerns about an economic slowdown. This can be seen in oil where despite production problems and geopolitical risks, there has been no major repricing.

The Rant.

The tariff war that Trump is using against China may yet have some interesting twists and turns. The impact of effectively sanctioning Huawei may backfire and allow China to develop its own software and capacity and create a 5G network. Eventually, China could then sell globally and compete directly against U.S. companies. The ambition of neutralising Huawei may just not happen and with 170,000 workers at risk China, in all probability, won’t let it happen.

Interestingly, President Xi visited a rare earths mining site.  Restrictions on rare earths whilst hurting domestic miners would help companies like JL Mag, which makes magnets using rare earths and are used in electric vehicles, wind turbines and anything that uses magnets. The Chinese Government will develop policies to bolster domestic industry and rare earths would play a pivotal role in the development of advanced manufacturing.

The problem is that this is not a winner takes all. Meanwhile, China is stoking the fires of patriotism. Commencing Monday, Chinese radio and television stations will be required to play the national anthem at 7 a.m. each morning through to year end. Propaganda and tensions are only now just starting to froth and bubble.

Market Recap.

Equities: The S&P 500 fell 0.67% and the Dow fell 0.33%.  The Vix closed at 16.31 while the Stoxx Europe 600 Index fell 1.1%.

Currencies: The Bloomberg Dollar Index was down 0.1% while the euro rose 0.1%.

Bonds: (as at 4.30pm). The ten-year is trading at 2.419% while the 2-year is trading at 2.223% and the 30-year is at 2.839%. The U.S. curve closed on the day with the following closes 2/10 at 19.4 bp and 2/30 at 61.5 bp while  the 10/30 closed at 41.9 bp. The U.S. 5-year closed at 2.206% and the 2/5 spread is now -1.8 bp. The ten-year bund closed at -0.087% and the British gilt closed at 1.057% while the 10-year yen gilt is trading -0.044%.

Commodities: WTI was up 0.6%. and oil rallied on the news that the Saudis were not going to increase production. Gold was flattish up marginally at 0.05% while copper fell 0.4%.

Bitcoin is trading around $8,071.

Aussie Market Today.

It should be an interesting day for stocks. Last night saw offshore markets sell on trade risks and the escalation of the trade spat between China and the U.S. The rhetoric shows no sign of abating. And this may well continue to unsettle Asian markets. I expect the ASX to drift on the day into the negative and that fall will simply be mimicking what is happening on the Asian exchanges. The trade war suddenly is getting very nasty and there is a now a lot at stake.

Bonds were choppy overnight and, if anything, drifted a little weaker.  And the long-term trend appears to be falling yields and rates on Government securities. On the day, bonds may look to drift wider and that would be reflecting the offshore movements.

But get ready to move, as the next risk off trade is just a comment away. The Aussie is barely hanging in and looks vulnerable to being sold. Credit may be paused as concerns rise for the health of the equity market. Meanwhile, there is still demand for well known credits. And these credits are seeing solid demand and the resulting spread tightening.