Volatility See-Saw
Rising interest rates, concerns over inflation, a rout in tech stocks, a less than great jobs number, and (especially} fears of a trade war with China have dragged U.S. equity markets lower and spurred one of the most sustained bouts of market turbulence in years. The volatility marked a sharp reversal from the prolonged period of calm that had kept Wall Street’s “fear gauge,” the CBOE Volatility Index, or VIX, near record lows. The VIX is up more than 70 percent since the start of the year. Traders have been buying futures contracts pegged to the VIX in the past two weeks, betting on continuing volatility.
The major domestic equity benchmarks ended last week lower after another week of significant volatility. Consumer discretionary and energy stocks fared less poorly, while health care, industrials, financials and tech shares lagged. President Donald Trump continued his Twitter attacks on Amazon, but Amazon’s stock recouped a portion of its recent losses at midweek before falling again in Friday’s broader sell-off. The week was also notable for the initial public offering of streaming music company Spotify.
Heightened trade tensions between China and the U.S. continued to dominate sentiment during the week. Stocks sold off sharply on Monday, following China’s announcement that it would retaliate on U.S. aluminum and steel tariffs with $3 billion in new tariffs of its own, targeting roughly 130 U.S. products and concentrated on agricultural exports. On Tuesday, the U.S. further upped the ante, outlining a list of $50 billion in proposed tariffs on 1,300 Chinese products, and China responded on Wednesday with its own $50 billion list of tariffs on U.S. soybeans, cars, and aircraft.
Throughout the middle of the week, traders took the tit-for-tat trade announcements in stride, as Commerce Secretary Wilbur Ross and President Trump’s new chief economic advisor, Larry Kudlow, sought to downplay the economic impact of the tariffs and suggested that further negotiations with China lie ahead. Traders were also encouraged by a Bloomberg report that President Trump might announce a tentative deal on a renegotiated North American Free Trade Agreement (NAFTA) at the Summit of the Americas in mid-April.
Market patience reached a breaking point on Thursday evening, however, after President Trump raised the stakes even further by ordering the consideration of an additional $100 billion in tariffs on Chinese goods. Stocks futures fell in response, and on Friday morning, Chinese officials struck back, which was a notable departure from their delayed and guarded response to earlier U.S. tariff announcements. Commerce Ministry spokesman Gao Feng threatened a “fierce counter strike” and stated that negotiations were unlikely in the current environment. U.S. stocks fell further in response.
With the announcement yesterday that he’s considering $100 billion more tariffs on Chinese goods (about which Republican Sen. Ben Sasse of Nebraska said, “He’s threatening to light American agriculture on fire. … This is the dumbest possible way to do this”), President Trump created confusion within his administration and abroad because of a negotiating style he has used his entire adult life and outlined in his book, The Art of the Deal. You might call it “governing by bluff.” For example, he threatened to veto a spending bill that conservatives hate, then signed it. He announced stiff tariffs on imports of steel and aluminum, then the administration started negotiating big carve-outs. He publicly talks of war with North Korea, then agrees to meet with Kim Jong-un. He muses openly of replacing top aides, including White House Chief of Staff John Kelly, then lets them stay.
Unlike most politicians, the President sees the “announcement” not as the rollout of a policy, but as the starting point for negotiations. A word Mr. Trump uses all the time privately, and sometimes publicly, is “flexible.” Everything is up for negotiation. Everything is zero sum. And he always wants a scorecard, to know minute-by-minute who is “winning.” With foreign countries like China, his scorecard is the trade deficit. Aides like former chief economic advisor Gary Cohn spent 14 months trying to explain to Mr. Trump why economists and market experts don’t see trade deficits as a win-loss ratio, but they failed to change his mind. So the bluff is really just his extreme, gambler’s negotiating style: Make a maximalist ask, frame the debate around that, and go from there, improvising all the way.
This approach had a mixed record in his business career, with some obvious successes. Its most spectacular failure was in Atlantic City, where his casinos went belly-up and he temporarily gave his life over to his creditors. It’s too early in his presidency to tell definitively whether his negotiating tactics will work in international relations, of course. As Eurasia Group’s Ian Bremmer points out, Mr. Trump has already gotten some concessions out of the Chinese and South Koreans, so the approach has worked, at least to a point.
That said, a bluff can only work when one has a history of following through. Mr. Trump has followed through on his threats enough that it’s impossible to determine what he’s really thinking, which seems to be his point. The president tossing his papers in the air during an appearance Thursday in West Virginia — saying it was the “boring” speech he was supposed to give on tax cuts — was a remarkably apt metaphor. Mr. Trump’s carefully crafted unpredictability may give the President leverage and keep people guessing, but it also stirs wild uncertainty and market volatility pretty much every single day.
For Mr. Trump, however, the tiff with Amazon isn’t just business—it’s personal. Fueling his ire is not so much Amazon itself, but Jeff Bezos, the company’s CEO, who also owns The Washington Post, whose coverage the president dislikes, people close to the White House say. It also almost certainly matters that Bezos is a lot richer – more than 35 times richer – than the President.
Friday also brought the monthly jobs report. The unemployment rate held steady at a 17-year low of 4.1 percent. However, the U.S. gained just 103,000 new jobs in March, less than the 170,000 consensus estimate, to mark the smallest increase since last fall, but also the tightest labor market in nearly two decades. Job openings are at a record high and big and small firms alike say they plan to add more workers. Although the number of new jobs created slowed sharply from February’s revised 326,000 increase, the U.S. still added an average of 202,000 jobs a month in the first quarter of 2018. That’s still faster than the average gains in 2017 and 2016.
The yield on the benchmark 10-year U.S. Treasury note rose following the employment report, although it fell back later on Friday amid the heightened trade rhetoric and ended the week modestly higher. Expectations for Fed tightening fell slightly during the week but at least two more rate hikes are generally expected in 2018.
European and Japanese stocks also weathered a volatile week as trade hostilities between the U.S. and China were the big news there too. The pan-European STOXX 600 Index ended the week higher due to a rally on Thursday that produced the biggest one-day percentage gain in nearly two years, according to FactSet data. Germany’s export-heavy index DAX 30 and France’s CAC 40 ended the week higher, fueled by their biggest one-day gains since April 2017. Chinese stocks, however, fell roughly in proportion to domestic U.S. losses. A trade war may be good politics, but it is bad for everyone economically and more markets.
If you are curious about what the U.S. economy looks like at full tilt,you might check out Elkhart, Indiana. The self-proclaimed RV capital of the world, which nine years ago had the country’s worst unemployment rate, offers up an intriguing view of what is possible: Area high-school students skip college for factory jobs that offer great pay and benefits. For-hire signs sprout like roadside weeds. And workers are so flush that car dealers can’t keep new pickups on the lot. However, strains are showing. Employers can’t hang on to their employees, and house prices are soaring. The worker shortage prompted a local KFC restaurant to offer $150 signing bonuses. A McDonald’s failed to open for lunch because managers couldn’t corral enough hands at $8 an hour to serve the lines waiting at the door. No place in the U.S. has seen a labor-market turnaround like this metropolitan region of 110,000 workers, a mix of blue-collar whites, Mexican immigrants and Amish. “It’s like 1955. If you show up and have minimal literacy skills, you can find a job here,” said Michael Hicks, an economist at Ball State University.
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