Q4 Market Spotlight: US or China, who’s winning the trade war?

While the US market has been firing on all cylinders, that hasn’t been the case for China. With the standoff over trade between the United States and China, President Trump has continued to put pressure on President XI Jinping to make a deal. In the meantime, the Chinese market has been hit hard by the ratcheting-up of tariffs, while the S&P 500 remains seemingly impregnable, reaching close to all-time highs. Though the US market isn’t immune to the trade war (as algorithmic programs react quickly to each and every headline) each move lower has been a buying opportunity for investors.

The divergence between the two markets is large, but I predict as Q4’s Equity Strategist, that they’ll actually begin to converge. For this to materialize, the US market must move lower, relative to the Chinese market, or else the Chinese market needs to move higher, relative to the US market. I believe we’ll see the latter, with China recovering and the S&P 500 continuing to move higher at a slower pace. One of the ETFs that we can specifically consider is iShares China Large-Cap ETF (FXI), which tracks an index of the 50 largest and most liquid Chinese stocks traded on the Hong Kong Stock Exchange. Let’s take a closer look at how the trade war is playing out and what this means for market trends.


The Consumer and the US Market

The S&P 500 has been impressively resilient, as investors continue to “buy weakness” and push it increasingly higher. In fact, we’re near all-time highs with the SPY rising by 8.45% YTD. The trend is likely to continue with the robust economy, especially in sync with current investor appetite for growth stocks, in particular the technology sector. Perhaps most crucial, “the consumer” as the backbone of the American economy (70% of GDP) has been notably strong. Two leading indicators for investors to gauge consumer activity are the University of Michigan Consumer Sentiment Index and the Manufacturers’ New Orders for Consumer Goods and Materials.


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The most current data shows that consumers are confident about future economic activity, as they continue to commit to purchasing durable goods. Until we see a dip in these leading indicators, there’s no apparent red flag that the market is ready for a move lower.


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The SPY looks quite attractive from a technical perspective, as the trend higher remains in-tact and rising. Though we had a few strong pullbacks in February through April, where the 200-day moving average was tested; the final test was in April when the market resumed its bullish trend. Since the brief consolidation in late June, the SPY has been holding a defined trend-line, giving investors a reference point for defining risk. I expect that there’ll be a sustained move higher, as we head into the heart of earnings season in October. Support currently sits between 2,864 and 2,880. 


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iShares China Large-Cap ETF (FXI) Versus SPDR S&P 500 ETF (SPY)

So who’s winning the trade war? If we look at both markets relative to one another, it’s pretty clear that the US market is far stronger than the Chinese market. The iShares China Large-Cap ETF (FXI) is slightly off its 52-week lows, down 11.02% YTD, while the S&P 500 is nearing record highs. Looking at the FXI relative to the SPY, the divergence is clearly extreme.


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Another way to gauge sentiment is to look at short interest. FXI’s short interest as of 8/31 was 23.57% of the float, with 0.89 days to cover. I expect the Chinese market to recover, by contrast to the US Market moving lower. Looking specifically at the FXI, we’re seeing an emerging double bottom at $40 (if we can close above $43.50).


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Additionally, I’m seeing a bullish divergence in the RSI, measuring increasingly stronger momentum since June, even as the ETF continues to move lower.


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Looking Ahead at the Game

At the end of the day, any trade deal between the two countries should lead to a substantial move higher in both equity markets. As of now, both countries are holding their ground. Some believe China is waiting until after November’s midterm election, to see how the political makeup of the US shakes out before making a deal. In the meantime, President Trump has mentioned several times that he’s playing with “house money,” in terms of these US market highs and the likelihood that investors can afford to shoulder some short-term pain for the long-term benefit of the US. In any and every case, it will certainly be compelling to see how all of this plays out.


Rodney Raanan is Q4’s Equity Strategist and Director. He writes Q4 blog’s monthly commentary on emerging markets and sectors. You can also follow Rodney on Twitter.

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