China Syndrome: Tech Leads, Industrials Lag

In 2017 virtually all stocks outside of the energy sector moved steadily higher. In 2018 our forecasted corrective period bifurcated the market into Trade War sensitive stocks and those with stellar earnings and immunity to trade retaliation. Essentially tech has been the big winner. One of the big losers has been the the large cap Industrials sensitive to China. We gave up on diversifying more to Industrials a couple months ago as it became increasingly apparent President Trump was willing to keep escalating trade tensions until either the US trade deficit with China narrowed or the US began to feel economic pain. The rest of the world seems to have caught a mild cold while the US has acquired some immunity thanks to massive tax cuts and repatriation. Industrials (XLI) will remain a drag however, until China and the US find a deal. Currently there are no signs of a true effort to begin negotiations. Originally we presumed a deal would be consummated this summer before the mid-term elections, but as long as the US has a strong economy, Trump’s calculus is likely to remain patient. If there are no concessions and the US continues to outperform other nations economically, Trump will keep escalating tariffs until the US trade deficit shrinks. Waiting for lower trade deficits historically means waiting for a recession, so it would be worthy of a Nobel in Economics should Trump improve the US trade flows while maintaining a healthy US economy. 

 

The Financial sector (XLF) was in line with the broader market until April when China fears began to hurt bulge banks which is being exacerbated by “falling” interest rates lately. Regional banks (KRE) which are more isolated to Trade worries have diverged from large cap by hitting record highs recently.

 

The volatile energy sector in 2017 and early 2018 has surged higher recently led by Permian Basin Oil and Gas activity. The infrastructure energy stocks have been particularly healthy. New OPEC supplies may slow the large cap energy stock appreciation, but capital spending budget increases trough 2019 should provide good opportunities, provided the Global economy continues to grow.

 

Tech is where its at! Nasdaq (QQQ and XLK) led by cloud and software solution providers have continued unabated to the upside in May and June in spite of escalating trade concerns. These stocks of course are less subject to foreign trade retaliation and continue to exhibit extraordinary earnings growth that demands higher valuations. Comparisons may be tougher for Tech in 2019, but currently the narrow leadership here can continue.

 

An honorable mention goes to biotech where buyouts and the healthcare wave keep escalating this volatile sector to increasingly overheated valuations.

 

In classic Trump fashion, our President has indicated he’s in no hurry to compromise on trade with any country without major concessions and rely on import barriers to reduce imbalances organically while injecting maximum stimulus into our domestic economy. It is a gamble, but Trump’s gamesmanship should not be a total surprise.

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