Stocktake: US has more to gain from trade war truce

Impact of tariffs has fallen largely on the US

Global stocks edged higher last week after China announced that it and the US had agreed in principle to phase out tariffs imposed in the ongoing trade war. Although the news helped European stocks hit four-year highs, the reaction was relatively muted. That's understandable; there have been "several false dawns" on trade this year, said State Street's Michael Metcalfe, while AJ Bell's Russ Mould cautioned China's talk of "phase one" of the agreement implies it "could be a long drawn-out process". How long? The US should be especially motivated to reach an agreement, says Metcalfe. "US manufacturing sentiment has collapsed in the past nine months, spectacularly so in the last quarter," he says. In contrast, the official measure used in China indicates little change in manufacturing sentiment compared to early 2019, while the Caixin/Markit purchasing manager index is bullish, with sentiment at its highest level in two years.

The data corroborates a new paper by researchers from Harvard, the University of Chicago and the Federal Reserve Bank of Boston, which finds the impact of tariffs has fallen largely on the US. “If economic rationale was a key driver, the pressure to agree a trade truce soon is growing,” says Metcalfe. “The only question now is when the economic rationale will coincide with the immediate political need.”

Insider trading and star CEOs

Investors often get excited when a famous CEO buys or sells company shares. However, a new study suggests there's no point tracking the big boys – rather, you're better off paying attention to the lesser-known executives. The study used three different measures to distinguish star CEOs from their non-star counterparts – whether they had won awards from prestigious business publications; how often they were searched for in Google; and how often they were mentioned in the media. It turns out insider trading by star CEOs was not a good predictor of returns over the following six months, but the purchases and sales of lesser-known executives was a strong predictor. Buys by this group were followed by stock returns of 6.4 per cent, compared to declines of 5.2 per cent for sales. Star CEOs were more likely to trade for routine reasons – for example, if they needed money for personal reasons, like buying a house – whereas non-star executives were more likely to make "opportunistic" trades. Why? The greater visibility of famous executives means they face more scrutiny, so they play by the rules; lesser-known executives face less scrutiny and are more likely to use their company knowledge to make a few quid for themselves. The study is at https://tinyurl.com/yy5lt7qs.

Have stocks gone too far, too fast?

Stocks have rallied hard over the last three months. Have they gone too far, too fast? Global equities have certainly partied, soaring 9 per cent since mid-August. In the US, the S&P 500 has hit several all-time highs and is now at its most technically overbought level in the last year, notes Bespoke Investment. Investor sentiment had been muted in recent months but that has changed, with CNN’s Fear and Greed index showing the highest levels of optimism since late 2017.

Meanwhile, the so-called smart money is becoming less confident that stocks will keep rallying, notes Sundial Capital Research's Jason Goepfert, while dumb money indicators suggest increasing confidence. The spread between the two is getting extreme, he says. Bullish sentiment can persist for some time, of course, while Bespoke admits technically overbought markets can remain overbought. Nevertheless, risks are elevated when overbought levels hit extreme levels, the firm cautions. Seasonal factors, on the other hand, bring some cheer for bulls and suggest any pullback may be fleeting. November and December tend to be strong months for markets and this remains the case even when stocks are flying high, says LPL Research's Ryan Detrick. The last seven times the S&P 500 was up more than 20 per cent at the end of October saw gains in November on all seven occasions; stocks enjoyed further December gains on all but one occasion.

Don’t fret about all-time highs

While overbought levels may be concerning, investors should remember all-time highs are not in themselves an issue. All-time highs can make people cautious, notes Ritholtz Wealth Management's Michael Batnick; you remember market highs during the dotcom bubble and prior to the global financial crisis and "how quickly these gains can evaporate". However, the reality is new highs are normal; people invest in stocks because, over time, they tend to rise in price.

Nor is near-term risk elevated; one-year returns following all-time highs are actually higher than normal, notes Batnick. The same point is stressed by LPL Research, which notes that, since 1982, the S&P 500 has enjoyed median one-year gains of 13.5 per cent after a new high. Furthermore, odds of a double-digit percentage loss in the six months following all-time highs are much lower than usual. There are always good reasons for investors to worry, but all-time highs aren’t one of them.

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