Market Beat: On those trade war fears
The stock market has been volatile lately due to the lack of a trade agreement with China. The world’s two largest economies have not come to a meaningful agreement over trade and both have imposed tariffs on each other’s products.
Cycles of volatility are normal in the stock market. The market spends about 85% of the time rising in relatively low volatility and the other 15% of the time falling with high volatility. Volatility is measured by the historical standard deviation of the stock market.
Another measure of volatility is the implied volatility of the market looking forward. There is a stock market index called the VIX or volatility index, which is also referred to as “the fear index.” It is called the fear index because it rises when investors are nervous and falls when investors are confident and complacent. The VIX is calculated by measuring the implied volatility of nearby options on the S&P 500 index. The options get expensive when people are nervous because they will buy index puts for portfolio protection. The buying and the forward-looking uncertainty cause the prices of these index options to rise.
Investors face many different types of risk. Legislative and geopolitical risk are two of them. Legislative risk means that laws can change that affect certain types of investments. Geopolitical risk is similar except that it includes foreign countries.
The market does not like uncertainty and issues like the trade talks have the potential to worsen. The United States recently announced that it will increase tariffs to 25% on $200 billion worth of Chinese goods, which are mainly consumer products. The US has also said that it may impose tariffs on another $300 billion worth of products.
China has responded by saying that on June 1st it will raise tariffs to 25% on $60 billion worth of U.S. products that include frozen fruit, vodka, peanuts, sugar, soybeans, wheat, chicken and turkey.
Larry Kudlow, an economic advisor to President Trump has said that, “both sides will feel the pain.” The stock market has been selling off because the tariffs will affect the margins of publicly traded U.S. companies. Their free cash flow is likely to be adversely affected which could have a negative impact on stock buybacks, dividends and acquisition activities.
Hopefully a reasonable resolution will be reached that works for both sides and the news driven market volatility that we’ve seen recently will subside.
Kenneth Roberts is a Truckee-based Registered Investment Advisor. Information is at his blog at http://www.sellacalloption.com or 775-657-8065. The mention of securities should not be considered an offer to sell or solicitation to buy investments mentioned. Consult your investment professional to understand the risks and/or how the purchase or sale of these investments may be implemented to meet your investment goals. Past performance is no guarantee of future results.