Major Moves

Something that is often lost in the discussion around the U.S. trade deficit is that the trade balance comprises both imports and exports. While it is true that imports greatly outpace exports, the U.S. (as of the latest trade data) is still the world's second largest exporter. The U.S. is second to China and is running ahead of the third largest, Germany. This matters because exports from the U.S. to both developed and emerging economies, like China, are a critical component of overall economic growth. We learned a little bit more about the cracks in that part of the GDP picture today.

Both NVIDIA Corporation (NVDA) and Caterpillar Inc. (CAT) reported earnings today with disappointing results largely due to slowing growth in China. In both cases, the charts look very similar to an example I used last week in the Chart Advisor newsletter. As you can see in the following chart, Caterpillar was bumping up against its long-term pivot at $135 per share. We've seen this many times before this season: a company bids higher on an improving outlook, then sells off at resistance levels following a disappointing earnings report or guidance statement from management.

Technical chart showing the performance of Caterpillar Inc. (CAT) stock

S&P 500

This back-and-forth puts the broader S&P 500 index in a tough spot as it continues to struggle against its own resistance/pivot level near 2,640. If cyclical stocks (companies that are sensitive to short-term economic cycles) like Caterpillar and NVIDIA continue to fail at their respective resistance levels, investor sentiment may shift in a much more negative direction on a macro level. However, in my view, investors shouldn't see the bad news as terminal for the current rally, as long as services and financial stocks are performing better than average. Currently, even on a bad day like this, financials were near breakeven, and services were well above average.

Read more:

Chart showing the performance of the S&P 500

Risk Indicators

From a risk perspective, most of the important indicators (high-yield bonds, currencies and volatility indexes) remained relatively sanguine today. It's a good sign that we're not seeing any early warning signs from the typical markets. Normally, news from Caterpillar would have led me to expect a sizeable retracement in Chinese stocks, which would have helped quantify the overall level of stress in the market even if we didn't see much selling in the U.S.

Instead, however, Chinese indexes have been surprisingly stable all session. For example, in the following chart of the Hang Seng index (Hong Kong stock index), you can see that the double bottom breakout from Friday's session is still intact. Today's "counterattack" candlestick pattern isn't ideal, but I wouldn't consider it to be a validated bearish signal until we have another negative close through 27,200. What this seems to indicate is that investors have pre-priced slowing in China, and therefore, another break higher is possible, barring additional material and unexpected bad news.

Read more:

Bottom Line: Shutdown Worries Are Ongoing

According to FactSet, 71% of the companies in the S&P 500 that have reported earnings so far have exceeded estimates. Although it is true that expectations have been reduced significantly over the past 90 days, that surprise ratio is in line with the average over the past five years. If the trend continues, the forward P/E ratio (currently 15.4) would be below the average of the past five years, which creates less of a valuation headwind for more gains in 2019.

While I think the evidence is still in favor of additional growth (at least through the second quarter of 2019), the key short-term X-factor that needs to be monitored as the remaining 75% of the S&P 500 report results is how much damage the government shutdown has actually caused the U.S. economy.

Estimates provided by the Congressional Budget Office puts the shutdown costs at -$3 billion in the fourth quarter and another -$8 billion in the first quarter, which would reduce GDP by 0.2%. In my experience, the bigger issue is the damage to expectations if further shutdowns are threatened when budget negotiations in Congress are unsuccessful in three weeks. Until we have more information about how those negotiations are proceeding, the major indexes may remain stuck at this pivot level in the short term.

Read more:

Enjoy this article? Copy and share the link below to invite friends to sign up for the Chart Advisor newsletter: