Tariff Relief Produces Another Small Gain

Major Moves 

I believe it was widely expected that President Trump's new tariffs on Mexican imports that were supposed to be imposed today were not going to materialize. The skeptics got this one right, as Trump backed off based on assurances of immigration cooperation from the Mexican government.

I will leave it to the political analysts to determine whether the agreement Trump announced on Friday was meaningful or not, but we can certainly see that investors seem to be relieved to have this little bit of uncertainty removed. Stocks were up again on Monday, and the Mexican peso (as you can see in the following chart) rallied as well.

I would not expect the peso to continue rising in the short term. In fact, this seems likely to turn into a fakeout because the currency is trending against the price of oil. Mexico's energy production places it near the top 10 in the world, and the nationalized structure of the energy sector means that its currency is very sensitive to the ups and downs in the price of energy commodities.

Although the new tariff threat was a problem, particularly for U.S. automakers, the reaction from Ford Motor Company (F) and General Motors Company (GM) has been somewhat muted compared to the peso and Mexican stocks. I suspect that the lack of a big reaction is partially due to most investors assuming the tariffs would not be applied today; that makes the rally in the peso even more suspicious.

Performance of the Mexican peso (MXN) vs. the U.S. dollar (USD)

S&P 500

The S&P 500 continued to rise today, although most of the short-term gains seem to have been realized last week. Generally, head and shoulders patterns fail in a bull market, which appears to be the case with this most recent pattern as well. However, the data is more unclear about how far the rally may run following a failure.

At this point, I feel comfortable renewing my call that the S&P 500 won't be able to break the prior highs above 2,940 in the short term. Tariff and growth worries continue to rise, and that should keep the lid on the major averages until we have more earnings data in July.

The strange behavior of yields over the past week is one of the big reasons I remain very cautious about the potential upside of the rally. As you can see in the following chart, although the S&P 500 has been rising, the divergence between the stock index and the 10-year Treasury yield has continued to grow. This is not normal market behavior and has been correlated with volatility in the past. A similar signal appeared before the bear market corrections in 2015 and 2012.

Read more:

Gold Completes 6-Year Basing Pattern

Why Contrarians Say China's Rare Earth Trump Card May Backfire

4 Ways to Play Equities if the Fed Cuts Rates

Performance of the S&P 500 Index and the 10-year Treasury yield

Risk Indicators – Investors Still Look Calm

While I have concerns about whether the market can break the resistance level of its prior highs, I can't see many reasons to worry about a major short-term shock either. Investors have been buying small caps, high-yield bonds, and some commodities last week; also, the CBOE Market Fear Index (VIX) is back off its highs.

Even the dollar has been relatively sanguine over the past week, which can't hurt the outlook for lower volatility in June. In addition to these traditional indicators, I like to revisit the SKEW index regularly. The SKEW indicator evaluates the price of out-of-the-money puts on the S&P 500 index that are used as a hedge when portfolio managers are worried about a decline.

When the SKEW is high (indicating aggressive hedging) but the market is rising, investors should be very careful. That kind of bearish signal appeared before the bear market took off in October 2018. However, when the SKEW is very low while the market is falling or beginning to bounce higher, that is usually a good sign.

As you can see in the following chart, the SKEW index is near long-term lows and signaling that traders are relatively calm. I wish this were a more affirmatively bullish signal, but it still has a good track record for at least being correlated with a stable market. If the SKEW were to start rising dramatically as the S&P 500 reaches resistance at its prior highs, I would suggest that investors evaluate their risk exposure very carefully.

Read more:

What Is Tail Risk?

Using Bullish Candlestick Patterns to Buy Stocks

Cup and Handle Definition

Performance of the S&P 500 Index and the SKEW Index

Bottom Line – Watch Interest Rate Indicators

The middle weeks of June are a little quiet; that is doubly true today while European banks are closed for the Whit Monday holiday. Often considered part of the so-called "summer doldrums," the last few weeks of the second quarter can wind up being a little boring. I wouldn't be surprised if that pattern persisted this year, but that's no reason to take your eye completely off the market.

The Fed is in its "quiet period" before the FOMC meeting next Wednesday, so we won't likely hear anything from them this week, but investors have been getting more and more aggressive about their estimates for a rate cut this year. Currently, traders in the futures market are pricing in a full percentage point cut, which seems like an unrealistic projection to me. This could be setting the market up for a big disappointment next week when the FOMC releases its economic projections. Watch the interest rate indexes closely for any early signs of problems or a shift in investor sentiment.

Read more:

Sensationalist Journalism and Bull Markets

Key Bitcoin Indicator Flashes Sell Signal That May End Crypto Euphoria

Learn the Basics of Investing

Enjoy this article? Get more by signing up for the Chart Advisor newsletter.

Take the Next Step to Invest
The offers that appear in this table are from partnerships from which Investopedia receives compensation. This compensation may impact how and where listings appear. Investopedia does not include all offers available in the marketplace.