Here’s what’s disconcerting about this morning’s stock market drop.
First, while we do know what caused the selloff–President Donald Trump’s Sunday tweet threatening China with higher tariffs on even more exports unless it agreed to a trade deal in the next few days–we really don’t know what real world events will follow on those tweets. Were they just a negotiating ploy designed to reverse what U.S. trade officials saw as backsliding in the Chinese position? Accounts now certainly suggest that U.S. Trade Representative Robert Lighthizer saw the Chinese as backing away from an agreement to restrict or end forced technology transfers by overseas companies that wanted to do business in China. The fact that Lighthizer briefed the President on the issue shortly before Trump tweeted opens the possibility that he was expecting exactly this action from the President and thought it might be helpful in pressuring the Chinese to return to their previous agreement. U.S. stock markets seem to be weighing in on the negotiating ploy theory today. After an initial plunge, the U.S. indexes have settled with the Standard & Poor’s down 1.01% and the Dow Jones Industrial Average off 0.90% as of 1 p.m. New York time. (The Shanghai Composite Index was down 5.58% overnight.) But that consensus belief today doesn’t guarantee that hardliners in Beijing and Washington won’t succeed in scuttling the talks. It is singnificant that while China’s official media is reporting that the Chinese delegation is headed to Washington where talks are scheduled to resume this week, the stories have stopped short on confirming that the talks will continue. We simply don’t know if there’s another shoe to drop.
Second, this morning’s market action exposed the fact that there are significant directional imbalances in bets in the futures and options market, but that we really don’t know the size of those bets. In the early going this morning the CBOE S&P 500 Volatility jumped 46% while the S&P 500 was down only 1.5%. That confirms, in my opinion, recent reports that hedge funds were hugely short the VIX–that is they were betting that volatility would continue to slide and the VIX index would move lower. The 46% jump on a strong but relatively small drop in the S&P 500 is exactly what we’d expect to see if traders who had shorted the VIX were covering on the China news. We don’t know, however, what other big positions might be “on” nor which of those positions might produce outsize volatility if the consensus view of events should shift. The VIX was down 27.74% as of 1 p.m. New York time.
And, third, we don’t know what other markets might plunge (or soar) on the news. For example, the farm market took the tweets much more seriously than the stock market. Soybeans and corn futures were off big this morning on worries that extended U.S. tariffs would at the best put off promised Chinese purchases of U.S. agricultural commodities,, and at worst, lead to retaliatory moves against U.S. farm exports. The Bloomberg Grains Subindex Total Return fell this morning to its lowest level since 1977.
My best guess–and honestly it’s only a guess–is that the President’s Sunday tweet was indeed a negotiating ploy. The move fits with the style of the Trump administration in other talks. The administration seems to believe that the best way to “win” is to hammer the other side with outrageous threats in the hope of settling for something less. How that might work when the other party across the table is a China just looking for any hint of a slight or insult to its national sovereignty remains to be seen. The possibility that one side– or both–will seriously mis-read the other is certainly there.
