The Standard & Poor’s 500 fell another 1.65% to 2,884.05 today on fears that there would be no agreement this week out of the U.S.-China trade talks and that President Donald Trump’s threats to raise tariffs on $200 billion in Chinese exports to the United States to 25% from 10%–and to impose those new tariffs on another $325 billion in Chinese exports–would result in a breakdown in the talks.
You can see the fears in the drop in the price of big exporters such as Boeing (BA) and Caterpillar (CAT), down 2.87% and 2.26%, respectively. The fear is that if the President imposed those tariffs, then China will retaliate with higher tariffs on U.S. exports to China.
And you can see it in the 1) the jump in the CBOE S&P 500 Volatility Index (VIX) to 19.32 today, a jump of 25.13%. The VIX rises when more investors and traders, seeking a hedge against market volatility, buy options and futures on the S&P 500 that would pay off if stocks fell. That buying drives up the price of those hedges.
And you can see it in the 2) inversion of the curve for the VIX futures. In normal times the futures that are based on the volatility index show an upward slope with prices for short-term futures–say, a month out–lower than the price of futures for longer periods–say, two months out. Â That’s because uncertainty–normally–rises with duration. Investors are more uncertain about events and market conditions three months away than they are about near term events and market conditions.But this week the VIX futures have inverted and the price for near-term futures on the VIX–which have about two weeks until they expire–climbing above prices for VIX futures that two months out.In other words, at the moment, investors and traders are more worried about what will happen in the next week than they are about what will happen six weeks from now.
Which is logical–since China’s top trade negotiator Vice Premier Liu He will arrive this week in Washington to talk with U.S. Trade Representative Robert Lighthizer and Treasury Secretary Steven Mnuchin on May 9 and 10. If the talks are to founder, they will fall apart on that schedule.
It’s much easier to see what the financial markets are afraid of than to handicap Liu’s visit. I think the odds are better than 50/50 that China will not simply roll over and accede to U.S. demands at this week’s meeting. That would be a significant humiliation. More likely is some kind of temporary halt to the talks (best) case or even a firm walk out of the negotiations by one side or the other with higher tariffs from the United States and retaliatory tariffs from China on Friday or over the weekend (worst case.) Then the important question is when will the two sides agree that their brinkmanship has accomplished whatever it can accomplish and talks can resume.
But it’s also important to note that the market is scaring itself with a look at past history. The last time the curve for the VIX futures inverted came in the fourth quarter of 2018 when Federal Reserve Chair Jerome Powell said that interest rates were a “long way” from neutral and should be expected to rise further. That took the U.S. stock market to the edge of a bear market. Before that, the previous VIX futures inversion came on February 2, 2018 following a non-farm payrolls report that suggested inflationary pressures were increasing in the labor market. The next trading session the VIX post a record jump and the markets fell.
So part of the current VIX futures inversion is a result of investors and traders positioning themselves to avoid a replay of that history.
A level to watch: U.S. stocks are up roughly 300 points–or 11.4%–since President Trump and Chinese President Xi Jinping agreed on a trade truce in November 2018. An end to that truce might take stocks back to that level–2641–on the S&P 500. The S&P 500 closed at 2884 today, May 7.
