RBC Strategist Doesn’t See Mini-Trade Deal Doing Much

RBC Capital Markets

Lori Calvasina of RBC Capital Markets doesn’t see any direct benefit from the U.S. and China finally agreeing to something. It’s really about the mood changing though.

It’s no secret that Friday’s trade deal in itself won’t so much to help stocks, the trade war, or the economy. Lori Calvasina, the head of U.S. equity strategy for RBC Capital Markets sure doesn’t think that the effects of this agreement will amount to very much, and on an objective level it’s hard to imagine how it could, but we also need to account for the subjectivity involved.

Calvasina points out that nothing has really changed in regard to the tariffs out there, as all the ones that we had are still there, and there are even more planned for December, which are very much still on the table.

She also believes that this deal does little to restore business confidence, and this remark ends up really revealing her hand, because while business confidence does matter, investor confidence matters a lot more.

Fundamental analysts seek to quantify everything, to attempt to fit what may happen into their model, and in this case, they would work back from the benefits of, say, additional investment on earnings and look to hang their hat on that as far as how a deal like this may affect things.

We see all sorts of things clearly affect market confidence, and we have particularly watched it sway back and forth a lot from the effects of this trade battle, where every nuance seems to become magnified in its effects. This is not really about people doing complicated calculations of how these events affect business fundamentals, they are hearing good or bad news and then reacting to it in a way that they see fit.

Friday’s late day move after the deal was announced demonstrates the disconnect with hard data, where we might think that selling off didn’t make much sense this this was good news, and it really didn’t. Some just saw their perspective altered in a negative way, being personally disappointed perhaps, and acted upon it.

We could say that the mood at the time was negative, and who the mood applies to is just those active in the market at the time by the way, which is an important point to realize generally but not one that very many people understand. Among those who were standing at the counter at the time, this was seen overall as bearish.

We Price in Various Degrees of Optimism

People may try to say that the market had “priced in” a better deal to some degree and this price was removed once we knew what the deal actually was, but this “pricing in” isn’t anything concrete like business or economic data but instead just degrees of optimism or pessimism.

If we are optimistic, this optimism will drive the price up, and if this ends up being too optimistic, our mood will decline in response. The important thing here though is that it is this mood, levels of optimism, that moves these prices. Once we understand that, then a more substantial effect than Calvasina imagines becomes much more reasonable.

Things like earnings affect our mood as well, and Calvasina expects that the latest tariff escalations will come home to roost in the coming earnings season. We generally overestimate the economic impact of these tariffs, even at the level they are now, and it turns out that this has only had a minimal impact on the economy thus far.

People have been warning us about an earnings recession all year, but earnings have held up well overall, and kept the market’s mood fairly high on this front. The market is a little leery of slowdowns here but as the earnings reports remain satisfactory overall, their mood and confidence becomes more bolstered.

We are at a point where just seeing more hits than misses will keep us pretty happy, and as the results start to come in, this trend appears to be continuing. If your concerns and your focus is on the fundamentals, earnings reports measure this completely, so when the story remains a good one overall, this eliminates these concerns.

We know that these tariffs have affected both the economy and the stock market, although these things affect the stock market more, where the participants end up magnifying these issues. This also happens when the Fed puts up interest rates and produces a reaction like we saw a year ago, where knocking off 20% of market capitalization is grossly disproportionate to the actual effect on business.

Imagine if you owned a billion-dollar company and you were told that your company is worth $200 million less because your profits over the next little while may decline by a few million. The movement in the price of stocks is only loosely connected to value in the real world, and it isn’t that everyone is looking at the effects of something on the book value of the company, otherwise movements in price would be quite small.

This works in both directions, and while it was certainly a positive thing for October’s tariff increase by the U.S. to be taken off the table, the potential that this may deliver has much more to do with people’s mood overall improving and adding positive momentum to stock prices.

A More Optimistic View Counts for a Lot

Sure, nothing has improved on a net basis from this little deal, except for the mood. Given the effects that mood can have on stock prices, this is not an effect that we can afford to not account for properly or even ignore.

Even the pricing in model can provide some insight here, as a way to try to put some numbers behind the effect of mood. We priced in this tariff, we didn’t get it, and this serves to raise the price. We also priced in a less optimistic view of the prospects of a full trade deal, and this being improved by the progress made by the mini-deal also serves to raise the price of stocks.

Calvasina also points to the lack of initial excitement that this trade news produced as further evidence of this not being significant to the market. There were some who got out on the news, but overall, three days later, we’ve resumed our upward path since the low of October 3 and the verdict right now has to be that this deal has brightened our mood and allowed us to sustain this recent move.

She also mentions her concern over institutional investors unwinding their positions, but that is already going on and these things are actually designed to not put too much downward pressure on prices. They will sell into strength by both design and necessity and while these things do limit markets, our mood brightening can maintain control, as it has during the current year overall.

We are quickly approaching all-time highs, and overall, things may be brighter now than they were the last time we were there, including both the rate cuts and the improved prospects of a trade deal.

The effect of this deal is clearly magnified in the price of stocks, and while the deal may be pretty tiny, it looks a lot bigger through a magnifying glass.

Ken Stephens

Chief Editor, MarketReview.com

Ken has a way of making even the most complex of ideas in finance simple enough to understand by all and looks to take every topic to a higher level.

Contact Ken: ken@marketreview.com

Areas of interest: News & updates from the Federal Reserve System, Investing, Commodities, Exchange Traded Funds & more.