Impact of Trade War in the US

Last week we looked at the impact of ongoing US / China trade tensions in the context of Chinese stocks through the lens of the Exchange Rate Sensitivity factor. In doing so, we were able to connect the impact that trade events had on Chinese net exporters and net importers. Today, we'll use the same analysis to examine US exporters/importers in our US model.

First, we'll start with a look at the past week's market and factor action:

‍US Market (5/17/19 - 5/23/19)

• Trade again dominated the investment landscape, with the market continuing to trend down on mostly negative trade headlines throughout the week, particularly around the US ban on Huawei Technologies and its effect on global markets.
• On Friday (not captured in above chart), the market saw slight relief after Trump's placating comments on Thursday night suggesting that the US might ease up on Huawei in the context of a wider trade deal. Still, the S&P 500 ended up tallying its third straight week of losses.
• Friday was the lowest volume trading day in 2019 ahead of Monday's holiday.
• Fueling concerns about the broader economy, data showed that new orders for U.S.-made capital goods were lower than expected in April.
• Short interest in the SPY (S&P 500 ETF) as a percentage of shares outstanding hit 7% this week, the highest mark since the Fed started raising interest rates in 2015.

Here's an update on how some key factors (and US Total Risk) have changed in the US model over the past week, using our normalized return indicator.

• Momentum saw another sizable upward move (+1.06 standard deviations over the past two weeks), and is rapidly approaching the Extremely Overbought designation in our normalized return framework.
• The free-fall in Size over the past month showed signs of slowing down, although it continued to move deeper into Oversold territory.
• Growth continued to gain ground, and at +0.97 SD above the mean is getting close to earning an Overbought label.
• Profitability and Earnings Yield were both slightly down this week, suggesting that Quality hasn't been a market priority.
• After a brief uptick last week, Volatility saw a return to negative normalized returns, while Market Sensitivity continued to drift further into Oversold space.
• US total risk (using the Russell 3000 as proxy) saw a slight move down, ending up at 13.73%

‍Impact of Trade War on US Stocks

‍Last week, we created a basket of Chinese stocks using the Exchange Rate Sensitivity factor in order to see how Chinese net exporters and importers fared around major trade headlines. Today, we'll use the same approach to examine US exporters and importers in our US model. In this case, Exchange Rate Sensitivity (ERS) is defined as 6 month beta to returns of currency basket containing USD, EUR, GBP, & JPY. Please reach out to me if you would like to receive the US basket constituents, or the Chinese basket stocks from last week.

‍Methodology:

• We created an equal-weight Long/Short basket using the constituents of the Russell 1000.
• On the Long side, we included all names in the model with > +1 z-score exposure to Exchange Rate Sensitivity (Net Exporters).
• On the Short side, we included all names in the model with < -1 z-score exposure to Exchange Rate Sensitivity (Net Importers).

Exposure

With a net +1.42 exposure to Exchange Rate Sensitivity on May 23, it's safe to say this portfolio represents the ERS factor in the US. It also exhibits high exposure to Medium-Term Momentum, while also showing negative exposure to the Market Sensitivity and Value factors.

Here's the historical exposure chart for this portfolio from the beginning of Trump's presidency until now:

Again, we can see this portfolio exhibits high exposure to ERS throughout the entire period. Other style factors of note were Market Sensitivity (underweight) and Momentum (overweight).

‍Performance

‍On the performance side, total return for this US basket is down -1.5% since Jan 2017. Consistently underperforming since hitting heights of +6.7% in Feb 2018, the basket has seen a massive rally since being down -6.2% on 4/22/19.

Digging deeper, we can see that the true drivers of negative return for this portfolio since 2017 have been Alpha (-4.14%) and Sectors (-2.765), rather than Style factors. We'll dig more into the Sector side in next week's note.

‍Last week, we were able to see a pretty direct impact on the Chinese basket when major trade headlines came out. Let's overlay the US basket over the Chinese basket's performance, to see how the US basket reacted to those same headlines.

1. April 2017 - Xi visits Trump at Mar-a-Lago and they set up a 100 Day Action Plan.
2. May 2017 - US and China agree to a trade deal, giving US firms greater access to China’s agriculture, energy, and financial markets, while China can sell cooked poultry to the US.
3. Nov 2017 - Trump visits China and strikes a warmer tone with Xi.
4. Feb 2018 - US implements “Global Safeguard Tariffs,” including a 30 percent tariff on all solar panel imports and a 20 percent tariff on washing machine imports.
5. Fall 2018 - US and China resume trade talks, Trump suggests he wants to fix things with China in order to avoid a prolonged trade war.
6. May 2019 - Trade talks in Beijing stall out and Trump threatens to raise tariffs, eventually doing so.

Conclusions

‍Unsurprisingly, there is a fairly inverse correlation between the two baskets' performance with regard to these pieces of trade news. It also seems pretty apparent that US ERS-sensitive companies aren't as exposed to trade news as their Chinese counterparts, since the overall exposure and performance story is more of a mixed picture in the US. Chinese stocks are more purely exposed to US stocks than vice versa, and it shows in how there are clearly other elements that drive the US group.

Next week we'll do a complete decomposition of the US and Chinese baskets from an exposure and performance perspective, in order to see what further insights we can gain by using Exchange Rate Sensitivity and applying it to the ongoing trade entanglement.

Regards,
Omer