Is the US-China trade war creating volatility? Part II

Part II of Measuring Stock market response to the Trade War

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Many eyes are on global financial markets as US-China trade tensions continue to escalate. Trump’s critics are concerned that the trade war will encourage a recession and drive down stock prices. His supporters, by contrast, insist that he is doing the right thing.

There are a couple of simple ways to think about whether — and how — the trade war affects financial markets. One is a comparison of indices across regions.

Below, we compare the Dow Jones and S&P 500, two widely cited US indices, to the Shanghai Composite.

The gap in performance has grown since Trump took office, with US indices outperforming Shanghai.

Divergence Between Dow and Shanghai

 
Closing prices since January 2017, indexed to a common starting point.

Closing prices since January 2017, indexed to a common starting point.

 

Some claim this performance gap is evidence that Trump is correct — trade wars “are good and easy to win.” Based on that chart, it looks like Chinese firms are “hurting more” than American ones.

However, the health of financial markets is about more than prices. It’s also about stability. In a pervious post, we saw that the VIX, a common indicator of uncertainty in the market, didn’t indicate any particular abnormality in the market.

But the VIX is not a direct measure of volatility. The chart below plots the rolling weekly standard deviation in Dow Jones closing prices.

Wild Mood Swings?

 
Dotted line is weekly standard deviation closing price. Solid line is 6-month average.

Dotted line is weekly standard deviation closing price. Solid line is 6-month average.

 

This picture tells a slightly different story. The Dow has been much more volatile after the 3rd wave of tariff hikes (Sept. 24, 2018).

This has to be read cautiously. Volatility isn’t always a bad thing. The same picture could be a result of stock prices roaring upward…

But they aren’t.

On Sept 21, 2018, the Dow was at 26,700. One year later, it’s at 27,100. Hardly a massive gain. So, all that volatility isn’t a result of massive gains. It’s a result of near-constant ups and downs as Wall Street responds to each new tweet from the White House.

 
AnalysisJeffrey KucikTrade