Trump's China Tariff Threat Is Convenient Excuse for Much-Needed Corrective Action

For months, investors have been looking for a reason for the market to sell off.  Worries and concerns about valuation and overbought technical conditions have been ignored and haven't mattered, though. 

What finally hit the market Friday had nothing to do with fundamentals or valuation. It was President Trump's warning that he was poised to impose massive tariffs on China due to its efforts to restrict the supply of rare-earth minerals.

It was the perfect catalyst for some long-overdue selling and triggered a loss in the S&P 500 of 2.7%. That is the largest decline it has suffered since a drop of 4.4% on April 10, when tariffs were also the primary issue.

The issue now is how deep this correction will go. The S&P 500 has not yet breached its 50-day simple moving average, but there isn't much nearby support because this market has had such a steady uptrend for so long.

The pattern this year with Trump's tariff threats has been a quick recovery when he modifies his position. There is a good likelihood that the issue will be resolved fairly quickly, but more threats are expected from both China and the U.S. before any agreement is reached. Uncertainty about the situation is likely to produce more selling next week.

The good news is that this corrective action is hitting just as the third-quarter earnings season is about to start. This selling will help to lower expectations and to create better conditions for a positive response to quarterly results. In addition, earnings will focus on specific company results and not the macro-economic situation, which will help matters.

When extreme selling hits like it did on Friday, it is mostly index-driven. Everything is solid regardless of its individual merits. Only 13% of stocks managed a positive close on Friday, and new 12-month lows surpassed new 12-month highs for the first time in a while.

While there is a good chance of more downside next week, I'm not convinced that this is a major top. Dip buyers have not had a good opportunity in a while and I expect them to avail themselves of this one. The threat of massive tariffs on China was just a good excuse for the market to do what it needed to do.

Have a great weekend. I'll see you on Monday. 

At the time of publication, Rev Shark had no positions in any securities mentioned.