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How to Use U.S.-China Trade War Market Volatility to Your Advantage

Donald Trump opened his mouth about China trade, and like that, market volatility is back. But after months of rallying, it’s probably a good thing.

There have been three full trading days since President Donald Trump decided to relight the U.S.-China trade torch. Not coincidentally, stocks have been down on net, and market volatility has suddenly returned, with the CBOE Volatility Index (VIX) spiking to three and a half month highs.

For those who believe in this ongoing bull market, it’s a buying opportunity.

U.S.-China Trade War and the Three-Day Rule

Jacob Mintz, our options trading expert and chief analyst of our Cabot Options Trader advisory, has written extensively about the Three-Day Rule. It works like this: If a stock took a big fall, whether it was on earnings or some other news event, you MUST wait at least three trading days before even thinking about putting on a bullish position.

The Three-Day Rule can apply to the market as a whole when a news event like the re-escalation of U.S.-China trade tensions prompts a rash of selling. U.S. companies didn’t suddenly stop growing because of the renewed tariff threat. They didn’t cancel earnings season. Much-better-than-expected first-quarter gross domestic product (GDP) growth (+3.2%) isn’t going to be rescinded, nor will the decades-low unemployment rate.
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Right now, it’s mostly words. Granted, those words are being exchanged between leaders of the two most powerful nations on the planet, and the ramifications of further escalation—and eventual action—could be quite damaging to both economies. But for now, the U.S. economy is humming. Thus, as it mostly has been when it’s cropped up over the last couple years, the U.S.-China trade war is a momentary concern for investors—one that bubbles to the surface every so often like a boiling pot of water, only to fizzle when the temperature is turned down.

You could point to last year’s fourth-quarter market correction as an exception—when stocks declined for three months as U.S.-China trade tensions reached a boiling point. But that’s oversimplifying the cause of that correction. While the trade war was an easy scapegoat, stocks were due for a big correction on the heels of a nine-year bull market. Trade concerns perhaps made the correction longer and deeper than it needed to be. But it wasn’t the root of why stocks retreated so dramatically from October through December (the Fed’s December rate hike and talk of continued balance sheet run-off comes to mind).

Now, stocks are back below their September 2018 peaks and a few signs of a stock market top have popped up. It’s been a rough start to the week. But I think the retreat is temporary—in large part because stocks are below their 52-week highs.

For weeks, our resident market expert Mike Cintolo has warned of an impending short-term pullback. Stocks never rise in a straight line unimpeded for too long, and after rising 25% in four months, the market was due for some consolidation. Now, that pullback has arrived, and as it has been several times in the last couple years, the U.S.-China war of words was the thing that nudged on-the-fence investors into selling mode.

Market Volatility Remains

So is the coast already clear? Not yet—not with market volatility still high. The Three-Day Rule may work well for stocks, but when it comes to the market as a whole, three days of retreating isn’t enough to feel like the coast is clear.

If stocks start to climb again today (Thursday) and tomorrow (Friday), that might be a good sign that the clouds have parted. The best thing you can do is keep reading, where we’re constantly taking the market’s temperature. Whether it happens next week or next month, eventually the selling will stop. There’s too much to like about this economy and this market for it to not.

When that happens, there will be plenty of good stocks available at bargain prices. And you can thank Trump’s big mouth for that!


Chris Preston is Cabot Wealth Network’s Vice President of Content and Chief Analyst of Cabot Stock of the Week.