We’re a week into August, and trade tensions have been the biggest driver of U.S. stocks, as we predicted in our latest Weekly Market Commentary. Markets don’t like uncertainty, and we are getting a heavy dose of it now.
On August 5, the S&P 500 Index notched its worst day of the year amid President Trump’s decision to level tariffs on the remaining $300 billion of U.S. imports from China. China retaliated by letting its currency (the yuan) weaken beyond the 7 per dollar mark that many had viewed as a line in the sand, as shown in the LPL Chart of the Day, Chinese Currency Move Escalates Trade Dispute. Then, the U.S. labeled China a currency manipulator, another obstacle to re-establishing any semblance of trust before productive talks can occur, even if that move was largely symbolic.
Both sides may inflict more pain on the other before we see more progress, but we still believe it’s in both parties’ interests to negotiate.
“If this trade war escalates further and drags on into the 2020 campaign season, President Trump could hurt his re-election chances,” said LPL Chief Investment Strategist John Lynch. “The pressure on the president could intensify if the global economy slows further, consumers are forced to pay higher prices, and corporate profits get hit by tariffs and disruptions to supply chains.” Some of that pressure may come from the farm belt where the President generally enjoys good support. Consumer incomes have historically been the best predictors of presidential election outcomes but presidential approval ratings also matter.
Sticking points remain. China wants the United States to remove tariffs and lift restrictions on telecom giant Huawei. The United States wants China to make structural changes to its markets, create a level playing field for U.S. businesses operating in China, including strengthening intellectual property protections, and buy significant amounts of U.S. crops.
Beyond further currency devaluation, China could retaliate by adding or raising its tariffs on U.S. goods; adding more red tape for U.S. companies in China; delaying mergers, acquisitions, and capital investments; intentionally holding up U.S. goods at the China border; banning exports of rare earth metals; or, less likely, selling U.S. Treasuries.
We will continue to watch trade developments. For now, though, we believe the fundamentals of the economy, corporate profits, interest rates, and inflation will put a floor under the stock market before this pullback gets much worse. We think progress on trade later this year will help, although we recognize managing through this volatility is difficult and will require some patience; find more of our thoughts on market volatility in the August 6 blog.
The dispute may drag on well into next year and further impact economic growth and corporate profits. If this decline does reach correction territory of 10%, we do not expect it to get much worse than that based on a still supportive fundamental backdrop. We maintain our year-end fair value target on the S&P 500 in the range of 3,000.
Please see the Midyear Outlook 2019: FUNDAMENTAL: How to Focus on What Really Matters in the Markets for additional description and disclosure.
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