Trade Tensions Upend Rally in Stocks

After a strong rebound beginning the day after Christmas and continuing through the first four months of 2019, the S&P 500 Index reached fresh all-time highs in late April. Since the start of May, however, the market has given up nearly 5% of its value—2.5% of it on Tuesday alone—as investors react very negatively to the sudden deterioration in the China trade negotiations. As recently as two weeks ago, investors seemed to be convinced that a deal was imminent. However, frustrated with slow progress and apparent backtracking by the Chinese, President Trump increased tariffs from 10% to 25% on $200 billion worth of Chinese goods last Friday. On Tuesday, China responded that it would impose tariffs of up to 25% on $60 billion of U.S. imports on June 1^st.

While it is impossible to divine the true goings-on in the talks, it seems that each side may have become emboldened by recent improvements in their respective markets and economies. The U.S. economy grew 3.2% in the first quarter and unemployment hit a 50-year low as equity markets rebounded from their December lows. In China, the Shanghai Composite Index was up by over 30% year-to-date by the end of April after a very difficult 2018 as stimulus measures took hold. Perhaps both President Trump and President Xi believe they now have more economic breathing room to take a harder line in the negotiations.

U.S. Economy on a Steady Course

While equities are reacting negatively to the latest headlines about the trade talks, the U.S. economy continues to move ahead in a steady but unspectacular fashion. Economic growth of 3.2% in the first quarter was ahead of expectations and a solid showing in the wake of severe market volatility in the fourth quarter of 2018. Nevertheless, this 3.2% likely included some inventory building by companies looking to procure product and materials ahead of time in case the China trade talks were to take a sour turn later in the year. Thus, some of the reported economic growth in the first quarter appears to have been pulled forward from future quarters. Right now, the average expected U.S. economic growth among surveyed economists is about 2.3% for all of 2019.

Earnings In-Line

On the earnings front, things are in decent shape. First quarter corporate earnings reports are nearly finished, and by and large they satisfied investors. While just weeks ago Wall Street analysts expected first quarter earnings, in aggregate, to be about 3.9% lower than the first quarter of 2018, earnings are actually tracking to be about 0.4% better than last year. While a fractional gain like this is nothing to be excited about, investors seem to be content with current corporate performance.

Trade Clash Reflects a Broader Competition

The trade dispute is now the most visible sign of competition between the U.S. and China, but it is merely part of a broader rivalry growing between the two countries. Any trade deal is not likely to forestall greater competition between the two countries in the military, technology or political realms in the years ahead. China’s rise to become a global superpower over the last couple of decades means that the U.S. and China will find themselves stepping on each other’s toes in an increasing number of ways and friction between the two is likely for the foreseeable future.