Is Wall Street ignoring the potential for simmering trade conflicts with China to intensify, upending the stock market’s newfound buoyancy?
It may be hard to fathom that consternation tied to President Donald Trump’s hard-line stance with China, Europe and other major economies may bubble up into something more severe for investors after the Dow Jones Industrial Average DJIA, +0.95% on Thursday booked its first record since Jan. 26, joining the S&P 500 index SPX, +0.78% and the Nasdaq Composite Index COMP, +0.98% both of which had already broken out of a lengthy downturn to notch their own records (as recently as Thursday for the S&P 500).
Although on some level the stock market’s climb to new heights represents a growing conviction about the U.S. economy, outweighing the threat that a Beijing-Washington trade fight could morph into the sort of a bellicosity that could disrupt global economic vitality, on another level a number of investors can’t shake a sense of unease about the current trajectory of tariff tensions.
Dec Mullarkey, managing director of investment strategy at Sun Life Investment Management, which manages some $47 billion, thinks the market is being too dismissive.
“I do think that the market right now is incredibly complacent,” Mullarkey said.
“I think both countries are on a collision course and that’s not going to get resolved quickly and I think we’re heading toward all China imports getting hit with tariffs,” he said.
The fact that the recent run-up in stocks comes just as tensions appeared to be ratcheting up earlier in the week hasn’t sat well with some market participants either.
On Tuesday, the Chinese government announced plans to impose new tariffs on $60 billion in U.S. exports, in retaliation to the Trump’s administration’s announcement that it was following through with an additional $200 billion in duties on China imports, with Trump adding that “if there’s retaliation against our farmers and our industrial workers and our ranchers, if any of that goes on we are going to kick in another $257 billion.” Both sets of tariffs are due to be implemented on Monday, decreasing the likelihood that the two economic superpowers would easily negotiate a way out of the tit-for-tat conflagration.
A Thursday report from Goldman Sachs Group Inc. GS, +0.77% analysts pegs the probability that tensions intensify at 60%, up from 55%. They anticipate that the U.S. will place tariffs on nearly all goods imported from China that aren’t already covered by current tariffs.
Read: Trade-war tracker: Here are the new levies, imposed and threatened
Moreover, Goldman’s stance appears to concur with those of Mullarkey. Here’s an excerpt of Goldman’s view:
While further negotiations between US and Chinese officials over the next couple of months are likely and could slow further escalation in trade tensions, we nevertheless believe additional tariffs are the most likely outcome, as the policy issues underlying the dispute will be difficult to resolve, the bilateral trade deficit at the heart of the dispute is unlikely to narrow substantially regardless of policy actions, and the White House will have greater political flexibility to increase tariffs after the midterm election.
Although most assess that the current state of play between China and the U.S. on trade may result in a negligible hit to the U.S. economy (or the rest of the world, for that matter), the real threat may be a knock-on effect.
S&P Global Ratings on Thursday wrote that escalating U.S.-China tensions raise the risk of lower domestic economic growth.
“We believe that the ‘shock’ arising from this escalation by both sides could eventually have a larger proportionate impact on the U.S.,” the agency wrote.
Industry experts and strategists also believe that it will be hard to close a veritable Pandora’s box of tariffs that have been unleased with extant import duties already being felt by both economies.
“Even if such a trade war doesn’t materialize, the mere perception of the [heightened] risk of one could be sufficient to depress business and market confidence to an extent that it has a significant impact on the real economy,” analysts at S&P Global Ratings wrote.
As Savita Subramanian, equity and quant strategist at Bank of America Merrill Lynch, put it in a research report in June, which she reiterated on CNBC on Thursday, Trump’s protectionist stance even in a “win” scenario for the U.S. could also choke off growth for the S&P 500 constituents. She estimated that about 40% of the rise in so-called margin expansion, or the increase in the rate of profit, since 2004 can be attributed to companies achieving cost-savings by taking their businesses abroad. “The most globally oriented sectors—tech, energy, industrials, materials—could see both margins and multiples hurt in such a shift,” she wrote.
Mullarkey believes that the source of Wall Street complacency is tied to the U.S.’s recent success in talks about revamping the North American Free Trade Agreement with Mexico and plodding progress with Canada, the other trilateral constituent of Nafta.
However, he believes that success isn’t a proper indicator of the possible outcomes in China talks.
“What I think is that this is an inflection point and it is important to [Trump administration] that they hold their ground. They have confidence that the trade path with China will follow the same path as Mexico, but China’s a completely different situation that is going on between the top two economies,” the Sun Life investment manager said.
To be sure, the market reflects optimism that things won’t race out of control. The fact that the U.S. kicked off tariffs with 10% levies against China (which rise to 25% before year-end) rather than a higher rate, were taken as cause to remain sanguine, particularly as data on the U.S. economy continue to indicate strength.
Jamie Cox, managing partner for Harris Financial Group, told MarketWatch that he sees a different sort of inflection point for markets “where the sectors and markets most heavily damaged by the trade disputes represent the most compelling future investment opportunities.”
“What we see now, is that markets are starting to discount the durations of trade disputes with the different nations, and trying to divine which disputes are going to be less impactful than originally forecast. For example, any announcements which result in less costs than markets have priced in (e.g. latest China tariffs at 10% instead of 25%) will immediately result in positive results for the companies most heavily impacted by trade disputes,” he said.
Read: Not just tech: The stock-market rally is broader than it’s given credit for
As always is the case with markets, only time will tell how this ultimately plays out, but for now stocks have thus far resisted the urge to unravel on the lingering trade fears, even as it remains the most closely followed risk factor on Wall Street.
According to the fund-manager survey, 43% of those polled said that a trade war was the biggest “tail risk” facing markets, writes MarketWatch’s Ryan Vlastelica.
Providing critical information for the U.S. trading day. Subscribe to MarketWatch's free Need to Know newsletter. Sign up here.
