By William Watts, MarketWatch
Investors are facing up to the potential for a protracted
fight
There goes the "hope" premium.
Stock-market investors spent the first four months of 2019
penciling in an easy resolution to a U.S.-China trade tiff. Things
have changed.
"While we, like most investors, are hopeful that a trade deal
gets done sooner rather than later, we don't think hoping for the
best is the ideal way to invest," wrote Lindsey Bell, investment
strategist at CFRA, in a Thursday note. "The nature of the issues
at hand are much more structural and complex than simply addressing
a trade deficit."
Read:Why the tariff fight prompted a major wealth manager to
change its U.S. portfolios
(http://www.marketwatch.com/story/a-major-wealth-manager-just-shifted-its-us-portfolios-as-tariff-fight-intensifies-2019-05-10)
That reality was brought home earlier this month as a round of
tit-for-tat tariff escalations was accompanied by hotter rhetoric
from both Washington and Beijing. The Trump administration's
subsequent decision to effectively blacklist U.S. companies from
doing business with Chinese tech giant Huawei -- and the specter of
Chinese retaliation -- ensured investors began to question their
expectations for a relatively painless resolution of the U.S.-China
trade spat. Instead, they now worry that the battle could signal
the start of something deeper -- and more threatening to global
growth and, ultimately, corporate earnings.
Need to Know:Trade tensions could last well into the 2020
campaign, says Nomura
(http://www.marketwatch.com/story/trade-tensions-could-last-well-into-the-2020-us-election-campaign-says-nomura-2019-05-23)
That said, the market is hardly in a panic. While the S&P
500 has retreated 4.1% in May and the Dow Jones Industrial Average
has given up 3.8%, they remain up 12.7% and 9.7%, respectively, for
the year to date. The S&P sits around 4% off its all-time high
set in late April.
The Nasdaq Composite , weighted toward tech shares seen among
the most vulnerable to an escalating confrontation, is down 5.7% so
far in May but is hanging on to a 15.1% year-to-date advance. Over
the past week, the S&P shed 1.2%, the Dow fell 0.7% and the
Nasdaq gave up 2.3%.
"We don't think this expansion is over, we think the stock
market has some new highs in it...but certainly what you need is
better hopes for a deal and you need some more confidence that the
global growth story is going to stabilize," said Scott Wren, senior
global equity strategist at Wells Fargo Investment Institute, in a
phone interview.
And Wren, like many other market watchers, has had to adjust
expectations around a resolution of the trade fight. For some
investors, it's a matter of accommodating the idea that the Trump
administration's goals may be more about containing or even
punishing China than getting to an agreement in short order.
"The presumption has always been that the U.S. has wanted to
strike free trade deals, with any short-term economic and financial
market damage from the tariffs required to create these deals,
outweighed by the longer-term gains once the deals are struck and
the tariffs removed," said Steve Barrow, head of G-10 strategy at
Standard Bank, in a note. But now investors are facing up to the
prospect of long-lasting tariffs, which could cause significant
economic uncertainty and changes in trade patterns.
"Many will hope that the U.S.'s trade aspirations revolve around
the former policy, not the latter. But acting in hope, when it
comes to financial market positioning, is fraught with danger," he
said.
Sounding a more ominous tone, Scott Minerd, global chief
investment officer at Guggenheim Investments, warned in a Thursday
note that the "war is at hand."
"Unless the current trajectory is quickly changed, the Chinese
are digging in for a long fight. The cost to the United States will
be high; the cost to the Chinese will be higher. The only question
is who will endure and be the most innovative in this battle of
wills," Minerd said.
So, what's an investor to do? Bell said the threat of a longer
and potentially more confrontational dispute is part of the reason
CFRA shifted to a more "tactically defensive" stance in early May
by overweighting the health-care sector and raising consumer
staples to marketweight from underweight.
In the near term, the threat to the market might be centered on
the potential blow to confidence from an escalating fight and the
threat it might pose to global growth. And with that, there's a lot
of uncertainty about what a long-lasting trade battle would mean
for corporate earnings.
S&P 500 earnings growth for 2019 is projected at 2.5%, up
from the 1.9% expected when first-quarter earnings season kicked
off on April 11 Bell noted. Meanwhile, expectations for 2020
moderated to 11.8% from 12.7% over the same period.
See: Why one stock-market bull thinks investors are overreacting
to trade-war rhetoric
(http://www.marketwatch.com/story/why-one-stock-market-bull-thinks-investors-are-overreacting-to-trade-war-rhetoric-2019-05-23)
The U.S. move to increase tariffs on $200 billion worth of
Chinese goods imported to the U.S. went into effect on May 10,
after more than 90% of S&P 500 companies had reported
first-quarter results and provided updated guidance, Bell said.
That makes it unlikely that the tariff increases, much less the
potential for an escalation in tariffs to cover all imported goods,
has been accounted for in current growth expectations, she said,
while noting that economists at S&P Global Ratings don't expect
the May 10 tariff rise to have a significant impact on economic
growth if left in place for the rest of 2019.
See:This is what Trump's latest tariff increase will cost the
typical American household
(http://www.marketwatch.com/story/this-is-what-trumps-latest-tariff-increase-will-cost-the-typical-american-household-2019-05-23)
Also read:Here's how hard the tariff fight could hit the economy
(http://www.marketwatch.com/story/heres-the-hit-us-chinese-and-global-economies-could-face-as-trade-battle-heats-up-2019-05-09)
"Nevertheless, CFRA thinks there is downside risk to the
second-half earnings growth outlook," Bell said, while noting that
the downside could be "minimal" if there's no further escalation in
tariffs and if consumers, buoyed by increased wages, higher home
prices, more job opportunities, and increased productivity can
support U.S. economic growth by absorbing the higher costs of
trade.
Wells Fargo has shifted to a more "neutral" stance in its
portfolios, but has favored tech, industrials and consumer
discretionary sectors, which have outperformed, Wren said. He wants
to maintain exposure to economically sensitive sectors on the
expectation that the expansion still has room to run.
But the worries about the impact of a protracted trade war and
the implications for global growth are the biggest wild card.
"You don't want to have a big bet on right now, but you want to
at least have a little bet on...It just seems like it could either
way, at least in the short term.
The holiday-shortened week ahead brings a relatively light
economic calendar, including a revision to first-quarter gross
domestic product data and April trade figures on Thursday. The
highlight will likely be personal income and consumer spending data
for April that's due on Friday and will include a look at personal
consumer expenditure, or PCE, inflation -- the Federal Reserve's
favorite price gauge.
Core PCE is forecast to come in flat, according to a MarketWatch
survey of economists.
(END) Dow Jones Newswires
May 24, 2019 17:11 ET (21:11 GMT)
Copyright (c) 2019 Dow Jones & Company, Inc.