Less than two weeks ago, investors were operating under the assumption that a U.S./China trade deal was all but certain. Much has changed in a short period. Uncertainty has been reintroduced around when, or if, an agreement will materialize. We continue to believe an eventual compromise is the most likely outcome, but for now, visibility is limited and further negative headlines could continue to weigh on sentiment.
On Friday May 3, the S&P 500 closed near an all-time high amid multiple reports that China and the U.S. were close to a trade deal. Chinese officials were due in Washington on Wednesday May 8 and many anticipated an agreement by Friday May 10. On Sunday May 5, President Trump announced that tariffs on $200B of Chinese goods would increase from 10% to 25% by the end of the week citing slow progress in trade talks. Chinese officials did visit Washington and both sides described discussions as “constructive,” though no deal was reached. Over the weekend, President Trump stepped up the rhetoric with another series of tweets. China responded by announcing retaliatory tariffs on $60B of U.S. goods.
On the spectrum of trade negotiation to trade war, the situation appears to have shifted unfavorably. Stocks gave back 2.5% last week and are more than 2% lower today as markets price in uncertainty and the risk of further escalation. Near-term, we see potential for additional headline risk, but longer-term, we believe a negotiated agreement will be in the best interests of both sides and is the most likely outcome. Looking forward, optics on U.S./China trade are increasingly important as the 2020 presidential election approaches. The President may have an interest in reinforcing “tough on China” rhetoric into the election, but would also seek to avoid economic damage from reciprocal tariffs.
In the absence of a negotiated deal, first order economic impacts of currently-announced tariffs themselves are likely minor. Economists project a 0.1% drag on global GDP from current tariffs. Additional tariffs would have a greater effect, but the greater risks may be from weaker sentiment and tighter financing conditions if trade policy uncertainty remains elevated.
It is important to consider recent trade-related market fluctuations in context. Through Friday May 3, major U.S. indices were up more than 18% on a year-to-date basis with very limited volatility. In contrast to 4Q18, the 1Q19 earnings season was strong, and consensus expectations for 2020 earnings held firm. Credit markets remain supportive, the labor market remains robust and real retail sales growth has been decidedly positive to start the year.
We remind investors that maintaining discipline during periods of uncertainty and market volatility is the most reliable course for growing and preserving wealth over the long-term. We will continue to monitor and evaluate developments between the U.S. and China. As the situation unfolds, we will be here to respond and communicate our views. Please contact any member of our team if you have questions.