Following one of the best four-month stretches for equity markets in recent memory, the month of May is proving more challenging with the S&P500 experiencing its worst week of the year. Despite a better than expected quarter of economic growth during the 1Q and earnings that are not as soft as feared, optimistic sentiment of investors that propelled the markets to swift recovery is now deteriorating due to escalating tension between the US and China in its ongoing trade negotiation. The US view is that China backed away/recanted from prior commitments and broke the deal. As a result, the S&P500 suffered a setback of -2.1% last week even despite a late-day rise on Friday (perhaps a show of optimism that drama between the US/China might progress over the weekend). That trade-related uncertainty and market pressure looks set to continue into a new week on headlines that discussions over the weekend made little progress and actually seem to be moving further apart. Abroad, international equities and emerging markets in particular are being punished more acutely as evidenced by the MSCI EM index forfeiting -4.5% last week.
From an economic perspective, most domestic data arriving in 2019 is so far supportive of a constructive narrative; one dramatically different from the pessimistic view just 5 months ago. The unemployment rate just hit fresh lows, home sales and mortgage applications are improving, and prices are signaling that the economy and demand are healthy with inflation not too low nor becoming problematically robust. Still, the current news driving markets is not hard data but rather rising fear and uncertainty that the more deal-seeking tone on US-China trade has evaporated. By some estimates, the hit to US GDP is likely about -0.1% point for every two months we go along with imposed tariffs (or -0.5% for a full year). To be sure, China would experience a hit as well, though they may be able to offset it with local stimulus and/or not actually report any impact by manipulating their numbers.
Investors should understand that an escalation of tariffs does not necessarily mean an end to negotiations and hope of a deal. In fact, it remains our belief that the rising tension, while creating some short-term pain, may serve to accelerate the final inking of mutually agreeable trade terms. Unfortunately, that negotiation is unlikely to be complete in the span of a few days and means more weeks (potentially months) of uncertainty for investors on a risk they started to price out of asset prices. Depending on the narrative that develops and amount of time in which it is perceived parties are fighting, it could mean a good chunk of the gains equities enjoyed during the first 4 months of the year is temporarily erased. This is because a more combative war-like tone threatens not just sentimental harm to investors, but will also begin to alter the mood and investment decisions of business leaders and manifest in the form of more muted growth. But, this weakness could also provide a much desired opportunity to find more attractive values at which to deploy new money arriving into client accounts. For investors, the best advice is to try and see through the short-term uncertainty and keep focus on the fact that a durable deal on trade is clearly in the best interests of all.