With just four trading days remaining for May, the “rear-view mirror-ists” will be quick to say investors should have expected the noticeable pullback coming (nevermind that the month of May was firmly positive in each of the last 5 years). The S&P500 is off -3.9% with most attributing the decline to renewed tension between the US and China over trade-related policy and the fact is that until recently, most investors anticipated a trade agreement was not just close, but a virtual certainty in early 2019. Combined with a US Fed that now seems firmly on hold from any additional interest rate hikes this year, the stock market enjoyed support. While the Fed still appears content with its patient posture (very important), a truce between the US and China on trade is no longer in clear sight. Interesting is that smaller-size companies which are often believed to be more insulated from the dynamics over global trade and should in theory experience less influence from tension are actually faring noticeable worse in this latest war of words. But more telling perhaps is that international equities and those domiciled in Asia especially are really getting crunched compared to US domiciled companies.
It is not that the direct hit from current tariffs are all that large, but more that it is tough to see where the imposition of new additional tariffs ends, or when political pressure will build enough on each or either side to bring Trump/Xi back to the bargaining table. At the moment, nationalist rhetoric is generally being embraced by public opinion in both countries; Chinese negotiators have said further trade talks with the US at this point are not useful and recent US polls show most (regardless of political orientation) believe it is time we stand up to China on abusive trade terms. In the meantime, this global uncertainty is beginning to reappear in key asset prices and hard data. Input commodities to manufacturing such as copper, iron ore, and oil prices are all experiencing acute price pressure which many interpret as a forecast of weakening economics. At the same time, a number of data points over recent days were almost uniformly soft with existing home sales off -0.4%, US PMI and durable goods orders slipping roughly -2% in their latest prints, and early estimates of 2Q growth appearing at risk of slipping below 2%. Weak data is also evident in Japan and Europe.
While we are of a similar perspective to most – that no one wins in a trade war – it is interesting to read between the lines that the market (via significantly more punishing stock market declines) believes China/Asia has more to lose from more restrictive trade. Yet in a global economy that continues to battle so many uncertainties (Brexit, political unrest, and trade dynamics) and soft economic progress, any additional self-inflicted hits like trade are unwelcome and worth close monitoring. We believe that while trade friction itself is unlikely to cause recession, the impact it can have on confidence and business decisions will be motivation to reach a deal. In the meantime, the weakness means that the Fed is only more likely committed to its on-hold stance (and increases the probability of a rate-cut later this year) which should keep further weakness relatively contained. If/as we get resolution on trade (which is unknowable in terms of timing), the market could well enjoy relatively swift rebound back toward or even above April highs.