Markets sold off heavily on Monday, following a sharp escalation in the China-U.S. trade war. Both the Dow Jones Industrial Average and the S&P 500® plummeted roughly 3% as China retaliated to U.S. President Donald Trump’s tariff threat.
A quick escalation
Trump’s announcement last week that the U.S. plans to impose a 10% tariff on the remaining $300 billion of Chinese imports not already being taxed was almost certain to draw a swift response from Chinese leaders. Sure enough, that’s what transpired.
Over the weekend, China struck back at the U.S. by devaluing its exchange rate by approximately 1.5%, with the yuan-to-dollar ratio falling below 7-to-1 in offshore trading today. In addition, the country instructed state-owned enterprises to stop buying U.S. agricultural products. Both of these measures are likely to draw even further ire from President Trump. Why? He has been an outspoken critic of Chinese currency manipulation in the past, and was reportedly also angered by China’s failure to follow through on its recent promise to increase U.S. agricultural purchases.
Why are markets so concerned? 3 reasons: Earnings, consumer spending and jobs
The rapid escalation in the trade war between the two countries almost guarantees a prolonged period of trade uncertainty, with the potential for the Trump administration to raise tariffs even further in the fall. We believe this may lead to potentially significant impacts for:
- Corporate earnings
- Consumer spending
- The U.S. labor market
Earnings outlook deteriorates
Simply put, tariffs weaken corporate earnings because they result in an increase in input costs. More tariffs on more products equals higher input costs. One need look no further than the second-quarter earnings season to see this. While companies have done a bit better than expected, earnings growth for the S&P 500® Index is tracking around -1% according to FactSet data. In our view, the increase in trade tensions makes a sustained earnings recession (defined as two consecutive quarters of declining earnings) much more likely. In addition, an industrial recession in the U.S. also appears increasingly probable, as manufacturing activity continues to slow, and appears on the verge of contracting already.
Consumer spending in jeopardy
Consumer spending, alternatively, has remained strong so far, despite the tariffs that the U.S. has already placed on $250 billion worth of Chinese goods. This, however, may change if the latest round of threatened tariffs go into effect. Why? The latest imports targeted by the Trump administration consist mostly of consumer goods, such as mobile phones and toys. Once again, businesses will be forced to either absorb the additional cost or pass it on to consumers. With corporate earnings already blunted by the trade war, it’s not hard to fathom the latter occurring this time around. The impact of a slowing consumer could be material, given that consumer spending accounts for 70% of the U.S. economy.
Job growth at risk
The escalating trade war also has the potential to detrimentally impact the U.S. labor market, which has already seen a modest slowdown in job growth from last year. Waning CEO confidence has already led some business leaders to scale back on capital-goods purchases. Typically, in a situation like this, the next thing CEOs tend to cut back on is hiring.
As the trade situation sours, downside risks to the global cycle have increased in the near-term. In our opinion, this makes a third U.S. Federal Reserve (the Fed) rate cut likely this year. At current yield levels we have a neutral to slight overweight preference for U.S. duration in multi-asset portfolios. The equity market selloff looks commensurate for the increased risks to the outlook. We are not inclined to add to risk positions here as we do not yet see compelling evidence of a broad-based investor panic.
Bottom line: Our preferred positioning is to continue to hold asset allocations near policy with an eye towards defensiveness.
These views are subject to change at any time based upon market or other conditions and are current as of the date at the top of the page.
Investing involves risk and principal loss is possible.
Past performance does not guarantee future performance.
Forecasting represents predictions of market prices and/or volume patterns utilizing varying analytical data. It is not representative of a projection of the stock market, or of any specific investment.
This material is not an offer, solicitation or recommendation to purchase any security. Nothing contained in this material is intended to constitute legal, tax, securities or investment advice, nor an opinion regarding the appropriateness of any investment, nor a solicitation of any type.
The general information contained in this publication should not be acted upon without obtaining specific legal, tax and investment advice from a licensed professional. The information, analysis and opinions expressed herein are for general information only and are not intended to provide specific advice or recommendations for any individual entity.
Please remember that all investments carry some level of risk. Although steps can be taken to help reduce risk it cannot be completely removed. They do no not typically grow at an even rate of return and may experience negative growth. As with any type of portfolio structuring, attempting to reduce risk and increase return could, at certain times, unintentionally reduce returns.
Investments that are allocated across multiple types of securities may be exposed to a variety of risks based on the asset classes, investment styles, market sectors, and size of companies preferred by the investment managers. Investors should consider how the combined risks impact their total investment portfolio and understand that different risks can lead to varying financial consequences, including loss of principal. Please see a prospectus for further details.
Indexes are unmanaged and cannot be invested in directly.
The S&P 500® Index, or the Standard & Poor's 500, is a stock market index based on the market capitalizations of 500 large companies having common stock listed on the NYSE or NASDAQ.
The Dow Jones Industrial Average (DJIA) is a stock market index of 30 large U.S. companies created by Dow Jones & Company co-founder Charles Dow. First calculated in 1896, the DJIA is currently owned by S&P Dow Jones Indices, which is majority owned by S&P Global.
Russell Investments' ownership is composed of a majority stake held by funds managed by TA Associates with minority stakes held by funds managed by Reverence Capital Partners and Russell Investments' management.
Frank Russell Company is the owner of the Russell trademarks contained in this material and all trademark rights related to the Russell trademarks, which the members of the Russell Investments group of companies are permitted to use under license from Frank Russell Company. The members of the Russell Investments group of companies are not affiliated in any manner with Frank Russell Company or any entity operating under the "FTSE RUSSELL" brand.
Copyright © Russell Investments Group LLC 2019. All rights reserved.
This material is proprietary and may not be reproduced, transferred, or distributed in any form without prior written permission from Russell Investments. It is delivered on an “as is” basis without warranty.