The conflicts between the United States and China are escalating and having stronger effects on markets.
When the conflicts began less than two years ago, markets would react. The reactions often were to presidential tweets but the effects on the markets weren’t lasting.
Subsequent news reports, interviews or other tweets convinced investors that the two countries would resolve their differences without adverse effects on either economy. So, markets recovered.
U.S. stock indexes bounced up or down with each new trade-related report. Some days the reports seemed positive and stocks rose. Other days, the conflicts seemed to be escalating and stocks took a hit.
Things changed lately. The effects on the markets are lasting longer, and the recent news about the U.S.-China conflict has been predominantly negative.
The escalation began when a potential meeting between the leaders of the two countries fell through. The United States then imposed new tariffs and extended others, after China reneged on previously agreed to terms shortly before a new trade deal was to be signed. China has taken some actions in response, and this week it threatened to deny the United States access to rare earth metals.
It is important to note that these disagreements now are more than trade conflicts. The United States has a list of concerns that include intellectual property theft, corporate espionage, government assistance and subsidization of businesses, barriers to U.S. companies seeking business in China and more.
The conflicts now appear to be deep-seated. There are fundamental differences between the cultures and beliefs of the two countries’ leaders, and they don’t seem likely to be resolved any time soon.
We can see in the markets that investors now seem more concerned. For example, the stocks of U.S.-based companies in the S&P 500 that derive at least half their sales outside of America are doing much worse than stocks of U.S.-based companies that derive at least 90% of their revenues domestically, according to Bespoke Investment Group.
Over the last 12 months, shares of the U.S.-focused companies consistently have done better than shares of globally focused companies. The domestic-focused companies are up 9.4%, while their globally focused counterparts have a 0.0% return.
The latest trade talks with China broke down in April. During May, the greater the percentage of international revenue that a U.S.-based business had, the poorer its stock performed. The 10% of companies with the most international revenue lost more than 10% for the month while others lost less.
Shares of U.S.-based companies that sell imported goods to U.S. customers also have been doing poorly since the trade conflict escalated.
It might be a coincidence, but stocks of U.S. technology companies also suffered more than the major indexes in May. The technology companies have a lot of two-way trade with China. In addition to tariffs, the U.S. government also is taking steps with U.S. national security policy to limit the extent to which U.S. companies can trade or have joint agreements with China and companies based in China.
After leading the market indexes for several years, technology stocks are down both absolutely and relative to other sectors of the indexes in recent weeks. At the same time, defensive stocks such as utilities have been rising.
In fact, the turnabout in the last month is so great that the utilities sector now has about the same price-earnings ratio as the technology sector.
Investors should accept that the conflicts with China aren’t going to be short term. There could be periods of relative calm and complacency as we saw for a while early in 2019. But the current administration wants to keep pressure on China to change its policies.
It still is early in these conflicts, and there are a lot of unknowns about the actions each country will take. But there are some moves investors should consider.
It might be wise to limit exposure to companies that depend on China for either sales or as part of their supply line. The more strategically important a U.S. company’s products or services are, the more likely the company is to be hurt by the conflicts.
Likewise, investors who buy shares of individual Chinese companies should avoid companies that depend on trade with the United States. You also should expect high levels of volatility in markets as investors react to the latest changes in the conflicts.
Investors also need to be prepared for the possibility that the trade conflicts will continue to escalate and could broaden into other conflicts, even war. That’s one reason why most of our Retirement Watch portfolios have a position in gold.
So far, the rhetoric from each country has exceeded the actions taken. That appears to be changing. It is likely that the conflicts with China will be with us for a while, and the conflicts involve a lot more than tariffs and trade.
Businesses seem to be investing less in plant and equipment after a modest surge in 2018. Durable Goods Orders declined 2.1% in April, and March’s orders were revised down from a 2.7% increase to a 1.7% increase. Core capital goods orders, considered a strong indicator of business investment, declined 0.9% in April. March’s core capital goods orders were revised lower from a 1.3% increase to a 0.3% increase.
The Dallas Fed Manufacturing Survey for May also declined. The General Activity Index of the survey was reported as a negative 5.3, compared to a positive 2.0 for April. The Production Index was a positive 6.3, compared to a positive 12.4 last month.
The Richmond Fed Manufacturing Index increased modestly to 5 from 3. This index had been weaker than the Dallas index the last few months and isn’t prone to such wide swings.
Consumer Confidence, as measured by The Conference Board, surged to 134.1 from 129.2. Components of the survey related to the labor market were particularly strong.
House prices barely increased in March, according to the FHFA House Price Index. The index increased 0.1% compared to 0.3% for February. Over 12 months, the index increased 5.0% compared to 5.1% in February. The 12-month price increase is the lowest in four years.
Likewise, the S&P Corelogic Case-Shiller Home Price Index increased only 0.1% for March, compared to a 0.3% increase for February. Over 12 months, the index rose 2.7%, compared to a 3.0% reading last month.
Pending home sales declined 1.5% for April. That follows a 3.9% increase last month. Over 12 months, pending sales declined 2.0%. This is the 16th consecutive month in which the 12-month change has been negative.
New unemployment claims increased by 3,000 to 215,000, and last week’s number was revised from a 1,000 decline to no change. The four-week average continues to decline as the surge in claims in April fades. It appears that April’s big increase in claims was not a new trend.
The second estimate of first-quarter gross domestic product (GDP) made minor changes from the first estimate. Overall, GDP growth was estimated at 3.1% instead of the initial 3.2%. Consumer spending was increased a little, while business investment and residential investment each were decreased a little. Each of the inflation measures in the report was decreased by 0.1%. The quarterly change in the price index was estimated at 0.8%, while the 12-month change is 1.2%.
The S&P 500 fell 2.58% for the week ended with Wednesday’s close. The Dow Jones Industrial Average declined 2.46%. The Russell 2000 dropped 2.75%. The All-Country World Index (excluding U.S. stocks) lost 1.30%. Emerging market equities fell 0.20%.
Long-term treasuries rose 2.25% for the week. Investment-grade bonds increased 0.54%. Treasury Inflation-Protected Securities (TIPS) added 0.61%. High-yield bonds lost 1.00%.
On the currency front, the dollar increased 0.11%.
Energy-based commodities declined 1.18%. Broader-based commodities rose 0.77%, while gold increased 0.49%.
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