In my April Newsletter, I mentioned the possibility of more market weakness in our future. Well, we certainly have gotten that, and Chinese trade tensions are primarily the cause. On May 5, President Trump threatened to raise tariffs to 25% (from 10%) on $200 billion in Chinese imports, surprising investors who thought the United States and China were close to a deal just a few weeks ago. Five days later, the U.S. announced it would impose higher tax rates on that swath of goods, and china announced its own tariff increase on $60 billion in U.S. goods. Now, the U.S. is considering tariffs on all Chinese imports.

Financial markets have struggled to process the rapid back and forth between both countries. The S&P 500 Index fell nearly 5% over six trading days before paring about half those losses through the end of last week. Bottom line, LPL Financial Research believes that higher tariffs can weigh on economic activity but doesn’t expect an escalation in this activity to derail the current economic expansion.

Drilling down, LPL believes any direct economic impact from these new tariffs should be small. The United States’ decision to hike rates on $200 billion in Chinese imports adds about $30 billion in cost per year (on top of existing tariffs). U.S. importers pay the direct cost, and some of those costs may be passed on to U.S. wholesalers or consumers. Chinese exporters can also choose to lower prices, but the evidence points to minimal movement in that direction so far. If the U.S. takes the next step and decides to implement a new tariff rate on all Chinese imports, the U.S. economy would bear about $80 billion in additional costs over a year, which is about 15% of LPL’s gross domestic product (GDP) growth projection this year. While this is still a possibility, it would be an unusually aggressive step after several weeks of progress in trade talks. In either case, LPL expects the fiscal stimulus tailwind alone to overpower any negative effects.

Corporate earnings season delivered as expected. With 92% of results for S&P 500 Index companies in the books, first quarter 2019 earnings are tracking to roughly flat with the prior year. While flat earnings don’t sound impressive, LPL considers it a victory given consensus estimates were calling for a 4-5% decline when earnings season began. Earnings season is considered a success based on the amount of upside to prior estimates generated by S&P 500 companies despite several headwinds.

These are the reasons for the equity markets rallying prior to the Chinese trade tariffs announcement by President Trump and the obvious selloff that then ensued. So, the markets are “watching and waiting”.  Encouraged by earnings yet concerned about trade. We will see how this unfolds this summer. – Mark

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual. No strategy assures success or protects against loss. Economic forecasts may not develop as predicted. Some of this research material has been prepared by LPL Financial. All indices are unmanaged and may not be invested into directly. Referenced material: LPL Research Weekly Market Commentary and LPL Research Weekly Economic Commentary, both dated May 20, 2019.