Trade War Fears Are Returning to a Virus-Lashed Wall Street

After months fixating on complex infection curves, ambiguous corporate announcements and haywire economic data, investors risk being blindsided by an old foe: U.S.-Sino tensions.

President Donald Trump and his administration have been sharpening their criticism of Beijing, demanding answers about the origins of the coronavirus pandemic as the death toll approaches 70,000 Americans.

That raises the specter of a resumption in the trade war at the worst possible time for global markets already pricing in heroic expectations of an economic rebound.

Expected volatility for American stocks is climbing as the S&P 500 heads for a third day of declines. Add dire projections for commerce and miserable economic data to this ratcheting up of stress between the world’s two biggest economies, and last week’s sell-off has legs.

“In the wake of the pandemic and recession, geopolitics is the next shoe to drop,” BCA Research strategists including Matt Gertken wrote in a Friday note. “Now is not the time to assume global stability.”

Instead, they reckon investors should prep for a renewal in U.S.-China tensions. In a Sunday evening interview with Fox News the president stirred concern of a resumption of economic hostilities between the two.

That’s a potentially huge headwind to any global recovery when investor expectations for a rebound were already looking ambitious. The gap between markets and economic data was the widest ever, Citigroup Inc. said last week. The S&P 500 has dropped more than 4% since.

“The biggest risk here is that President Trump adds geopolitical stress on top of the worst economic shock to the U.S. economy in a century,” said John Normand, head of cross-asset fundamental strategy at JPMorgan Chase & Co.

Normand reckons that risk assets could drop another 10% if Trump decides to increase tariffs on a broader range of goods, which would mark a return to the strategy pursued by the president in 2018 and 2019. The potential declines would be even worse, Normand says, if not for the fact many investors already cut their exposure this year due to the recession.

As the pandemic swept the world crippling major economies, investors fled equities — about $17 billion left U.S. stock funds in 2020 through April 29, according to Bank of America Corp. citing EPFR Global data. Despite a rapid rebound that saw the S&P 500 rally more than 30% from a March low, the American benchmark equity gauge remains more than 15% from its peak.

Virus Origins

Relations between the U.S. and China have been simmering in recent days, with Trump even claiming Beijing is trying to damage his election campaign.

Since then he has promised a “conclusive” report on the Chinese origins of the coronavirus outbreak, adding that he has little doubt that Beijing misled the world about the scale and risk of the disease before it became a global pandemic.

That’s contributing to a revival in volatility, alongside the decline in equities. A gauge of expected price swings for the S&P 500 known as the VIX index rose a third day on Monday, the longest such streak since early March — at the height of the first quarter rout.

The scale of the moves remains contained this time around, however.

The hope for many investors will be that mutual self-interest helps prevent a U.S.-China escalation. Both countries will want to avoid any further pressure on their virus-lashed economies. Data last week showed China’s exports plunging and U.S. gross domestic product shrinking the most since 2008.

The wild card is that it’s an election year in America, and the incentives for Trump to take action may be higher because his approval rating has dropped amid the coronavirus crisis.

“Investors should take seriously any credible reports suggesting that Trump is growing increasingly frustrated with his trailing Biden in head-to-head polls in the swing states,” the BCA strategists wrote.

Next Steps

Back when the trade war started, the global economy was in relatively rude health, and it proved surprisingly resilient despite rising tariffs between the U.S. and China.

Even so, the S&P 500 was in thrall to the conflict’s twists and turns and when a deal was signed in January it helped push stocks to repeated all-time highs. This time the global economy is on its knees, and investors are on edge after the violent market events this year.

Stephen Jen, the chief executive officer at Eurizon SLJ Capital, reckons there are three broad ways the U.S. could punish China if things do escalate: through trade tariffs, through more restrictions on technology exports, and through financial sanctions.

The risk of all three options will hang over markets in months or even years ahead, he said. He anticipates the U.S. pressuring China to allow an international investigation into the origins of the virus. Beijing may relent and allow some transparency, given similar pressure from Europe and Australia.

“This process may buy some time until perhaps later this year when the global economy will have gained a bit more momentum before real punitive actions are taken, in the event that China will not have done enough,” said Jen.

— With assistance by Ksenia Galouchko

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