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An Easing of Trade Tensions Could Keep the Rally in the U.S. Stocks Alive

Trade and Fed policy continue to be critical to the outlook for the U.S. stocks. A comprehensive trade deal looks unlikely in the near-term, notwithstanding the planned meeting between Presidents Trump and Xi at the upcoming G20 meeting. The hope is that the meeting leads to the resumption of serious negotiations between the two sides. In addition, we’ve seen that new trade uncertainties can flare up at a moment’s notice; including with Mexico, Canada, India, and the Eurozone. To date, the effects have been relatively muted, although the upcoming earnings season will likely tell a more complete story. Corporate confidence is mixed—larger company weaker, smaller company stronger—but consumer confidence remains strong, keeping consumer spending humming.

If the trade stalemate lingers and/or the next round of tariffs on Chinese imports kicks in, the damage to the U.S. economy is likely to escalate. The Fed addressed its concerns about trade and its impact on both the global and U.S. economies; but the burning question remains about the sufficiency of monetary policy ammunition as an offset to weak growth. The month-long inversion of the yield curve has been adding to that angst.

U.S. stocks are hovering around all-time highs, kept afloat by hopes that the Fed will begin cutting rates as soon as the July Federal Open Market Committee (FOMC) meeting. But are rate cuts sufficient to help what is ailing the U.S. economy? Absent a comprehensive trade deal, it’s difficult to imagine that executives will be confident enough to expand capital spending, which had been one of the primary rationales for 2018’s corporate tax cut. In addition, Wall Street’s analysts have yet to reflect the recent escalation in the trade war in their estimates for the U.S. corporate earnings. Given that consensus estimates are already near-zero for the next two quarters (Refinitiv), an additional haircut to those expectations could mean an earnings recession.

What might a U.S. military strike on Iran mean for markets?

Geopolitical tensions always have the potential to be a wild card in the investing deck, with today’s card being heightened potential for military conflict between the United States and Iran. Although it may pose another threat to an already-vulnerable global economy, markets’ past negative responses to U.S. military strikes have tended to be short in duration.

Over the past 12 months, Iranian oil exports have fallen by 90% due to the re-imposition of U.S. sanctions; much of that coming in the past two months. Within the next month, Iran will likely exceed the caps on uranium enrichment set out in the 2015 nuclear agreement and may restart parts of its nuclear program (The Wall Street Journal). These actions could prompt a military strike by the United States. Limited U.S. strikes on Iran’s naval assets could hinder Iran's ability to disrupt traffic through the Strait of Hormuz.

As worrisome as these developments are to a vulnerable global economy—not to mention the human toll that may result—the market impact may be modest. Global stock markets’ past response to U.S. military strikes has been negative, but short in duration. There is a long history of U.S. missile strikes outside of declared war in the past 30 years which we can use to assess the potential market impact of these types of geopolitical events.

Markets and U.S. missile strikes

The global stock market reaction was mixed—roughly half of the days after the event seeing losses but the other half flat or showing gains—not a pattern we can take much stock in. Hopefully, a military escalation will be avoided. But, should one occur, the market reaction may be short and brief. Geopolitical risks are a regular part of investing, and that a long history of geopolitical developments shows us that holding a well-diversified portfolio may buffer the short-term market moves that are most often the result. Investors should avoid overreacting to geopolitical developments and stick to their long-term financial plans.

So what?

U.S. stocks have made little headway over the past 18 months; and with indexes around the highs of the recent range, another pullback is possible. Continued trade uncertainty and the potential for a limited Fed response could weigh on stocks in the near term; while an easing of trade tensions could keep the rally alive. We continue to recommend investors stay at their long-term strategic equity allocation with an eye on diversification and using volatility to rebalance as needed.


Important Disclosures

Investment involves risk. Past performance is no indication of future results, and values fluctuate. International investments are subject to additional risks such as currency fluctuations, political instability and the potential for illiquid markets. Investing in emerging markets can accentuate these risks.

The information provided here is for general informational purposes only and should not be considered an individualized recommendation or personalized investment advice. The investment strategies mentioned here may not be suitable for everyone. Each investor needs to review an investment strategy for his or her own particular situation before making any investment decision.

All expressions of opinion are subject to change without notice in reaction to shifting market conditions. Data contained herein from third-party providers is obtained from what are considered reliable sources. However, its accuracy, completeness or reliability cannot be guaranteed.

Diversification and rebalancing a portfolio cannot assure a profit or protect against a loss in any given market environment. Rebalancing may cause investors to incur transaction costs and, when rebalancing a non-retirement account, taxable events may be created that may affect your tax liability.

Past performance is no guarantee of future results. Forecasts contained herein are for illustrative purposes only, may be based upon proprietary research and are developed through analysis of historical public data.

The Consumer Confidence Index is a survey by the Conference Board that measures how optimistic or pessimistic consumers are with respect to the economy in the near future.

Indexes are unmanaged, do not incur management fees, costs and expenses, and cannot be invested in directly.

The Schwab Center for Financial Research is a division of Charles Schwab & Co., Inc.

About the author:
Liz Ann Sonder, Senior Vice President, Chief Investment Strategist, Charles Schwab & Co., Inc.
Jeffrey Kleintop, Senior Vice President and Chief Global Investment Strategist
Brad Sorensen, CFA, Director of Market and Sector Analysis, Schwab Center for Financial Research

Content provided by Charles Schwab, Hong Kong
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