The stock market has staged a meteoric rise so far in 2019, buoyed in part by a months-long lull in the U.S.-China trade war. Now that bull market run is in danger of turning into massive stock declines as President Trump threatens to escalate the conflict. Unhappy with slow progress in trade talks, Trump tweeted that he will hike tariffs on $200 billion of imported Chinese goods from 10% to 25% by Friday unless a significant breakthrough is made. He added that another $325 billion of China imports not currently subject to tariffs also may be taxed.

Morgan Stanley calls these developments "a credible risk to the markets," and outlines in a new report how an expanding trade war would hurt U.S. and global equities, currencies, economies and other areas. The S&P 500 Index (SPX) fell at the market's open on Monday and has stayed down throughout most of the day since then. Also on Monday, a report from Bank of America Merrill Lynch warned that "the threat of trade friction creates incremental structural risk to auto companies' business models, as well as general uncertainty regarding the operating environment." The report also warns that already weak auto sales are likely to deteriorate further, as higher tariffs on components flow through to higher prices for finished vehicles.

The table below summarizes five ways in which renewed trade conflict between the world's two largest economies is likely to harm U.S. businesses, U.S. consumers, and securities markets.

5 Ways The U.S.-China Flareup Threatens The Markets

  • Disrupting supply chains for U.S. companies
  • Raising costs for U.S. consumers
  • Provoking Chinese retaliation against U.S. companies that sell in China
  • Putting U.S. semiconductor and other tech firms at particular risk
  • Damaging other countries that depend on China for demand

Significance For Investors

As noted above, a number of U.S.-based companies are highly dependent on global supply chains, often involving components or finished goods that are manufactured in China. The U.S. auto industry is just one example. In addition to disrupting their operations, increased tariffs on components imported from China inevitably will lead to higher prices of finished vehicles. "Consumers are already facing affordability headwinds," BofAML writes, noting that year-to-date sales are down by 2% on a year-over-year basis. They warn that tariffs and other trade restrictions could set the stage for further deterioration in 2019.

Meanwhile, U.S. tech firms are caught in the middle of a broader "Cold War" between the U.S. and China, as described previously in a detailed report by Barron's. The Trump administration is concerned about national security implications of global supply chains that make the U.S. tech industry highly dependent on components or finished goods manufactured in China. The administration also is worried about the degree to which U.S. technology is being used to bolster China's military and espionage apparatus.

China already has initiatives underway to upgrade its own tech industry, thereby reducing reliance on imports from the U.S., notably regarding semiconductor chips. Major U.S. semiconductor manufacturers are at particular risk, as described in that Barron's article.

In addition to U.S. chipmakers, coffee shop chain Starbucks Corp. (SBUX), iPhone maker Apple Inc. (AAPL), and aircraft manufacturer The Boeing Co. (BA) are among the companies threatened by a renewed U.S.-China trade conflict, since they derive significant revenues from the Chinese market, per an earlier story in The Wall Street Journal. The risks include possible trade retaliation by China, and that reduced exports to the U.S. will hasten a Chinese economic slowdown. Apple has the added risk of outsourcing manufacturing of many of its devices to Chinese-based companies.

Despite Trump's threats to China, these stocks were down less than 2% on Monday, suggesting that many investors are expecting the U.S. and China to settle their differences soon.

Looking Ahead

In fact, Morgan Stanley indicates that Trump's threat "could be a pressure tactic to speed an agreement on pending issues such as existing tariff removal timing, details related to the enforcement mechanism and industrial subsidies." In a hopeful note, the firm adds: "we expect a re-escalation [of tariffs] would be temporary, as market weakness would help bring both sides together." That remains to be seen.