Worst-Case Trade War Lasting To 2020 Threatens To End Bull Market

Big financial firms' optimistic expectations for a quick resolution to the U.S.-China trade conflict are fading fast as the odds increase that President Trump will levy a 25% tariff on about $300 billion of additional imports from China, thus taking the trade war into uncharted territory.

Nomura Group, for one, now estimates that Trump's threat of new tariffs has a 65% chance of happening in 2019, as early as the third quarter. “The U.S.-China relationship has moved further off track over the past two weeks after a period of what appeared, on the surface, to be steady progress towards reaching an admittedly narrow agreement,” economists at Japan-based Nomura observed in a note to clients, according to a detailed story in Bloomberg. “We do not think the two sides will be able to get back to where they seemed to be in late April,” they add.

Goldman Sachs also is becoming less optimistic. “While we still think an agreement is more likely than not, it has become a close call,” write the firm's economists, as quoted in the same article. They warn that, unless tangible progress is made in the trade talks over the next few weeks, additional tariff hikes may become Goldman's base case. Meanwhile, analysts from JPMorgan anticipate that tariffs imposed by both countries so far are likely to persist into 2020, and a senior researcher with the Chinese government warns that "fighting and talking" may continue until 2035.

The table below summarizes these predictions.

Pessimistic Views of U.S.-China Trade Negotiations

  • Nomura: 65% odds of U.S. tariffs on almost all imports from China
  • JPMorgan: Existing tariffs by both sides may remain through 2020
  • Goldman Sachs: Additional U.S. tariffs soon may be base case
  • Chinese government researcher: Tensions may last into 2035

Source: Bloomberg

Significance For Investors

The senior Chinese government researcher quoted above is Zhang Yansheng, currently at the China Center for International Economic Exchanges, and previously with the National Development and Reform Commission, China's top economic planning agency. He says that none of the key demands made by the U.S. in the areas of trade balance, structural reform, and legal amendments can be “realized in the short term," per Bloomberg.

Zhang warned that tense U.S.-China disputes in the areas of economy, trade, technology, and finance are likely to rage from 2021 to 2025. From 2026 to 2035, however, he believes that the relationship between the nations can shift from "irrational confrontation" to "rational cooperation." He spoke at a briefing on Wednesday organized by the Chinese government.

Zhang's opinion is in stark contrast to that of American economist Gary Shilling, who recently asserted that "China will begrudgingly give ground" since the U.S., as the chief buyer of Chinese goods, has "the upper hand" and "the ultimate power," per an interview with Business Insider. Shilling did not predict a time frame for resolution, though his remarks did not appear to anticipate years of stalemate.

While the stock market has been rattled by the recent escalation in trade tensions, the S&P 500 Index (SPX) nonetheless opened Thursday trading a relatively modest 4% below its all-time intraday high on May 1. “The tepid response of equity markets to the trade-war threats has increased the likelihood of an even longer period of more intense brinkmanship,’’ according to a note from Bank of America Merrill Lynch economists, per Bloomberg.

Looking Ahead

Bank of America projects that the S&P 500 may tumble into bear market territory, down by 20% to 30%, if Trump imposes tariffs on all Chinese imports, thereby hurting a wide spectrum of consumers and businesses, as reported by Barron's. Also, further restrictions that the Trump administration may wield against Chinese telecom giant Huawei are likely to further disrupt equities markets by provoking retaliation from China, thus heightening the strategic battle over technology.

The bulls, however, say the strong U.S. economy will minimize any damage. “If you were ever going to impose costs on the U.S. consumer, the time is when unemployment is at 50-year lows and inflation is a pancake,” Christopher Smart, head of Barings Investment Institute, told Barron's.

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