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May 29, 2019, 9:14 a.m. EDT

How stock-market bulls are adjusting to the reality of a messy U.S.-China trade war

‘We don’t think hoping for the best is the ideal way to invest’: CFRA’s Bell

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By William Watts, MarketWatch


AFP/Getty Images
All at sea?

There goes the “hope” premium.

Stock-market investors spent the first four months of 2019 penciling in an easy resolution to a U.S.-China trade tiff. Things have changed.

“While we, like most investors, are hopeful that a trade deal gets done sooner rather than later, we don’t think hoping for the best is the ideal way to invest,” wrote Lindsey Bell, investment strategist at CFRA, in a Thursday note. “The nature of the issues at hand are much more structural and complex than simply addressing a trade deficit.”

Read: Why the tariff fight prompted a major wealth manager to change its U.S. portfolios

That reality was brought home earlier this month as a round of tit-for-tat tariff escalations was accompanied by hotter rhetoric from both Washington and Beijing. The Trump administration’s subsequent decision to effectively blacklist U.S. companies from doing business with Chinese tech giant Huawei — and the specter of Chinese retaliation — ensured investors began to question their expectations for a relatively painless resolution of the U.S.-China trade spat. Instead, they now worry that the battle could signal the start of something deeper — and more threatening to global growth and, ultimately, corporate earnings.

Need to Know: Trade tensions could last well into the 2020 campaign, says Nomura

That said, the market is hardly in a panic. While the S&P 500 /zigman2/quotes/210599714/realtime SPX -0.01%  has retreated 4.8% in May and the Dow Jones Industrial Average /zigman2/quotes/210598065/realtime DJIA +0.20%  has given up 4.5%, they remain up 11.9% and 8.8%, respectively, for the year to date. The S&P sits around 5% off its all-time high set in late April.

The Nasdaq Composite /zigman2/quotes/210598365/realtime COMP -0.16% , weighted toward tech shares seen among the most vulnerable to an escalating confrontation, is down 5.9% so far in May but is hanging on to a 14.8% year-to-date advance. Last week, the S&P shed 1.2%, the Dow fell 0.7% and the Nasdaq gave up 2.3%. Stocks struggled for direction but then turned lower Tuesday as investors returned from the long Memorial Day weekend.

“We don’t think this expansion is over, we think the stock market has some new highs in it…but certainly what you need is better hopes for a deal and you need some more confidence that the global growth story is going to stabilize,” said Scott Wren, senior global equity strategist at Wells Fargo Investment Institute, in a phone interview.

And Wren, like many other market watchers, has had to adjust expectations around a resolution of the trade fight. For some investors, it’s a matter of accommodating the idea that the Trump administration’s goals may be more about containing or even punishing China than getting to an agreement in short order.

“The presumption has always been that the U.S. has wanted to strike free trade deals, with any short-term economic and financial market damage from the tariffs required to create these deals, outweighed by the longer-term gains once the deals are struck and the tariffs removed,” said Steve Barrow, head of G-10 strategy at Standard Bank, in a note. But now investors are facing up to the prospect of long-lasting tariffs, which could cause significant economic uncertainty and changes in trade patterns.

“Many will hope that the U.S.’s trade aspirations revolve around the former policy, not the latter. But acting in hope, when it comes to financial market positioning, is fraught with danger,” he said.

Sounding a more ominous tone, Scott Minerd, global chief investment officer at Guggenheim Investments, warned in a Thursday note that the “war is at hand.”

“Unless the current trajectory is quickly changed, the Chinese are digging in for a long fight. The cost to the United States will be high; the cost to the Chinese will be higher. The only question is who will endure and be the most innovative in this battle of wills,” Minerd said.

So, what’s an investor to do? Bell said the threat of a longer and potentially more confrontational dispute is part of the reason CFRA shifted to a more “tactically defensive” stance in early May by overweighting the health-care sector and raising consumer staples to marketweight from underweight.

/zigman2/quotes/210599714/realtime
US : S&P US
2,917.44
-0.31 -0.01%
Volume: 84.82M
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US : Dow Jones Global
26,519.61
+54.07 +0.20%
Volume: 12.52M
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US : U.S.: Nasdaq
7,941.17
-12.71 -0.16%
Volume: 130,418
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