The U.S.-China trade war escalates. Will business confidence levels take a hit?

On the latest edition of Market Week in Review, Chief Investment Strategist Erik Ristuben and Research Analyst Brian Yadao discussed the implications for markets after prospects for a U.S.-China trade deal soured.

U.S. raises tariffs on Chinese imports as markets swoon

Earlier this month, the U.S. and China appeared to be close to striking a new trade agreement, but prospects for a deal quickly unraveled in recent days. “Evidently, as part of a proposed agreement, China was set to change some of its laws around intellectual property rights — and the U.S. believes China has since backed away from this commitment,” Ristuben explained.

U.S. President Donald Trump’s 5th of May threat to raise tariffs to 25% on $200 billion worth of Chinese goods — which the administration officially followed through with on the 10th of May — led to a broad market sell-off the week of the 6th of May, he noted. The S&P 500® Index was down approximately 4% on the week, as of mid-morning Pacific time on the 10th of May 10, with the STOXX Europe 600® Index falling 3.5% and the MSCI Emerging Markets Index tumbling nearly 5%.

“The sell-off hasn’t amounted to a panic in markets,” he observed, “but it’s certainly not been well-received.”

Victim of the trade-negotiations setback: U.S. business confidence?

Given the setback in trade talks, Ristuben believes that investors may want to pay particular attention to business confidence levels in the U.S. “One of the likely reasons the U.S. Federal Reserve (the Fed) shelved interest-rate increases earlier this year is because of the precipitous hit U.S. CEO confidence took during the fourth quarter of 2018 — a drop thought to be partly a result of U.S.-China trade tensions,” he stated. The Conference Board’s measure of CEO confidence fell from 55 to 42 during Q4, he noted, adding that a reading above 50 indicates a positive outlook, and a reading below 50 reflects a negative outlook.

Interestingly enough, despite a sharp uptick in markets during the first quarter of 2019, CEO confidence barely budged — rising from a reading of 42 to just 43, Ristuben said. “This is a somewhat troubling sign, as it makes the market wonder whether business leaders will continue hiring and investing in their companies, thereby keeping the nation’s engine of commerce running,” he explained. With the recent breakdown in progress on the trade front, Ristuben believes these fears are creeping back into the market.

“Investors are likely now wondering if this setback will impact how corporations do business in the U.S. and globally — and if this, in turn, will hamper the nation’s growth rate moving forward,” he concluded.

Trade-talk fallout: More fiscal stimulus in China?

If the two countries fail to reach a trade deal, Ristuben and the team of strategists at Russell Investments believe China will likely respond by pumping additional fiscal stimulus into its economy. “We think China has a political imperative to hit its targeted growth rate — otherwise, the country risks rising political tensions and social unrest, due to what would be an increasing unemployment rate among the younger generation,” he explained.

Aside from benefiting China’s GDP (gross domestic product), Goldman Sachs has estimated that the Chinese stimulus measures currently in place will boost eurozone growth rates by 0.6% in 2019, in addition to also benefiting emerging markets and Japan. The U.S., he said, is likely to be impacted to a much lesser degree, as trade with China only makes up a small portion of the U.S. economy.

Any opinion expressed is that of Russell Investments, is not a statement of fact, is subject to change and does not constitute investment advice.