There was a trade deal between the U.S. and China that was reportedly on the verge of getting done this week. By the end of the week, though, the market recognized there was a good possibility the trade deal could unravel.
It all began last weekend when President Trump shocked the world with a tweet indicating the tariff rate on $200 billion of imported Chinese goods would be increasing from 10% to 25%, effective May 10, and that another $325 billion of imported Chinese goods could soon be subjected to a 25% tariff rate.
Those declarations were borne out of his frustration with China moving too slowly to get a deal done. A subsequent Reuters article, however, made it apparent that there was more to the president's frustration than simply the pace of negotiations.
According to sources who talked to Reuters, China reneged on nearly every aspect of the negotiated language of the trade deal in question, balking at the provisions that would require a change in Chinese law.
It was an unexpected move. It caught the president by surprise; it caught U.S. Trade Representative Lighthizer and Treasury Secretary Mnuchin by surprise; and it clearly caught the stock market by surprise.
A Big IF
The stock market has been on auto-pilot this year in its flight to a new record high, propelled by the twin engines of the Fed pivot and the assumption that the U.S. and China would work out a trade agreement.
Those engines have encountered some mechanical issues, however. Fed Chair Powell tempered the market's expectations for a near-term rate cut and, as alluded to above, China has tempered the market's expectations for a trade deal getting done soon, if one gets done at all.
That's a big IF as it relates to the fortunes of the stock market.
To this point, the market has been riding the hope that earnings growth estimates will pick up in the back half of the year with the signing of a trade deal that squelches negative tariff actions and lifts prospects for global growth. That's why the market has tolerated the estimate cuts for the first half of the year and has risen on the back of multiple expansion.
If the trade deal doesn't happen, the earnings growth is unlikely to pull through like the market is hoping it will. The counter trade would be one of multiple compression, which is what was seen this week.
We're finding it increasingly hard to believe a trade deal will get done in the manner the U.S. would like to see, whereby China is forced to change its laws and to submit to enforcement oversight.
First, that would be embarrassing for President Xi -- and China as a whole. Second, President Xi recognizes he has time on his side. He does not face a term limit like President Trump does, and he recognizes that 2020 is an election year in the U.S. that could possibly lead to the election of a new president.
President Trump seemed to be sniffing out this possible strategic approach when he observed in another tweet this week that, "The reason for the China pullback & attempted renegotiation of the Trade Deal is the sincere HOPE that they will be able to 'negotiate' with Joe Biden or one of the very weak Democrats, and thereby continue to ripoff the United States ($500 billion a year) for years to come."
There's no telling what the future holds. It's not inconceivable to think, however, that China is thinking a trade deal gone awry could hurt President Trump's re-election chances if it leads to an extended stock market slump and slowdown in the U.S. economy.
Why give in now to the remonstrations of a president and administration that could be out of office in less than two years? Some would argue China's economy can't afford to take the hit of the tariff actions, yet China is likely willing to endure some short-term pain instead of accepting trade terms dictated to it by a foreign country.
That's not to say China won't compromise at all, but it does imply that changes in Chinese law will be made at China's behest -- and that probably won't happen quickly, if at all.
China has indicated it will enact countermeasures in response to the U.S. raising its tariff rate on imported Chinese goods. It has not stated what the countermeasures will be, but it has touched off some speculation that they could be more than tit-for-tat tariff action since China imports far less from the U.S. than the U.S. imports from China. Some ideas include:
- Slowing down inspections of U.S. imports
- Refraining from buying U.S. Treasuries
- Imposing new restrictions on U.S. companies, like Apple (AAPL), already doing business in China
- Reducing the amount of agricultural goods purchased from U.S. farmers
What It All Means
There are many ways to fight back we suppose, but it's a guessing game right now, which gets to the heart of the matter for the stock market.
A trade deal that the market had grown content to think was certain sometime soon is now uncertain and it could remain that way for some time considering national pride -- and the pride of President Trump and President Xi -- is at stake.
It has been said the motivating factor for getting a deal done is that both sides have much to lose from an extended trade war. That is true, but unless both sides swallow some pride, then pride will goeth before a further fall in stock prices.