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Why The Trade War Won't Sink The Stock Market

By Michael KramerStock MarketsMay 24, 2019 03:04AM ET
www.investing.com/analysis/why-the-trade-war-will-not-sink-the-stock-market-200424650
Why The Trade War Won't Sink The Stock Market
By Michael Kramer   |  May 24, 2019 03:04AM ET
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This post was written exclusively for Investing.com.

The stock market has been resilient in the face of the rising trade tensions between the U.S. and China, with the S&P 500 falling about 5% from its May 3 close of 2,945.64. Certainly not a massive decline given all the warnings of economic doom that a potential trade war could have on the U.S., China, and the global economy. Is it the calm before the storm, or will the rising tensions have a much smaller effect than some dread? At this point, with the S&P 500 still trading near its all-time highs, it is hard to get nervous.

Despite the dire proclamations, it seems entirely possible that a trade war may not have a big hit on the U.S. economy. The most obvious reason: the value of the Chinese currency itself, the renminbi, also known as the yuan. Since the trade war started in 2018, the yuan has devalued by as much as 11% versus the dollar. A cheaper currency may very well soften the blow or even neutralize any tariffs imposed on China by the U.S.

Still, investors are nervous a trade war could hurt earnings in the U.S. But even a 4.5% a decline in the S&P 500 estimates forecast by some analysts would leave the S&P 500 trading at 16 times its 2020 estimates, which is below the historical average of one years forward PE of 17 to 18.

S&P 500
S&P 500

China's Secret Weapon: Using Its Currency

Since the trade war started in early 2018, the yuan has weakened against the dollar rising from around 6.25 to around as high as 6.95, quoted as the dollar to the yuan; a rising value indicates a weakening yuan. Additionally, the yuan is not a free-floating currency: the Peoples Bank of China (PBOC) sets a mid-point value every day, and the currency can then trade in a range up or down of as much as 2%.

With control over the direction of its currency, China could easily use the currency as a tool to fight off any tariffs the U.S. imposes, allowing it to devalue versus the dollar. As the currency weakens, U.S. imports from China become cheaper, which in turn helps soften the blows from any tariffs.

USD/CNY
USD/CNY

S&P Trading Near the High

Given the broader S&P 500’s pullback to this point, it appears that overall investors aren't overly concerned about a U.S., Chinese, or even global slowdown. A 5% decline off an all-time high isn't massive, especially coming off a rally that had seen the S&P 500 rise by nearly 25% from its December lows, in an almost straight line. Indeed, in a broader context, the recent pullback may be as related to tariff concerns as any natural pause in a rally.

The Australian Market Agrees

S&P/ASX 200
S&P/ASX 200

When taking it one step further, the Australian stock market appears to agree that the impact of U.S. tariffs isn’t likely to trigger a Chinese slowdown. The S&P/ASX 200 is trading at its highest level since November 2007. Based on data from the World Bank, Australia exports about $95 billion a year of goods to China, more than half of what the U.S. exports to China. Except, Australia has a GDP of about $1.3 trillion, making China a significantly more important trading partner to the Australian economy.

Australia's key export to China is iron ore, a key material for the creation of steel used in construction. A slowing China economy would likely result in less demand for this metal, and that weakness would reflect in the Australian stock market.

At this point, it isn’t clear just how impactful a U.S./China war will be on the global economy or the stock market. Should the trade war linger in the status quo, the markets are suggesting the impact may be small and the current declines may prove to be just a temporary pause in a long-term uptrend for stocks.

Why The Trade War Won't Sink The Stock Market
 
Why The Trade War Won't Sink The Stock Market

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Joshua Tafoya
Joshua Tafoya May 26, 2019 12:27AM ET
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If the 3 month/10yr treasury bond yield curve inverts for 30 days straight, I would say we are in trouble for a possible recession. So far it has had 3 consecutive days inverted within the last 3 business days. Not a good sign. It has Been fluctuating but this isn’t the first I have seen it 3 straightt days.
Wes Thomas
Wes Thomas May 25, 2019 1:28PM ET
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I disagree. We are only now about to feel the gravity of the trade war on U.S. corporations.
Kevin Le
Kevin Le May 25, 2019 12:29AM ET
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I believe your idea of the Yuan "devaluation" is antiquated and prior to their acceptance into the IMF as a reserve currency. They also want to strm capital outflows and a devaluation would only exasperate the situation.
AIM Investor Journal
AIM Investor Journal May 24, 2019 10:48AM ET
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The devaluation of the Yuan is relative. The Yuan has devalued against the USD over the past 5 years but if you take the GBP or the Euro, the Yuan was actually strengthening until recently.....The biggest threat to US growth might yet be it's strength.
AIM Investor Journal
AIM Investor Journal May 24, 2019 10:48AM ET
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Does anyone remember the credit crunch of 2007-08? A strong USD. . . In the past two decades US debt has risen from around $5 trillion to more than $22 trillion today. Debt-to-GDP is more than 100% and rate rises have stagnated. US stock market just off highs while a trade war brews. Interest on US debt has been flat for the past decade despite rising debt levels due to low long-term interest rates paid on government debt in recent years. However the interest paid as a percentage of GDP is expected to rise from 1.4% to 3% in the next 5 years. I expect the economy will slow and the stock market take some hits in the coming years
sibusiso gumede
sibusiso gumede May 24, 2019 10:40AM ET
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The stock market is detached from the economy. It is in a bubble fueled by nothing else but Debt( easy money) and share buybacks. This thing is going to crash hard, all this is just delaying the inevitable. People are highly in debt and their ability to to acquire more debt to keep up the economy is waning. LIKE Mr Graham put it : if you are only buying a stock because the price is going up and not bother to ask if the value has increased, you will be sorry. That's a certainty.
Filippo Bulgarini d'Elci
Filippo Bulgarini d'Elci May 24, 2019 10:36AM ET
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How China can INTENTIONALLY devalue the yuan (as a countermeasure against the USA), avoiding a negative impact on its economy? Buying Bitcoin, of course!
Очень Злой Иванов
Очень Злой Иванов May 24, 2019 10:36AM ET
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very interesting. How does BTC and cheper yuan correlate?
Zoltan Dosa
Zoltan Dosa May 24, 2019 10:15AM ET
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How about these reasons: the US stock markets are detached from the underlying economy and that is why all these bad data doesn't affect it, or the inverted yield curve, or the disconnection from the world indices, or is it that Trump wants to be reelected and uses the stock market as a tool? Which one is it?
Michael Kramer
Michael Kramer May 24, 2019 10:15AM ET
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3.2% GDP Growth?
Marshall Hiepler
Marshall Hiepler May 24, 2019 10:15AM ET
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Good luck with choosing one, Zoltan. All of the reasons that you mention seem like worthy candidates to lead the rest. When faced with such a multiple choice question, I've found it helpful over the years to select "D" (All of the Above)
Zoltan Dosa
Zoltan Dosa May 24, 2019 10:15AM ET
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Right. Then what is debt/GDP ratio now vs 2008?
Lam gol
Lam gol May 24, 2019 10:15AM ET
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Michael Kramer Right, you believe that fluke number LOL How about the profits recession? Even without the trade war Q1 profits are negative YoY and the forecast for the next two quarters is certainly negative as well.
Short Leverage
Short Leverage May 24, 2019 10:13AM ET
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Cause big money has not exit fully yet
Michael Kramer
Michael Kramer May 24, 2019 10:08AM ET
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just like how you forget to mention how the yuan devalued from 6.07 to 6.95 from 2014 until 2017?
 
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