Could the Trade War Escalation Create an Attractive Entry Point for Investors?

China

Investment Themes for 2019

Real gross domestic product (GDP) grew 3.2% for the first quarter, well above the upwardly revised consensus estimate of 2.3%. Some analysts picked apart this GDP “beat” suggesting that underlying the headline figures are concerning underlying numbers, such as private domestic sales, which could suggest that a slowdown is ahead. While we would not disagree with this assessment, it is hard to not be impressed by the overall growth of the U.S. economy during the first quarter of the year.

We also think that the report is consistent with our “Slowing but Growing” theme that we have been talking about here for 2019. While the pace of economic growth and earnings growth may slow this year from the torrid pace that they set in 2018, we believe that they both will continue to grow and this level of moderate growth, coupled with a more dovish leaning Federal Reserve, should be constructive for additional, potential growth for select stocks ahead. The GDP report also provided some credence to our belief that the consumer is still confident and spending – remembering that consumer spending accounts for approx. 70% of GDP. Consider that for the first quarter, consumer spending itself rose above forecast – albeit slightly –by 1.2% and topped consensus estimates for the month of March as well with a growth rate of 0.9% from the prior month. Consider also that with 78% of S&P 500 companies reporting Q1 earnings thus far as of May 3, 2019, 76% have beaten earnings estimates and 60% have reported positive revenue surprises.

Investors were rewarded by these economic and earnings gains. Following a strong first quarter, stocks continued their upward ascent during the month of April with the largest gains being realized in developed market countries, notably the United States. For the month, the Dow Jones Industrial Average (DJIA) gained 2.66%, the S&P 500 Index (S&P 500) increased by 4.05% and the technology-heavy NASDAQ Composite Index advanced by 4.77%. This was on top of the quarterly gains of 11.81%, 13.65% and 16.81% respectively for these three widely-known U.S. equity indices.

Perhaps the strength of the U.S. economy and growth of the U.S. stock market during the initial stages of 2019 led to an even tougher U.S. stance on the trade negotiation front, culminating in an increase in tariffs on $200 billion of Chinese goods from 10% to 25%. This was met by a response from China initiating their own new tariffs, effective on June 1, which would impact $60 billion in U.S. imports and would range from 5% to 25%. As we understand it, the tariffs will impact a wide range of U.S. products, including coffee, beef, salmon, flowers and some fruits and vegetables.

The U.S. has also suggested that additional tariffs on another $325 billion of Chinese goods are also consideration if a deal is not reached. It has been reported that if this final round of tariffs is ultimately put in place, nearly every Chinese import that enters the U.S. will be subject to some form of a tariff. According to a CNBC report this morning, Goldman Sachs has given a 30% probability to the U.S. actually following through and imposing tariffs on the remaining $325 billion in Chinese imports.

Markets were previously pricing in some form of an upcoming trade deal announcement so the re-emergence of prolonged trade war fears and uncertainty over what comes next has led to a market sell-off. As of the writing of this post, the Dow Jones Industrial Average was down over 620 points, representing a 2.40% loss for the underlying U.S. stocks from its open. As it relates to Chinese stocks, the Shanghai Shenzhen CSI 300 Index was down over 61 points today, representing a 1.65% loss, in USD terms, from its own respective open.

While it is not known, at this time, how far the current sell-off will extend or how long any new tariffs will be in place, this market pullback may present an attractive entry point for certain investors with cash still on the sidelines due to concerns with high stock market valuations. Remember that when President Trump first tweeted on May 5 about the new round of tariffs, both the S&P 500 and the DJIA were trading near all-time highs. Consider the following data points as markets closed on Friday, May 3 and where markets are currently trading on May 13.

Trade

In this regard, consider also that the Forward P/E ratio** of the S&P 500 at the close of May 3 was 17.69, while the intra-day Forward P/E of the S&P 500 on May 13 was 16.90 – just slightly above the 25-year average of 16.2 according to J.P. Morgan Asset Management as of March 31, 2019.

Recognizing the potential longer term impact on the GDPs of both countries, we still believe that an agreement, or at least a report on positive progress towards an ultimate agreement, can be achieved during the second quarter – perhaps after the G20 meeting in Japan later in June. If so, we would expect global stock markets, specifically in the U.S. and China, to bounce back significantly from this pullback. From that point in time, the prevailing, underlying theme of “Slowing but Growing” should provide additional stock market growth potential for the remainder of 2019. If an agreement, or significant progress towards an agreement, is not reached during the second quarter, additional bouts of market volatility can be expected and diversification will become even more important when managing investment portfolios. Of course, it is important to remember that diversification does not guarantee a profit or protect against a loss in a declining market bur rather is a method used to help manage investment risk.

* The price-to-earnings ratio (P/E ratio) is the ratio for valuing a company that measures its current share price relative to its per-share earnings (EPS).
** The forward P/E ratio (or forward price-to-earnings ratio) divides the current share price of a company by the estimated future (“forward”) earnings per share (EPS).

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Disclosure: Hennion & Walsh Asset Management currently has allocations within its managed money program and Hennion & Walsh currently has allocations within certain SmartTrust® Unit Investment Trusts (UITs) consistent with several of the portfolio management ideas for consideration cited above.