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Investors Will Absorb Latest Tariff News, but Chinese Retaliation on U.S. Crude Will Be Game Changer

James Hyerczyk
Updated

The major U.S. equity markets opened lower on Wednesday with most of the pressure coming during the pre-market trading session late Tuesday as investors reacted to the news of new U.S. tariffs on China.

Investors responded like they normally do to an unexpected geopolitical event by selling higher risk investments and buying safe-haven assets. There was no panic selling with most investors following the rules highlighted in Trading 101. In other words, “when in doubt, get out”. Or in this situation, “when in doubt, take a little money off the table.” This is because prior to the announcement late Tuesday, the major indexes were in the midst of an impressive 7 day rally.

One reason for the limited response to the fresh tariff news was that it was just the announcement of a list of new items. We’re going to have to wait until the public hearings are over before we find out exactly what will be tariffed, and when they will start.

Secondly, we don’t know how China will retaliate. Placing tariffs on U.S. made bicycles or whiskey is not likely to trigger the response we’re likely to see if Beijing decides to place tariffs on imported U.S. crude oil.

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So while investors were willing to take protection from the initial move by the Trump Administration, the markets are not likely to flip from bullish to bearish with the flick of a switch.

At this time, we’re going to maintain our stance that this is an on-going trade dispute and not a trade war. Therefore, there’s no need to abandon stocks with a vengeance at this time. However, placing tariffs on imported U.S. crude could be the game-changer, especially given the fragile supply/demand situation in the world’s oil market.

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Don’t Overlook the Impact of Earnings

While worries over an escalation of the trade dispute between the United States and China can be expected, the start of earnings season could bury these concerns if the S&P 500 companies can deliver robust earnings on above-average revenue growth and sharply higher margins. These are the benchmark indicators.

Corporate earnings are expected to have risen 20 percent in the second quarter, according to FactSet. During the first quarter, earnings rose nearly 25 percent. Investors are likely to continue to respond to stronger earnings data, but like we mentioned yesterday, if guidance comes in bad then gains will likely be limited and we may even start to see some additional profit taking.

Many money managers see the trade dispute situation as a short-term event, while earnings, revenue and growth are all long-term factors used to value a stock.

We’re going to stick with our outlook for higher stock prices because earnings carry more weight at this time than does the trade dispute. I don’t think we’re going to see any significant sell-off in the stock market until the impact of the tariffs starts to show up in the economic numbers, and even after that, in the projections by U.S. Federal Reserve Policymakers. Of course, if China places a tariff on U.S. crude oil imports then it will be a whole new ballgame and time to reassess my bullish outlook.

What we’re probably going to see over the short-run is price action like we saw early Wednesday. Short-term breaks because of uncertainty then another move higher once professional investors can figure out how to hedge the risk.

This article was originally posted on FX Empire

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