Phase One Trade Deal Happening, But Here’s What Stocks Really Need

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The U.S. and China seem to have agreed to phase one of a trade agreement, and the U.S. market rose only marginally.

Select economic data points may not improve immediately, but when they do, stocks may stand to benefit.

The agreement rolls back tariffs set for Dec. 15 and for 2020.

The S&P 500 wavered Friday, spending the last four hours of trading hugging the flat line.

The index has risen 9.5% since Oct. 8 as investors had grown optimistic that some form of deal would come to fruition.

The benchmark index is up 26% year-to-date, with the average stock trading at 17.8 times next year’s earnings, higher than the average multiple in the past 10 years of 14.9, according to FactSet data.

But the rollback of December tariffs that were set to go into effect accounts for only $160 billion of goods. That’s roughly 0.7% of a U.S. economy that economists predict will produce $21.35 trillion of goods and services in 2019.

Stock investors will likely need to see business confidence and investment tick up from here, an outcome that will not likely appear immediately.

The real impact of the trade war — which Wall Street has consistently noted — has been on business confidence.

Companies have hesitated to invest as they’ve been uncertain about demand in light of the trade war. An index created by Citizens Bank showed Q3 business confidence dropped to 60.2 from 61.2.

Manufacturing activity, measured by the ISM Manufacturing Index, has consistently fallen below 50 since August. A reading of below 50 indicates contraction.

“While it appears that both sides can take away small wins from the first phase of the deal, the bigger impact should come from added stability and certainty over the long run,” Charlie Ripley, senior investment strategist for Allianz Investment Management, told TheStreet. “Investors were likely looking for a larger rollback of the tariffs in place, but the important takeaway here is that things are continuing to deescalate.”

“The tariffs being removed will have a positive impact on businesses’ willingness to spend and invest,” Citizens Bank’s head of corporate finance and capital markets, Ted Swimmer, told TheStreet.

Wells Fargo recently flagged the issue that weak investment and manufacturing activity could ultimately lead to weak job growth, undermining the currently strong consumer, who has spent roughly 2% more than last year. A full trade deal would help safeguard the economy against that scenario.

Swimmer says the stimulus that trade progress provides can bring the 10-year treasury yield up to around 2% in 2020, since investors would buy more stocks and fewer treasurys. The yield is currently 1.83%. Bond yields and prices move inversely to each other.

This would be a “risk-on” scenario in the market. For a few weeks in mid-2019, a rise in yields sometimes caused stocks to fall because it indicated the Federal Reserve might not cut interest rates. Some of the gains in U.S stocks this year have been attributable to monetary stimulus from the Fed.

Now, the Fed has made it clear it is on hold for cutting interest rates as recent economic data has improved, partially resulting from the rate cuts the Fed did indeed implement.

With a Fed on hold, stock investors want to see economic growth trend well, regardless of rate cuts.