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Wall Street Was Just Getting Optimistic on Trade — and the Tariff Picture Turned Cloudy

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Just as Wall Street was becoming markedly — not cautiously — optimistic, the news broke up the party.

Investment shops were publishing research saying the expected phase-one trade deal between the U.S. and China was another marker that the two countries were working toward a comprehensive trade agreement and that stocks would benefit, at least in the near-term.

Then, Bloomberg News reported that all existing tariffs on Chinese goods coming into the U.S. are likely to remain in place until after the presidential election in November.

After all three major U.S. indexes started the day higher, the S&P 500 fell as much as 0.33%, with the Nasdaq around flat and the Dow Jones Industrial Average up 0.26%, but below its intraday high.

Toward the end of 2019, Wall Street was hoping for a trade resolution and stocks were rising. Recently, strategists have begun to factor in true progress on trade and rolled back tariffs into their estimates for stock gains for the year.

"Weaker segments of the economy are poised to improve, especially as trade tensions subside,” the UBS Global Wealth Management team wrote in a Tuesday morning note.

The currency manipulator "label was first placed on China in August amid rising trade turmoil and is being lifted ahead of the scheduled phase one trade deal signing on 15 January. Its removal signals fading downside from U.S.-China trade tensions, supporting our tactical overweight to equities.”

"The macroeconomic situation remains positive, investor sentiment is extremely bullish,” wrote strategists at Unigestion, a global asset manager with roughly $23 billion under management.

"With the decline of the trade war and clarity on Brexit, much of the uncertainty of recent quarters has evaporated, benefiting the world economy.”

Importantly, it’s more than just trade optimism that is enabling positive sentiment about stocks. Fourth-quarter earnings are rolling in and Q1 will soon follow.

Expectations for 2020 are for earnings growth of roughly 5%, a number that has come down from about 8%. And the rolled-back tariffs in the phase one deal (15% on Chinese goods halved to 7.5%) could add upside to current estimates, some have noted.

While investors have been buying stocks, they’ve still got substantial cash in their portfolios, which means they’re willing to take incremental risk and put more into equities. This sets up as a positive with earnings season looking promising.

JPMorgan, JPM Citigroup C and Wells Fargo WFC reported strong fourth-quarter earnings, presenting more positivity on economic growth.

While Wells Fargo missed estimates badly due to far higher-than-expected litigation charges relating to deceptive consumer-banking practices, JPMorgan and Citi put estimates to shame.

JPMorgan’s net interest income of $14.3 billion beat estimates by 2% even as net interest margin narrowed, one indication that low

interest rates are supporting demand for loans.

The overall backdrop may be good enough to keep stocks climbing for the next few months, but some are wary that a pullback or even a correction could be in the offing.

The average stock on the S&P 500 trades at roughly 19 times the next 12 months’ earnings, above the five-year average multiple of 16.7. Canaccord Genuity Chief Market Strategist Tony Dwyer, who has been calling for an outright correction, on Tuesday pounded the table.

“The tactical backdrop has pointed to an environment ripe for a temporary correction, and as a result we have been waiting to add exposure on weakness,” Dwyer wrote in a note.

For Unigestion, “sentiment could turn quickly” on the back of “excessive valuations.”

The point: Wall Street has been looking for a continued melt-up in stocks before a pullback. Now, that near-term melt-up might be in question.

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