Trade-Induced Sell-Off Tells Us Something About How Investors View China Deal

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Tuesday's market sell-off told us something beyond the obvious -- that a no-deal between the U.S. and China would be a drag on companies' earnings power.

Before we get into the analysis, let's go over what happened.

What Happened

Tuesday, Trump said he may not be interested in having the U.S. agree to a trade deal until after the 2020 election. "In some ways I think it's better to wait until after the elections to deal with China, to tell you the truth," Trump said. "In some ways I think it would be better."

Stocks sold off hard.

The S&P 500 fell as much as 1.4%. The Dow Jones Industrial Average fell as much as 1.3%. Both indexes pared some of those losses by the close.

The Trend

It seemed that when the trade war was born, in March 2018, stocks would sell off whenever there was negative trade news and gain when there was positive news. And certainly, trading algorithms, which pick up news headlines and cause selling or buying in the market, have their way with the market as well.

But recently, investors have been responding more to Trump's renewed imposition of tariffs, than just his latest comments.

Since October 8, the S&P 500 rose as much as 8.9%, as Trump's "phase one" deal with China, which would take December and 2020 scheduled tariffs off the table, looked somewhat likely. "Markets are pricing in a positive outcome ultimately with China -- U.S. trade agreements," Tony Bedikian, head of global markets at Citizens Bank told TheStreet in November, when market sentiment was high.

The overall gain for the last few months came as Trump had alluded several times -- not once -- to wanting to come to terms with China. Even though there were whispers that no deal was actually on the table, the market looked past those headlines and kept powering higher. When asked why investors were then so optimistic about a trade deal, Bedikian said (in November), "Just the trend at least in the news and the headlines seem more positive recently." He added, "The trend has been very positive."

But stocks got hammered Tuesday. That's because the trend has clearly flipped.

"The narrative on trade has quickly been turned upside down as negative headlines on tariffs have ignited a risk averse tone in the markets," said Allianz Investment Management Senior Investment Strategist Charlie Ripley. "Where it once looked like a trade agreement between the U.S. and China was progressing, investors are seeing a different picture portrayed."

And while the narrative flipped quite fast, there's already a new trend in a negative direction. It wasn't just Trump's comment about not coming to an agreement with China until after the election. The White House levied tariffs of about $2 billion worth of goods coming into the U.S. from the European Union this week. Trump also restored steel and aluminum tariffs on imports from Argentina from Brazil. These tariffs all amount to small dollar counts for the U.S. economy, but the new trend in trade is clear and the market is reacting.

Also not helping stocks was the worse-than-expected manufacturing index of 48.1, missing economists expectations of 49.4 and falling below October's reading of 48.3. Businesses have been cutting back on capital expenditures as trade-war uncertainty clouds the outlook for demand.

On a medium-term basis, some think projections of 8% earnings growth for the S&P 500 in 2020 has minimal upside. And "trade is really the biggest risk in the market place right now," Lindsey Bell, chief investment strategist at Ally Invest, told TheStreet.