How could trade talks between the U.S. and China that push closer to a full-blown agreement be a negative to stocks?
There are a few ways that could happen, as explained by Josh Emanuel, chief investment officer at Wilshire Funds Management.
"If a trade deal gets done, how is that likely to impact economic growth? And I think the answer to that is it's likely to be a positive impact?" Emanuel said. "It would be a positive impact in that it's likely to boost consumer, corporate confidence. What we've seen on a year-to-date basis is the consumer is healthy. But sentiment in the corporate sector started to deteriorate and it's reasonable to expect that company management is going to sit on their hands until there's some clarity with respect to trade going forward." Meanwhile, the S&P 500 is up 20% on the year. While the market is looking for interest rate cuts, it's also optimistic neither side will induce further tariffs.
On net, so far so good in terms of stocks, based on Emanuel's comments, right?
Well, here's what would happen should trade talks be too positive. "Now the spillover of that however, is interest rates," Emanuel said. "As we all know, interest rates have continued to move lower and equity valuations or equity prices have been very much supported by the expectation that the Fed is going to continue to cut rates more aggressively."
He added, "So to the degree that we get a trade deal done with China and expectations of economic growth improve going forward, there is a reasonable probability that investors need to price in a fewer number of interest rate cuts. And that actually can serve as a headwind to equity valuations in particular, particularly in those parts of the market where valuations are more rich."
As Mike Loewengart, vice president of investment strategy at E*Trade told TheStreet in early July, "It's become perverse. If we see strong economic metrics that indicate the economy is firming, that's going to be interpreted by investors that the Fed won't have to cut. If there are any metrics that don't drive that narrative, you see stocks come down."