By Scotia Wealth Management - The Zukiwsky Group

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Market Watch: May 17, 2019

May 18, 2019 | 10:11 AM

Big Picture

N.A. Markets Recovering After Rough Monday, as Trade Tensions Spike

Global stock markets tumbled and the Chinese yuan hit its lowest level since December as the trade war between the U.S. and China intensified on Monday. The sharp declines were largely the response to news that Beijing planned to raise tariffs on roughly $60 billion worth of U.S. imports, making good on threats last week to hit back at the U.S. after its own tariff hikes went into effect. The Dow fell 617 points, or nearly 3%, its biggest one-day loss since January. The S&P dropped 2.4%, and the Nasdaq shed 3.4% in its sharpest decline since early December. In Canada, the TSX lost 104 points, weighed down by the energy sector, which fell more than 2% Monday. The renewed trade tensions also hit the U.S. bond market, with the yield on the benchmark 10-year U.S. Treasury note sliding below 2.4% for the first time since March. Major U.S. stock indexes recovered some ground Tuesday after President Trump further signalled that U.S. and Chinese officials could still salvage a trade deal, leaving shaken investors with a glint of optimism. Ten of the 11 major S&P sectors advanced Tuesday, with technology companies, which were battered during Monday’s selloff, rising nearly 2%. Concerns over global growth mounted Wednesday as data released showed U.S. retail sales fell unexpectedly for April. Figures also showed Chinese industrial production and retail sales slowed in April, while Germany’s economy expanded a scant 0.4% in Q1. Despite the latest numbers, North American markets regained more ground Wednesday and Thursday, buoyed by strongerthan-expected earnings reports. Finally, Ottawa is reportedly close to reaching an agreement with the Trump administration to lift America’s steel and aluminum tariffs, as is Mexico. Removing the tariffs will be key if there’s to be any hope for ratification of the renegotiated NAFTA agreement.

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Markets Claw Back After Monday’s Selloff

For the four days covered in this report, the Dow declined 79 points to close at 25,863, the S&P 500 lost 5 points to settle at 2,876, while the tech-heavy Nasdaq was down just 19 points to close at 7,898. In Canada, the TSX proved resilient, as Canada’s major index gained 146 points to end at 16,444.

Equities/Strategy

Strategy

Too early to assess the impact of tariffs. U.S. imports approximate 15% of gross domestic product (GDP), with 20% sourced from China. Suffice it to say, the knock-on effects of a trade war are difficult to discern and may affect corporate profitability, productivity, growth, and inflation. We anticipate that many U.S. companies will be able to mitigate the impact of tariffs by increasing prices, reengineering their supply chains, and reaping the benefit of U.S. dollar strength. The S&P500 Index is comprised of companies domiciled in the U.S., accounting for over 80% of the value of all publicly listed U.S. stocks. In the worst case scenario, we estimate that implementing tariffs of 25% on all Chinese imports would increase the cost of goods sold (COGS) for S&P500 companies by over $50 billion. The impact would equate to a gross margin decline of 50 basis points and depress earnings per share by roughly 4-5%. The underlying strength of the U.S. economy and data dependent policy should help sustain corporate profits until we get further clarity. However, volatility will likely create an opportunity for investors to capitalize on trade-related concerns that may not have an impact on medium-term fundamentals for high-quality companies.

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