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Market Volatility in Wake of China Trade Talks

| May 13, 2019
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China Trade Talks Spark Higher Tariffs

Trade fears drove stocks to their worst week of the year, down 2% after President Trump announced the U.S. would increase tariffs from 10% to 25% on $200 billion of Chinese goods and threatened fresh tariffs on an additional $325 billion in Chinese goods after the Chinese reportedly backed out of a trade agreement. It could’ve been worse, but talks in Washington, D.C., were reportedly constructive, according to Treasury Secretary Steven Mnuchin, which helped stocks get back some of the losses from earlier in the week.

On May 6, the United States announced it would implement additional tariffs on Chinese imports at the end of the week if no trade agreement is reached. In response, China threatened its own retaliatory measures. China and U.S. officials are still scheduled to continue trade talks in Washington, D.C. May 9, but the threat of escalation looms large in investors’ minds.

Volatility in the Market - View of the S&P 500 

“Keep in mind that even with Monday morning’s losses, the S&P 500 Index is still only about 4% below the all-time high,” said LPL Chief Investment Strategist John Lynch. “In the past, by this time of the year, stocks have typically pulled back 8–9%, so even though fundamentals still look pretty good to us, a pickup in market volatility should be anticipated.”

Recent market volatility has been uncomfortable, but not particularly surprising given the lack of turbulence year to date. As shown in the LPL Chart of the Day, the S&P 500’s largest pullback this year has been unusually small relative to previous years. Since 1970, the S&P 500 has made it through the first five months of the year without at least a 2.5% pullback only once—in 1995.

2019's Biggest Drawdown is the Smallest Since 1995

On average, the S&P 500 has endured an 8.5% pullback from January to May each year. This year, stocks haven’t come close to that. The largest S&P 500 pullback this year has been a one-day slide of 2.48%.

“Given the recent run we’ve had, we believe conditions are ripe for an increase in volatility,” said LPL Research Chief Investment Strategist John Lynch. “Though we remain optimistic about U.S. stocks’ longer-term prospects, stocks recently reached overbought levels.”

Economic Growth

While volatility could take over in the near term, we see the resurgence in trade risk as a temporary obstacle to new S&P 500 highs later this year. In our view, current trade headwinds will have a negligible impact on economic growth, and the U.S. economy has emerged relatively unscathed from what is traditionally the weakest quarter of the year. Economic fundamentals also point to higher prices: The labor market is steadily improving, corporate profits are at all-time highs, and inflation is healthy.

Last week’s sector performance clearly reflected trade concerns, with globally exposed sectors—industrials, materials, and technology—pacing the decline, as shown in the LPL Chart of the Day. These sectors have among the highest percentage of international revenue, and in China in particular.

Most Global Sectors

Materials companies have a lot at stake here because China has reportedly offered significant agriculture purchases as part of a potential agreement. Copper prices fell last week, reflecting fears of weaker Chinese demand if tariffs remain in place. Industrials and technology sectors have high exposure to China, particularly aerospace and defense, machinery, and semiconductors.

While volatility can be uncomfortable, we continue to encourage investors to focus on long-term fundamentals rather than daily headlines. 

Want to Talk? Contact Anne. 

Important Disclosures

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual security. To determine which investment(s) may be appropriate for you, consult your financial advisor prior to investing. The economic forecasts set forth in this material may not develop as predicted

Investing in foreign and emerging markets securities involves special additional risks. These risks include, but are not limited to, currency risk, geopolitical risk, and risk associated with varying accounting standards. Investing in emerging markets may accentuate these risks.

Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments.

Because of their narrow focus, sector investing will be subject to greater volatility than investing more broadly across many sectors and companies.

The Standard & Poor’s 500 Index is a capitalization-weighted index of 500 stocks designed to measure the performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries. The modern design of the S&P 500 stock index was first launched in 1957. Performance back to 1950 incorporates the performance of predecessor index, the S&P 90.

All indexes are unmanaged and cannot be invested into directly. Unmanaged index returns do not reflect fees, expenses, or sales charges. Index performance is not indicative of the performance of any investment. All performance referenced is historical and is no guarantee of future results.

This research material has been prepared by LPL Financial LLC.

To the extent you are receiving investment advice from a separately registered independent investment advisor, please note that LPL Financial LLC is not an affiliate of and makes no representation with respect to such entity.

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