- US stocks have rebounded strongly since late December.
- One factor has been increasing investor optimism towards the path of US-Sino trade negotiations.
- BAML’s equity and quant strategy team has looked at three possible scenarios as to how trade negotiations are likely to impact US stocks.
- It expects a deal to be reached, potentially seeing the S&P500 move back to the highs struck in September last year if it involves the removal of tariffs from either side.
- It says an escalation in the trade conflict will likely see stocks give back most or all of its recent gains.
US stocks have been on a tear since late December, bouncing strongly on the back of greatly diminished expectations for tighter monetary policy in the years ahead, especially from the Fed, along with a growing sense that the US and China will be able to resolve their differences on trade.
The US S&P500 index has surged 18.3% from December 26, leaving it less than 170 points away from the record high set in September 2018.
According to Bank of America Merill Lynch’s (BAML) equity and quant strategy team, whether the index can return to the highs, or perhaps even go beyond, will likely come down to whether a trade deal between the US and China can be reached in the coming months.
The bank has outlined three possible trade scenarios below, along with the expectation of how China will potentially react as well as what it will likely mean for the performance of US stocks.
In its opinion, and given the recent price action seen since late December, “a partial deal is increasingly priced into the equity market amid recent positive rhetoric out of the White House”.
BAML’s economics team agree with that assessment, suggesting a deal of some form will be reached given the need for US President Donald Trump to have a “win” ahead of fresh elections next year.
“Our economists have expected a trade deal to occur in the first half of this year all along,” it says.
“Resolution on trade would likely soothe investors.
“Key components of a deal include treatment of in-place and additional tariffs, a sizable import order for China, access to Chinese markets, and improved protection of US intellectual property.”
While that’s what BAML is anticipating, it says an escalation in the trade war — seeing the US up existing tariffs and potentially add additional tariffs on all Chinese exports entering the country — would likely lead to US stocks erasing most, if not all, of the gains seen so far this year.
Given current market expectations, and just how fast stocks have rebounded, that’s a small-yet-significant tail risk still facing US stocks in the weeks ahead.
Trade negotiations between the two sides will resume again in Washington later this week.
At this point, the hard deadline for a trade deal to be struck still remains March 1, although Trump has acknowledged this may be extended further should the two sides be close to reaching a lasting agreement.
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