Analysis Sees 11% More Market Upside from Trade Deal
Many are speculating on the potential effects of a successful trade deal between the U.S. and China, and since this is still weighing us down, there is still upside left with this.
There hasn’t been any real doubt that the recent trade tensions between the United States and China have weighed pretty heavily on stock prices, and seeing the market drop a healthy amount when this relationship deteriorated into at least the makings of a trade war certainly confirmed this pretty clearly.
While we normally would look to how the market responds to developments in an issue like this to get a good feel of how much it is affecting it, where the effects of both good news and bad can be measured, we can also look at the more fundamental side of the numbers and look to use this to also predict the effect of these things.
This analysis, like all fundamental analysis, is at best one step removed from reality, where changes in fundamentals may cause the market to react in one way or another and to one degree or another, but this relationship clearly isn’t linear and these effects really depend on subjectivity, how much this bothers or excites the market overall.
Therefore, when we look at the actual market response, we go from just a theoretical perspective of market action to the practical, the market reaction itself, and therefore what we learn from the actual trading is more meaningful and pertinent.
Stock prices rarely move based upon the view of a single event or issue though, and there are a lot of factors involved, so this can sometimes make it more difficult to tell how much a situation is moving price. Over the course of time though, further data can have us being more confident about the effects of something, for instance by looking at the many tidbits of news on the U.S.-China trade front and seeing how each move affects things, and then being surer of the impact of this after each incident.
We Can Measure the Upside from the Downside
From how much this has appeared to bring things down when the issue was more contentious, including threats of the trade war escalating, and then seeing things come back more and more as the news improves, we can be pretty confident at this point that this is an issue that indeed has more upside to it.
To add to this, we do know that the current situation is a restraining one, and there is also some chance that it might not get resolved during the current round of talks, and that a successful resolution would indeed benefit business conditions and open up markets. We don’t have to do any math to figure this out, but there are still people who seek to calculate these things, including economist Neil Dutta of Renaissance Macro Research.
The first order of business here is to determine how much of a negative effect that this trade battle has had on the market. Dutta tells us that “since January 2018, we estimate that trade tensions have shaved a cumulative total of 300 points off the S&P 500. In other words, if not for all the negative trade news over the last 14 months, the S&P 500 would be about 11% higher.”
We’ve already seen an 11% rise in the S&P 500 so far in 2019, so if this is accurate, this suggests that we may see a further recovery of 11% should we at least get back to where things stood before the swords started swinging over this.
We need to realize though that in January 2018, the trade relationship between the U.S. and China wasn’t exactly that great, and we went from a fairly problematic situation to one even more problematic.
Why this may matter is because if and when this deal gets done, we are almost certainly going to see a situation that has improved over where we were 14 months ago, and probably a quite significant improvement at that. If we started out at, say, a 50, and dropped to 30 during the tensions, we could end up at 70 or more on this scale, which would suggest not just the retracing of the negative influence of this but also add a positive influence and perhaps a pretty big one.
This Issue Does Appear to Have More in the Tank
As the prospects of the talks improved, and then as the talks progressed, the promise of a successful resolution become measured by the market, where the probability of this becomes adjusted. If it’s 50% likely, the market will give it a certain weighting, and as the probability increases, to 75% for instance, this means that the odds of this have increased and the market will price in these improved outlooks.
Once a deal like this gets done, it won’t be the full impact of the deal that affects the market, but instead the incremental amount from how likely we thought this was yesterday to it being completely likely today due to an agreement. This is why we don’t really see events that have a long lead-up period affecting stocks like we might think that they would, like something that hits us completely out of the blue might.
When news is announced, while we don’t necessarily see a selloff on the news, this can happen, and what is behind this is investors seeing this as an opportunity to take profits, those who for instance were riding the move up based upon positive expectations on the trade front, and their reason for being in the trade once this has concluded may go away.
There are other reasons why we see selling pressure when deals are wrapped up, for instance if people are nervous that the market may sell off when an agreement happens, they might do it themselves, and this places more downward pressure on prices.
It is not a matter of one or the other side winning out as much as it is what degree of strength and influence the pressures on each side exert. We might see stocks continue to rise after a trade agreement is signed, but this downward pressure may still mute such a rise.
The best perspective to take with this is to compare where we are now with where we could go, and from this view, doubling the gains we’ve seen already this year, gains that have been significantly influenced by the progress we’ve had with these trade talks looks pretty reasonable and realistic.
The significant and relatively long-lasting effects of a trade deal of this magnitude will probably portend enough good to bring in enough longer-term money to overcome any fear of a selloff on the news here. While we may not want to completely rely on the sort of calculations and predictions that Dutta has provided us, this at the very least has value in confirming the view that we get from comparing the news to the charts, and this does lend credibility to the belief that a U.S.-China trade deal will indeed add more bullishness to the market in 2019 if it is successfully reached.
Editor, MarketReview.com
Eric has a deep understanding of what moves prices and how we can predict them to take advantage. He also understands why so many traders fail and how they may help themselves.
Contact Eric: eric@marketreview.com
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