NEW YORK (Reuters) - Trade tensions that have simmered in the background for investors are starting to boil over into a more severe problem for the U.S. stock market.
The latest developments involving a trade dispute pitting the United States against China and other countries are creating such uncertainty that investors are struggling to value stocks at a time strong corporate profits would otherwise bolster stocks as the bull market extends into its 10th year.
“The uncertainty regarding policy leads to uncertainty regarding profits,” said Richard Bernstein, chief executive and chief investment officer at Richard Bernstein Advisors in New York. “I’m not sure how one could say that trade is fully discounted because policy is being set somewhat randomly.”
Although concerns over a global trade war have loomed over the stock market since March, the issue has barged into the foreground in recent days, as motorcycle maker Harley-Davidson Inc (HOG.N) and Mercedes-Benz maker Daimler (DAIGn.DE) warned of a financial toll from the trade tensions.
Investors, meanwhile, are reconsidering whether statements from U.S. President Donald Trump and his administration may be more than just an effort to gain leverage in any trade negotiations.
“As it seems that this is not just a negotiating tactic - this could be reality - that is beginning to unnerve the market,” said Eric Kuby, chief investment officer at North Star Investment Management in Chicago.
The dilemma of weighing trade concerns was cast into stark relief for investors on Monday when the S&P 500 dove 2 percent amid conflicting signals from the Trump administration over proposed restrictions on foreign investment in U.S. technology companies.
The benchmark index recovered somewhat to close down 1.4 percent, but still marked its biggest single-day decline in nearly three months. The S&P 500 rebounded modestly on Tuesday, ending up 0.2 percent.
Rick Meckler, partner at Cherry Lane Investments in New Vernon, New Jersey said the trade dispute was definitely making it harder to value the stocks.
“Handicapping it is extremely difficult, and contributing to the overall nervousness of investors,” he said.
“It’s given me pause about committing new capital and I’m in the position of a lot of investors where with these sell-offs, my first reaction is to step back rather than to leap in,” Meckler said.
The S&P 500’s current price-to-earnings ratio, or P/E, is 16.7 times earnings estimates for the next 12 months, according to Thomson Reuters Datastream. That makes stocks significantly cheaper than they were in January, when the index traded at 18.6 times estimates, but still more expensive than their long-term average of 15 times.
Trade has become one of the main uncertainties facing stock investors as they value stocks, along with the path of interest rate increases by the U.S. Federal Reserve, said Dan Veru, chief investment officer at Palisade Capital Management LLC in Fort Lee, New Jersey.
“It is making it harder,” Veru said. “What sort of P/E do you put on a company? That’s the struggle right now.”
Recent comments from Harley and Daimler indicate that the impact from tariffs could cloud the second-quarter earnings season starting in a few weeks in which S&P 500 companies are expected to increases profits by 20.7 percent, fuelled by the recent U.S. corporate tax cuts.
“This will be a huge topic,” said J. Bryant Evans, investment adviser and portfolio manager at Cozad Asset Management in Champaign, Illinois.
“CEOs are starting to think about how this affects them and what moves they’re going to make ...,” Evans said. “It’s very hard for them to plan anything with this uncertainty, but they have to move forward as if the current trend is going to continue for several more years.”
There does not seem to be as yet any significant impact from the trade uncertainty on analysts’ projections for earnings. Analysts estimate earnings will rise by 22.4 percent for 2018, up from a 19.8 percent increase expected at the start of April, according to Thomson Reuters I/B/E/S.
But some market strategists are beginning to project fallout from an intensified trade war. Using assumptions including a 10 percent increase in import costs stemming from heightened tariffs, BofA Merrill Lynch projects a 3-4 percent hit to S&P 500 earnings per share.
Deutsche Bank economists calculate that escalation of the trade dispute to include $200 billion of imports could reduce economic growth by 0.2 to 0.3 percentage points, which translates to a 1 to 1.5 percent reduction in S&P 500 earnings growth.
Whether such projections become more relevant could become clear at the end of next week, when U.S. tariffs on $34 billion worth of Chinese goods are scheduled to go into effect.
“The market is starting to price in that the tariffs will start to become real,” said Brian Battle, director of trading with Performance Trust Capital Partners in Chicago. “The rhetoric is getting stronger rather than weaker. We’ll keep trading off if the trend persists.”
Some investors continue to doubt that the U.S.-China tensions will escalate into a full-blown trade war and that, given that Trump himself has measured his success by the stock market, the administration will be wary of policies that would seriously undermine stocks.
“You can still value stocks,” said Hugh Johnson, chief investment officer of Hugh Johnson Advisors LLC in Albany, New York. “You have to take a giant leap of faith that this so-called trade war won’t unfold.”
Graphic - S&P 500 quarterly profit growth (interactive): tmsnrt.rs/2Ko5516
Graphic - S&P 500 quarterly profit growth: tmsnrt.rs/2Is3ipT
Graphic - S&P 500 P/E vs S&P 500 price move: reut.rs/2Kq2XpM
Additional reporting by Sinead Carew; Editing by Alden Bentley and Susan Thomas