For the first half of 2019, it was all quiet on the trade front. But the script flipped right around May when tensions ratcheted up between the United States and China.

The reemergence of trade fears is a bit of a pump-fake, given the narrative for much of the year was that China and the U.S. were edging closer to a deal. So, what are investors to make of this latest bend in U.S.-China relations? Are these simply bombastic, public negotiation tactics between two nations that fully intend to reach a deal, or is this stand-off something more malignant that will have lingering effects that bring this historic economic expansion to a close?

Despite a palpable shift in the trade story, Brent Schutte, chief investment strategist at Northwestern Mutual, maintains his belief that trade fears remain a short-term concern that long-term investors shouldn’t be overly concerned about. And although trade fears are circling, Schutte notes that right now, as opposed to last year, a second major market specter is noticeably absent, and that gives him further confidence that this historic expansion still has room to run.

ON THE TRADE FRONT

Since the beginning of the trade spat between the U.S. and China, Schutte’s view on this market fear has been consistent: It’s in neither country’s best interest to watch their economies unravel. He still sees a deal getting inked in the intermediate-term, but that doesn’t mean there won’t be some rough patches for businesses and markets in the short-term.

“We view this as a manageable supply shock and companies will likely absorb increased costs in the nearer term, while shifting supply chains to remedy it in the intermediate term,” says Schutte. “While we believe each administration will temper trade demands if their markets and economies begin to buckle, there is risk that both sides stubbornly dig in if distrust deepens.”

The Chinese government has moved to stimulate its economy, the U.S. stock market has rallied, and the economy has remained on firm footing in 2019, which gives both sides leverage to “spend some upside” to push their respective trade agendas. Basically, that means both sides can continue to bargain from a position of strength – for now. But when push comes to shove, neither China nor the United States will let their economies crumble over trade, says Schutte.

More cause for optimism regarding trade: Although Trump increased the heat on trade talks with China, his administration simultaneously cooled trade tensions in other parts of the world. On Friday, he agreed to lift tariffs on metal imports from Mexico and Canada, and they agreed to lift tariffs on U.S. pork, cheese and milk. Trump also delayed by six months a deadline to impose tariffs on Japanese and European autos. Together, these maneuvers signal an administration that isn’t interested in an all-encompassing, global trade war.

“The administration seems to be striking a balance to keep the market in a good place in terms of trade and tariffs,” says Schutte. “For the rest of the world outside of China, trade pressure has certainly come down a bit.”

FED FEARS FADE

There’s another reason Schutte thinks the economy can weather the trade storm: The Fed isn’t teaming up to compound market fears.

The stock market correction that occurred during the close of 2018 was driven by a potent combination of trade fears and Fed policy fears. Investors were concerned that the Fed would continue to raise rates too quickly, which could risk bringing the economic expansion to a close. Instead, the Fed has struck a dovish tone, opting to take a wait-and-see approach regarding rate hikes – especially since inflation has remained quite low.

“With overall inflation recently declining and now running at 1.6 percent year over year, we believe there is ample room for inflation to rise before the Fed contemplates playing its historical role of shutting down the economic and market party by aggressively raising rates,” says Schutte.

Interestingly, the recent market slide may have given the Fed reason to stay on the sidelines, as its third mandate is to prevent bubbles from forming in markets. With stocks losing some momentum, the Fed should be in no hurry to alter its current course.

“The Fed wants a rising equity market to help it in its quest to create inflation, but also avoid a bursting bubble that harms the economy,” says Schutte.

FUNDAMENTALS ARE STRONG

Ultimately, a strong economy has a way of plowing through Fed and trade fears. Schutte says the body of economic data points to an economy that is still forging ahead with strength. Although the markets may gyrate in the short-term, over the intermediate term a strong economy tends to pull markets along with it.

“We see an economic cycle that, from a fundamental perspective, has further room to run before a recession ensues,” says Schutte. “I’ll repeat our well-worn mantra: If the economy is growing, there is a very high probability the equity markets will follow suit.”

Commentary is written to give you an overview of recent market and economic conditions, but it is only our opinion at a point in time and shouldn’t be used as a source to make investment decisions or to try to predict future market performance. There are a number of risks with investing in the market: if you want to learn more about them and other investment related terminology, click here.

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