Facts About The Recent Volatility And Fears Of A Trade War

Published Friday, April 6, 2018 at: 7:00 AM EDT

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Stocks soared in January, hitting new all-time highs after the tax bill was enacted and then plunged 11% from January 26 to February 8. By March 9, prices had largely recovered when President Trump slapped $50 billion of tariffs on China and fears of a trade war triggered another selloff and capped off Friday with a 2.2% plunge. For whipsawed investors, here are the straight facts.

On March 22, President Trump signed a memorandum officially targeting "China's economic aggression," and proposing $50 billion in tariffs on Chinese imports into the United States. China responded within days by imposing tariffs on the United States. On Thursday, the president added another $100 billion of proposed new tariffs on Chinese goods, triggering Friday's 2.2% selloff.

These actions followed an investigation initiated at the request of President Trump on August 18, 2017 by the U.S. Trade Representative (USTR) under Section 301 of the Trade Act of 1974 into the government of China's acts, policies and practices related to technology transfer, intellectual property, and innovation.

The key findings of U.S Trade Representative Robert Lighthizer's investigation document unfair practices by China, accusing the world's second largest economy of requiring joint-ventures, restricting foreign investment, and imposing administrative reviews or licensing requirements that force technology transfers from American companies. In addition, convicted Chinese cyber intrusions into U.S. computer networks to gain access to valuable business information are well documented and are only a small part of the USTR's 215-page report.

While China has earned its reputation for unfair trade activities, and the chance of a trade war, the President's position is looked upon as a negotiating tactic and it could stir a coalition of U.S. trade partners to act against China in unison.

"We're talking to World Trade (Organization), we're talking to NAFTA, we're talking to China, we're talking to the European Union," the President said on March 22. "And I will say, every single one of them wants to negotiate. And I believe that, in many cases - maybe all cases - we'll end up negotiating a deal."

Before the trade war fears caused the recent spate of volatility, stock valuations had exceeded the upper range of their historical range. Measured by the S&P 500, stocks historically average a price 17- to 19-times the trailing 12-month earnings, indicated in the two red lines.

In the euphoria that followed the signing of the tax reform law on December 22, 2017, the price of the S&P 500 pierced its historic range and became vulnerable to a fall. With the recent price drop, stocks have fallen back within their historical range based on earnings expected for 2018 and 2019, as shown in the dashed red lines.

This is not a forecast or prediction. It's simply a calculation to illustrate a path that the S&P 500 could reasonably be expected to take given the current outlook for economic and earnings growth coupled with continued expected low inflation.

Over the 10-year period ended March 31, the S&P 500 total return index has gained 148% - more than doubling. From the financial crisis market bottom on March 9, 2009, the S&P 500 total return index gained 372% - nearly quintupling.

On Friday, the S&P 500 closed at 2604.47. Stock prices are reasonable, considering extremely strong earnings expectations for 2018 compared with their historical norm. It's prudent to expect stock prices to be vulnerable to more plunges on frightening headlines, but economic fundamentals remain very strong.

2017 (estimated), 2018 (estimated) and 2019 (estimated) bottom-up S&P 500 operating earnings per share as of April 3, 2018: for 2017(e), $131.98; for 2018(e), $157.99; for 2019(e), $173.97. Sources: Yardeni Research, Inc. and Thomson Reuters I/B/E/S for actual and estimated operating earnings from 2015. Standard and Poor's for index price data as of March 29, 2018; and actual operating earnings data through 2014.

This article was written by a veteran financial journalist based on data compiled and analyzed by independent economist, Fritz Meyer. While these are sources we believe to be reliable, the information is not intended to be used as financial advice without consulting a professional about your personal situation.

Indices are unmanaged and not available for direct investment. Investments with higher return potential carry greater risk for loss. Past performance is not an indicator of your future results.

This article was written by a professional financial journalist for NFI, LLC. and is not intended as legal or investment advice.

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