An escalation of the trade dispute between the U.S. and China dealt a blow to market confidence on Monday, accelerating a pullback in stock prices globally.
After the world’s two largest economies imposed a fresh round of duelling tariffs, the U.S.’s main stock indexes posted their worst day in more than four months. With technology stocks leading the losses, the tech-heavy Nasdaq Composite Index dropped by 3.4 per cent.
A corresponding flight into safer assets, meanwhile, saw the prices of government bonds and gold rise on the day, both of which helped limit the damage in the Canadian stock market, as the S&P/TSX Composite Index declined by 0.6 per cent.
Market sentiment in recent days has hinged on trade talks in Washington, which, up until about a week ago, were tracking toward a resolution.
A deterioration in the relationship between the two countries has now revived fears that a prolonged trade dispute could pose a real threat to global economy, said Michael Craig, a managing director at TD Asset Management.
“Anytime you see this confluence of various asset markets telling you the same story, you know the market's taking it quite seriously,” Mr. Craig said.
“It looks like there will be no easy resolution short term.”
The flare-up in trade tensions saw the U.S. impose a 25-per-cent tariff on US$200-billion of Chinese imports, to which the Chinese retaliated with its own tariffs on US$60-billion of U.S. goods.
The reaction in financial markets closely followed the script of a typical flight to safety over macroeconomic concerns. The pockets of the stock market closely linked to the broader economy, like technology, consumer discretionary, and industrials, were hit the hardest.
A shift of capital into bonds pushed down long-term yields in both Canada and the U.S., with 10-year yields falling to 1.67 per cent and 2.40 per cent, respectively.
In both countries, long-term yields fell below short-term yields, marking the second time in two months that yield curves have inverted. That relatively rare phenomenon is considered to be a predictor of economic stress, and serves as a message to central bankers, Mr. Craig said.
“The bond market is telling central banks that they're running policy too tight.”
Traders have priced in a greater likelihood of interest rate action as a result, with the probability that the U.S. Federal Reserve reduces policy rates this year at 75 per cent. The chance of the Bank of Canada doing the same is currently about 30 per cent.
Lower bond yields, however, seemed to lend support to Canadian dividend stocks on Monday, as utilities and real estate stocks outperformed the broader market.
Gold was also a beneficiary of Monday’s stock market retreat, as the spot price hit US$1,300 for the first time in a month, which also provided some reinforcement to the resource-heavy TSX. The materials sectors within the S&P/TSX Composite Index rose by 0.5 per cent on the day.
In a broader sense, Canadian equity resiliency may suggest improving investor attitudes toward the country, said Jennifer Radman, vice-president and senior portfolio manager at Caldwell Investment Management Ltd.
“For several years, there’s been so much negativity around the Canadian market,” she said. “But there are pockets where you can hide on a relative valuation basis versus the U.S.”
The S&P/TSX Composite Index currently trades at a forward price-to-earnings multiple of about 14.5, compared with about 17 for the S&P 500 index. Meanwhile, the market is currently expecting U.S. earnings growth of about 7.3 per cent over the next year.
“That will be impossible to achieve if U.S.-China negotiations morph into a trade war,” Stéfane Marion, chief economist and strategist at National Bank Financial, said in a note.
Foreign sales account for 44 per cent of revenues for the companies in the S&P 500 index, he pointed out. For the materials, energy and tech sectors, that number is well over 50 per cent.
It should serve as some consolation for stock investors, however, that U.S. President Donald Trump likely has little appetite for an extended market slide. “Trump looks at the market as kind of the barometer of his presidency and his success,” Mr. Craig said.
On the other side, a significant slowdown in the Chinese economy puts pressure on its leadership to avoid any further growth constraints.
That all makes for a bit of an uncomfortable standoff, Mr. Craig said.
“Who will blink first?”