Deal or No Deal? As the U.S. and China again lock horns on trade, the answer to that question becomes increasingly uncertain.

Negotiations veered off track this month after reports that China backtracked on key elements of a deal.  In response, the U.S. rolled out 25% tariffs against an array of Chinese imports.  China then retaliated by announcing tariffs against $60 billion in U.S. goods.  The escalation of the trade battle and accompanying war of words between the economic superpowers has caused global stocks to fall 5% (chart).

What happens next? Even the leaders of the two nations themselves may not know. However, because the U.S. and China are economically interdependent, neither has an incentive to drastically escalate the trade war – similar to the way “Mutually Assured Destruction” helped to keep the peace between the U.S. and Soviet Union during the Cold War.  Accordingly, we do not expect a dramatic escalation in tensions that puts the bull market and economic expansion at risk.

That being said, not all of the incentives involved are economic. As the U.S. approaches an election year in 2020, Presidential politics appear to be influencing negotiations. According to some reports, the White House now believes that demonstrating toughness with China and walking away from a deal could be preferable from a political standpoint.  China, meanwhile, may wish to slow walk a deal in hopes of finding a friendlier negotiating environment after the election.  All of which means a trade deal could be delayed or not happen at all. On the other hand, a deal could come together quickly if progress is made on key areas of disagreement.

Trade-related market volatility may persist over the coming months, particularly in emerging market countries that are most reliant on global trade. However, we believe the basic building blocks of a bull market remain in place: solid economic data, low inflation, a market-friendly Fed, strong corporate earnings, and improved valuations. Accordingly, we believe that further near-term selling pressure in stocks will prove to be temporary.  In fact, if equity market weakness does continue, it may provide the motivation for U.S. and Chinese leaders to finally reach an agreement.