Stock Markets Are Primed to Rally. Trade-War Risks Are Standing in the Way.

The simmering U.S.-China trade war is back to full boil this week. (AFP via Getty Images)

Key Points

• Renewed trade-war risks between the U.S. and China are impacting investor sentiment, despite a bull market in stocks.
• President Trump’s threats of 100% tariffs on China-made goods has caused market volatility.
• China’s September exports increased, with gains in Europe and Latin America, offsetting a 27% slump to the U.S.

The bull market in stocks, now entering its fourth year, has a host of tailwinds behind it, but the renewed risk of a trade war between Washington and Beijing is likely to linger over investor sentiment for the next several months.

President Donald Trump’s latest salvo in the reheated spat between the U.S. and China, delivered during the final minutes of Tuesday’s trading session and focused curiously on cooking oil, snuffed out a solid market rally and dragged all three major indexes into the red by the time the closing bell sounded.

Last week’s record-setting rally was also stopped dead in its tracks when the president threatened an additional 100% tariff on China-made goods in retaliation for Beijing’s decision to limit the export of rare-earth elements that are critical to the U.S. tech sector.

Capital Economics’ chief China economist, Zichun Huang, is also concerned that the Trump administration could tighten cross-border investment rules and possibly even move to delist China-based companies from U.S. stock markets.

The surprise escalation of the simmering trade dispute, which investors had hoped was advancing toward a deal following a series of bilateral meetings in Europe, has caught markets largely off guard.

Trump’s Friday comments describing China’s “extraordinarily aggressive position on trade” triggered a 30% surge in the Cboe Volatility Index , or VIX, the market’s key volatility gauge, and pushed gold prices firmly past $4000 an ounce.

His characterization of China’s refusal to buy American soybeans as an “economically hostile act,” meanwhile, blunted the impact of dovish remarks from Federal Reserve Chairman Jerome Powell that stoked bets on more central-bank rate cuts.

The sensitivity to trade war headlines likely means investors will need to remain focused on a planned summit between Trump and China President Xi Jinping at the Asia-Pacific Economic Cooperation forum later this month in South Korea.

And with the Fed signaling rate cuts, third-quarter earnings on track to top analysts’ forecasts, and the economy holding up well into the final months of the year, a positive conclusion to U. S.-China trade talks might be the final hurdle the market needs to clear before it can extend its long rally into 2026.

“Our baseline view is still that an extension of the tariff truce on Nov. 1 is more likely than a return to a fully-fledged trade war,” said ING’s currency strategist Francesco Pesole. “The risks remain rather elevated, though. China’s trade numbers released on Monday showed Beijing can afford to stretch its muscles on trade with the U.S. thanks to strong export diversification.”

China posted a surprise September increase in overall exports earlier this week, with big gains in Europe, Latin America, and the broader Asia region offsetting a 27% slump in goods shipped to the United States. It also saw imports rise the most in 17 months, suggesting that its efforts to diversify trade away from the U.S. is starting to bear fruit.

That could give Beijing some extra breathing room in talks with Washington over the coming months, particularly if it can leverage its advantage in rare-earth elements, and its critical connections to the U.S. tech sector, at the same time.

The latter was in evidence Wednesday, in fact, as Apple CEO Tim Cook arrived in Beijing for a meeting with government officials aimed at boosting investment in the tech giant’s biggest non-U. S. market.

Cook’s visit, which included a visit to Apple’s flagship Shanghai store and a donation to Tsinghua University, comes just two months after he accepted a gold-based plaque from Trump commemorating Apple’s $100 billion U.S. investment commitment.

But Huang at Capital Economics still thinks the U.S. has the upper hand, particularly if it limits U.S. companies’ investments in China.

“Investment restrictions would leave China worse off, given how much it benefits from these financial ties,” she said.

“And while the long-term impact may be limited, a sudden tightening could trigger near-term market instability,” she added. “This adds to our sense that China’s equities are more vulnerable than U.S. ones to a further escalation in tensions.”

Write to Martin Baccardax at martin.baccardax@barrons.com