The S&P 500, tracked by the C Fund, had its worst week of 2019 so far, with a decline of more than 2%. If not for the reversal leading into a major late-day rally on Friday, the week could have been down 3-4%.
The sell-off was triggered by a significant setback in the trade negotiations between the United States and China. The two countries have been in a months-long negotiation to form a new bilateral trade agreement, and failure to secure a deal is expected to lead to higher tariffs and reduced trade between the countries.
This past week’s sell-off began after President Trump tweeted that he would be raising tariffs from 10% to 25% on $200 billion worth of Chinese imports.
The market was taken by surprise about this, which led to a rough week in markets around the world. Investors are concerned about reduced consumption due to higher prices, retaliatory tariffs on U.S. exports, and disrupted supply chains. The official statements by representatives of both the United States and China over the past month have been consistently saying that trade talks were progressing and agreeing on various subsets of the deal, so this reversal was unexpected.
More information became available throughout the week, with sources saying that Chinese trade officials backtracked on large portions of the agreement that had already been generally agreed upon. The decision by the president to raise tariffs came as a retaliation.
Torsten Slok of Deutsche Bank Securities has quantified these new tariffs well:
The blue columns represent tariff levels in major developed markets and black columns represent tariff levels in major emerging markets. The red portion on U.S. tariff levels represents new tariffs that President Trump already put into place in 2018. The yellow portion represents the next escalation of tariffs that President Trump announced a week ago. The green portion is not yet in place but has been put on the table for further escalation if the bilateral trade negotiations do not improve.
It remains to be seen how this will turn out over the coming months. Both countries have a certain type of leverage over the other.
The United States is a much bigger buyer from China than the other way around, so tariffs on Chinese imports can have a bigger impact on China’s economy than tariffs from the other side. Additionally, China uses a number of trade policies that are widely viewed as unfair by many countries, with the most serious ones involving theft or forced transfer of intellectual property. The U.S. has the stronger legal stance as far as global trade agreements are concerned.
On the other hand, China’s government does not change political parties, and can potentially wait a year and a half to see how the 2020 elections go in the United States, to see if they will have a different administration to negotiate with or still this administration. China also owns over $1 trillion in U.S. national debt, or about 5% of the total, and could potentially discontinue buying debt which could put some upward pressure on treasury yields. Wealthy Chinese buyers have also been pulling out of the U.S. stock market and real estate market, which potentially allows for bigger drawdowns due to less buying pressure.
U.S. Small Cap Stocks Still in a Bear Market
The C Fund and S&P 500 temporarily reached all-time highs in April 2019 before running into this latest pullback, but the S Fund and other small-cap index funds are still technically in a bear market from last year.
The S Fund’s all-time high was in August 2018, and the fund plunged almost 25% from that point to its Christmas Eve low. The fund has recovered strongly in 2019, but still remains firmly below its August 2018 high point.
Investors in many of the TSP’s lifecycle funds have had a less volatile journey over the past year. Diversifying into U.S. stocks, foreign stocks, and bonds, helps to avoid major losses in any one area. The L2030 fund, for example, suffered less than a 12% maximum drawdown during the big market sell-off in the fourth quarter of 2018, and reached new all-time highs in April 2019.