Stocks have stumbled, but here’s how the bull market could get back on track

Stocks have stumbled, but here’s how the bull market could get back on track

October is the cruellest month, or at least it has been so far this year for investors.

Trade tensions, tightening monetary conditions and political uncertainty are stoking fear and risk-off sentiment. Animal spirits have been dampened, to say the least.

What could turn them around? Well, a few upcoming developments, or possible developments, at least have the potential to shift market sentiment and give the decade-long bull market some more runway. None are sure things; some might not amount to much even should they occur. But if you’re looking for signs of hope — well, here’s a quick rundown.

The most imminent wiggle factor is the Nov. 6 U.S. midterm elections. Polls suggest that congressional control will be split, with Republicans remaining in charge of the Senate and Democrats regaining the House of Representatives. If that happens, it will probably provoke a yawn from Wall Street, since it’s the outcome already baked into valuations. Some investors who see government gridlock as good for markets might see a Democratic House as a net positive — though it’s tough to see much net gain in congressional inaction, given how little Congress has managed to get done when the Republicans have controlled both chambers.

However, as 2016 proved, nobody knows anything. Recent polls have suggested that the House race is tightening. Should the Republicans maintain control of the House and the Senate, it should at least increase the chance that President Donald Trump’s long-promised/never-delivered infrastructure plan gets off the ground; maybe even that cryptic consumer tax cut he promised last week could come to pass. Of course, more stimulus spending is precisely what the overheating U.S. economy doesn’t need in the long run, but a Blue Wave in the midterms might provide a short-term boost to U.S. equities.

Still, the biggest benefit to markets from the midterms might be simply that they will be over. U.S. markets tend to rally after midterms anyway, but to whatever degree this year’s round — with its rhetorical nastiness and partisan violence — has stoked unusual political uncertainty, then the post-election relief bump might be amplified.

But — that could prove short-lived, if the U.S.-China trade war heats up even further. Without a resolution by the end of the year, tariff rates on US$250 billion of Chinese imports could rise to 25 per cent, and the threat of slapping taxes on all US$500 billion or so of goods from China hasn’t dissipated in the runup to the midterms. If bad comes to worse, then we can count on more tariff pain, not just for global markets but also for U.S. multinationals. Equipment manufacturer Caterpillar’s acknowledgment in last week’s quarterly earnings announcement that tariffs are hitting the bottom line could augur bad things to come for the impact on markets.

The next G20 summit, taking place at the end of November in Buenos Aires, might be the last kick at the can for the U.S. and China to reach agreement, even though Trump’s pre-election rhetoric makes that look like a remote possibility. If the midterms go the way polls suggest, with Democrats taking the House, the China-bashing won’t likely recede — not just because Trump will be inclined to double down on issues that he sees as motivating his base for re-electing him in 2020, but also because leading Democrats support a tough stance toward China on trade, although they differ on tactics.

Ironically perhaps, the best chance for a U.S.-China resolution might be a big win for Republicans on Nov. 6

But what if there is an agreement at the G20, or even before? It could happen. Ironically, perhaps, the best chance for a resolution might be a big win for Republicans on Nov. 6. With the base sufficiently pacified to vote red in the midterms, Trump could agree to a solution with China and then have two years to explain or apologize. Doing so would also appease whatever’s left of the free-trade contingent in the Republican party. And finally, it would be true to form for Trump, who seems to like nothing better than creating a crisis, eventually agreeing to a resolution that doesn’t change much, and then claiming victory. (See “NAFTA.”)

If, on the other hand, Trump feels the need to continue his China-bashing, then the combination of tariffs, tightening monetary conditions and the strong U.S. dollar will, at some point, start to impact the American economy in the same way it is already hitting Europe, Japan and emerging markets. European growth in particular, which plumbed a four-year low of 0.2 per cent in the third quarter, is a troubling sign that the adverse effects of China’s slowdown, trade tensions and political uncertainty are real. The U.S., while better insulated than most, is not immune to global trends; exports are already down, and if the tariff war with China intensifies, corporate earnings, consumer spending and jobs could take a hit. Inflationary forces might end up the least of the Fed’s worries. To whatever extent rising rates have been dulling investors’ risk appetite, a pause from the Fed could provide a market boost in the U.S. and help emerging markets by easing upward pressure on the greenback.

Finally, if none of those upside outcomes materialize, at least investors can take comfort in the fact that nothing lasts forever. Even if we are entering an end-of-cycle bear market, with an economic downturn around the corner, few expect it to be as severe or as durable as the last recession. And remember what happened to stocks in the 10 years after that one.

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