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Note: Unless otherwise specified, currency amounts described in this article are in U.S. dollars, and government references are to the U.S. government.

Stocks Drop as U.S.-China Trade War Escalates

Stocks dropped on Monday as the trade war between the United States and China escalated, with China announcing a retaliatory tariff hike on U.S. imports. The S&P 500 index closed down 2.41% and the Dow Jones Industrial Average lost 2.38%, their worst day in four months.

China’s announcement on Monday morning followed a U.S.-imposed tariff hike on Friday on $200 billion of Chinese goods. Late Monday, the U.S. began laying the groundwork to impose tariffs on an additional $325 billion in Chinese imports—essentially, the remainder of goods that the United States imports from China.

Although the government is seeking to fast-track the process, which includes a public-comment period, the additional tariffs “likely won’t be in place before mid to late summer,” says Michael Townsend, Schwab’s vice president of legislative and regulatory affairs.

The White House scrambled Monday to balance tough talk aimed at China with reassurance to U.S. investors that talks with China had not broken down. Treasury Secretary Steven Mnuchin said Monday that talks were ongoing and that he planned to return to Beijing in the coming weeks for further negotiations. Late Monday, Trump announced that he would meet face-to-face with Chinese President Xi Jinping on the sidelines of the G-20 summit, scheduled for June 28-29 in Osaka, Japan.

Tariffs weigh on stocks, economy

Current tariffs are expected to shave about 0.5% from U.S. gross domestic product, according to Schwab Chief Investment Strategist Liz Ann Sonders.

“The current round of tariffs targets consumer goods more directly, so the hit to the economy may begin to feel more ‘real’ to investors,” Liz Ann says.

A failure or lengthy delay to a trade deal would come at a bad time for the world economy, says Jeffrey Kleintop, Schwab’s chief global investment strategist.

“Global manufacturing activity is in the longest slump of month-after-month declines in the more than 20-year history of the global purchasing managers’ index,” Jeffrey says.

Trade isn’t the only geopolitical risk the market is facing—other threats include North Korean missile launches, Iran abandoning the nuclear deal, instability in Venezuela, and the upcoming European parliamentary elections, Jeffrey says.

“In general, these geopolitical threats tend to weigh on global stocks broadly,” Jeffrey says. “Fortunately, the degree to which the world’s stock markets move in sync with each other has fallen to the lowest level in 20 years. The lower correlation enhances the potential risk-reducing benefits of global diversification. This may be especially good news right now, with stocks seemingly set for a pullback.”

Will China sell Treasury bonds?

China is the largest foreign holder of U.S. Treasuries, with $1.13 trillion, and some investors have voiced concern that the escalating trade war could prompt China to sell Treasuries.

“We don’t expect China to retaliate against the U.S. by selling Treasury bonds,” says Kathy Jones, chief fixed income strategist at the Schwab Center for Financial Research. “Selling could inflict as much damage on China’s economy as on the U.S. It would likely send the yuan lower against the U.S. dollar, making Chinese exports less competitive in the global markets, and push U.S. interest rates higher, which could cause interest rates to rise in other major economies, leading to a slowdown in global growth that would be negative for China’s exports.”

China also would still need to invest the large reserves generated by its trade surplus. “Finding another large and liquid market in which to invest would be difficult, and likely mean accepting lower returns,” Kathy says.

Trade concerns may pull Treasury yields even lower, however. “During periods of market volatility, demand for U.S. Treasuries usually increases, pushing their prices higher and their yields lower,” Kathy says.

Considerations for long-term investors

It’s generally healthier for your portfolio if you resist the urge to sell based solely on recent market movements. You can’t control what the market does, but there are things that you can control. Here are some things you might consider doing now:

  • Revisit your risk tolerance. Volatility is often a wake-up call for investors who haven’t been engaged in their portfolios. If you’re not comfortable with your risk level, it may be prudent to dial back the overall risk in your portfolio, while taking into account both short- and long-term goals.
  • Make sure your portfolio is appropriately diversified. A globally diversified portfolio tends to be better positioned to weather market swings and provide a more stable set of returns over time. Because a diversified portfolio is invested in many asset classes, it can benefit from owning top performers without bearing the full effect of owning the worst performers.
  • Rebalance your portfolio regularly. Market changes can skew your allocation from its original target. Over time, assets that have gained in value will account for more of your portfolio, while those that have declined will account for less. Rebalancing means selling positions that have become overweight in relation to the rest of your portfolio, and moving the proceeds to positions that have become underweight. It’s a good idea to do this at regular intervals.

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