Trump’s Trade War Will Kick off an Avalanche of Selling in the Stock Market

• Over the weekend, Donald Trump ramped up claims that he’ll use tariffs to punish China.
• The news could spur on panic selling.
• The precarious position that the stock market is in means any negative catalyst could create a downward spiral.

There’s a lot of debate about whether the coronavirus pandemic will have a lasting impact on the U.S. stock market. Judging by April’s stellar returns, the bulls are winning that argument.

But with a slew of terrible economic data expected over the next few weeks, many wonder whether investors can continue looking past it. Rising unemployment and the prospect of a 40% decline in GDP  hasn’t been enough to sink the stock market rally. But what about adding a trade war to the mix? 

Trump Trade War

That seems to be Donald Trump’s plan after he slammed China over the weekend  for allegedly covering up the origin of the coronavirus. Trump has warned that China would be held accountable for its actions. He even said that he’d consider punitive tariffs  in response to the nation’s handling of its coronavirus outbreak:

We signed a trade deal where they’re supposed to buy, and they’ve been buying a lot, actually. But that now becomes secondary to what took place with the virus.The virus situation is just not acceptable

Trump’s rhetoric was cheered by his supporters, who have been speculating about China’s nefarious role in the coronavirus pandemic for months. On the other hand, traders collectively rolled their eyes. Here we go again. 

Trade Talk Could Tank the Stock Market

Stock futures immediately started to tumble following Trump’s remarks. At the time of writing, Dow futures were down nearly 300 points.

This isn’t the market’s first experience with Trump’s trade war merry-go-round. In 2019 the market was dominated by volatility stemming from the president’s trade-war tweets.

This time, it’s no different. But the stakes are much higher.

In 2019 when the economy was firing on all cylinders and U.S. firms were resilient enough to cope with trade war-related disruptions, the stock market ebbed and flowed with positive and negative trade rhetoric.

Now, as the economy struggles to restart and the stock market teeters on the brink of a meltdown, Donald Trump’s jabs at China could be far more catastrophic. 

This Rally Lacks Commitment

That’s because there’s likely not a lot of commitment in the rally we saw in April. The biggest market players—hedge funds and long-term investors—haven’t jumped back in yet.

A Bank of America survey shows that fund managers have cash positions equivalent to those seen after 9/11. Nomura’s Masanari Takada wrote in a note to clients  that he believes it will be “some time” before these big players start taking up positions.

Without a commitment from long-term investors and hedge funds, the market not only has a ceiling, but it lacks a floor.

This graph depicting the anatomy of a bubble shows how an initial bear-market rally quickly changes into steep losses as retail investors jump ship: 

It was plausible that a quick economic rebound was enough to keep the market from retesting March lows a few weeks ago. But throw a trade war into the mix, and all bets are off.

Support Levels Breached

If Donald Trump’s tariff rhetoric has the same impact in 2020 that it did in 2019, it’s hard to imagine a scenario in which the stock market doesn’t end up slipping beneath its previous lows. The prospect of more trade drama with China is enough to push the market beyond the support levels that have kept this rally going.

Market timers have been watching the S&P 500 for evidence that it will dip lower in the coming weeks. They use Fibonacci retracement levels to mark specific levels of support. According to this analysis , if the market dips below those levels, it opens the door for the decline to continue until it hits the next layer of support. 

The first marker of support was breached last week when the S&P 500 dipped below 2,933. The next milestone (2,790) will likely be tested on Monday as the market adjusts to Trump’s rhetoric. If the index slips below that level, 2,650 and 2,475 are the next tests for support. 

In a precarious rally like the one we saw in April, the slightest nudge could turn into an avalanche of selling. Donald Trump exploring the possibility of retaliatory tariffs against China is more like a powerful shove.