Uncomfortable, but Expected

Trade tensions have flared up again, and they’ve caught the stock market off guard.

The S&P 500 Index has dropped 2.1% over the past two days amid a slew of trade-related headlines. On May 6, the United States announced it would implement additional tariffs on Chinese imports at the end of the week if no trade agreement is reached. In response, China threatened its own retaliatory measures. China and U.S. officials are still scheduled to continue trade talks in Washington, D.C. May 9, but the threat of escalation looms large in investors’ minds.

Recent market volatility has been uncomfortable, but not particularly surprising given the lack of turbulence year to date. As shown in the LPL Chart of the Day, the S&P 500’s largest pullback this year has been unusually small relative to previous years. Since 1970, the S&P 500 has made it through the first five months of the year without at least a 2.5% pullback only once—in 1995.

2019's Biggest Drawdown is the Smallest Since 1995

On average, the S&P 500 has endured an 8.5% pullback from January to May each year. This year, stocks haven’t come close to that. The largest S&P 500 pullback this year has been a one-day slide of 2.48%.

“Given the recent run we’ve had, we believe conditions are ripe for an increase in volatility,” said LPL Research Chief Investment Strategist John Lynch. “Though we remain optimistic about U.S. stocks’ longer-term prospects, stocks recently reached overbought levels.”

While volatility could take over in the near term, we see the resurgence in trade risk as a temporary obstacle to new S&P 500 highs later this year. In our view, current trade headwinds will have a negligible impact on economic growth, and the U.S. economy has emerged relatively unscathed from what is traditionally the weakest quarter of the year. Economic fundamentals also point to higher prices: The labor market is steadily improving, corporate profits are at all-time highs, and inflation is healthy.

In the meanwhile, we look for S&P 500 support in the 2,775 range, the index’s 200-day moving average. If this level were to be reached, it would represent a 6% slide from record levels, and at the low range of a typical 6-10% market correction. Solid fundamentals and technical support may provide investors with potential for relief from the recent bout of market volatility.

For more of our thoughts on U.S. stocks, check out our latest Weekly Market Commentary: Sell in May?

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