By William Watts, MarketWatch

Hopes rise for another 'cease-fire' in trade war

Stock-market bulls might find their summer riding on what happens when President Donald Trump and Chinese leader Xi Jinping meet at the Group of 20 summit in Japan later this week.

Skeptics argue that investors, after spending May in a painful reassessment of the U.S.-China trade fight, have become complacent once again in the run-up to the gathering on expectations that the leaders will be eager to at least tone down tensions.

If the gathering disappoints, investors are likely in for a "rough July and August" as it finally becomes clear that the trade fight is likely to drag on far longer and than they had anticipated, said Sandy Villere, portfolio manager at New Orleans-based Villere & Co., in an interview.

'Small blink'

Trump stoked expectations for the summit after tweeting on Tuesday about a "very good telephone conversation" (http://www.marketwatch.com/story/trump-today-president-sets-extended-meeting-with-xi-as-he-rebukes-draghi-over-possible-new-stimulus-2019-06-18) with Xi and announcing plans for an "extended meeting" during the G-20 summit in Osaka, which begins June 28. That was credited with helping soothe fears over a protracted trade battle.

"We see Trump's phone call to Xi as a small blink in the trade war," said Allan von Mehren, chief analyst at Danske Bank, in a note. "It reveals that he is keen on meeting with Xi at the G-20, which China had not confirmed before the call. We now see a higher than 50% probability that the meeting will end with a cease-fire and resumption of trade talks."

Stocks pulled back significantly in May after Trump accused China of backtracking on commitments made earlier in talks, raised existing tariffs on a range of goods and threatened to impose levies on the remainder of Chinese imports. The U.S. also moved to blacklist China's Huawei Technologies Co. by restricting access to U.S. technology. Beijing has threatened retaliation. The impasse has stoked fears of a spiraling trade fight that could pose a significant danger to global growth and corporate earnings.

Stocks have bounced back in June, with the S&P 500 returning to record territory last week and the Dow Jones Industrial Average moving within hailing distance of its all-time closing high set in October. The S&P 500 posted a 2.2% weekly rise, while the Dow saw a 2.4% rise and the Nasdaq Composite advanced 1.8%.

Check out:How the stock market rally could spark a 'FOMO' rerun for investors (http://www.marketwatch.com/story/how-the-stock-market-rally-could-spark-a-fomo-rerun-2019-06-25)

Stocks were (http://www.marketwatch.com/story/stock-index-futures-point-cautiously-higher-as-investors-await-g-20-meeting-2019-06-24) (http://www.marketwatch.com/story/stock-index-futures-point-cautiously-higher-as-investors-await-g-20-meeting-2019-06-24)putting in a subdued performance (http://www.marketwatch.com/story/stock-index-futures-lower-ahead-of-fed-speakers-including-powell-2019-06-25) (http://www.marketwatch.com/story/stock-index-futures-point-cautiously-higher-as-investors-await-g-20-meeting-2019-06-24)early this week as investors appeared to shift into waiting mode.

Fed delivers

The Federal Reserve did its part. Investors took the policy statement and remarks by Chairman Jerome Powell that followed the central bank's policy meeting on Wednesday as a signal significant rate cuts are in the offing before the end of the year -- a prospect that's served to cheer stock-market bulls who appear confident the central bank's efforts will ensure the expansion continues.

The rally in stocks this month suggests Fed rate cuts are already priced into the market, wrote UBS strategists Keith Parker and Stuart Kaiser, in a Friday note. That leaves the outlook for equities and other assets viewed as risky to be driven by expectations for economic growth, "with the G-20 potentially another key fulcrum."

"Within equities, stocks that benefit most from lower rates (defensives, growth) are trading at a record 120% price-to-earnings premium to stocks hurt most by lower rates (financials, cyclicals)," Parker and Kaiser wrote. A neutral or positive outcome to the G-20 meeting could narrow that "extreme premium" somewhat, they said.

Feedback loops

And then there are the feedback loops between developments on the trade front and the outlook for Fed policy. After all, Powell has emphasized concerns about the impact of rising trade tensions, which are seen as a reason for the Fed's turn toward potential easing.

See:Why the path for stocks and other markets now depend 'critically on politics' (http://www.marketwatch.com/story/stock-market-investors-discover-they-cant-ignore-politicians-anymore-2019-06-08)

Indeed, Ward McCarthy, chief financial economist at Jefferies, sees a direct relationship.

"We think that favorable and compelling developments on trade at the G-20 will obviate the need for the Fed to cut rates," he said, in a Friday note. "Without a trade deal, we think that the Fed will cut the fed-funds rate by 50 basis points."

Tough talks

While Danske Bank's von Mehren sees a better-than-even chance the meeting will soothe tensions and jump-start talks, he warned there are significant hurdles.

He said China will likely stand firm on its demands, including its call for the U.S. roll back tariffs to pre-trade-war levels. Xi may also condition new talks on a withdrawal of the export ban on Huawei, which is a sharp attack on Chinese technology and seen as an attempt to contain China, von Mehren said.

If Trump refuses to withdraw the export ban, China could retaliate by placing U.S. companies on its "unreliable foreign entities list," he said.

Of course, presidential tweets and other developments could go a long way toward further shaping expectations for the meeting. Villere, who manages the small- and midcap focused Villere Balanced Fund , said he isn't sweating the outcome. Lamenting the difficulty of finding reasonably priced companies at current levels, he said some summer volatility would likely provide some "good opportunities."

(END) Dow Jones Newswires

June 25, 2019 11:42 ET (15:42 GMT)