Even if the United States and China can resolve their differences, trade battles may not be over. President Trump may put tariffs on European and/or Japanese autos to extract concessions after a potential China deal.

Policy uncertainty is not just trade related. Monetary policy uncertainty has swung stocks around quite a bit recently. After last week’s disappointing jobs report that included a smaller-than-expected increase in wages, the odds of a July rate cut by the Fed jumped to more than 80 percent, based on what the bond market is pricing in. The longer China tariffs remain in place, the greater the chances of a rate cut. The Fed's current monetary policy is probably too tight for a prolonged trade war.

Meanwhile, parts of the yield curve remain inverted, which will become increasingly concerning the longer it lasts. The 3-month/10-year spread currently is -0.19 percent, which historically has preceded stock market weakness by about nine months, if the inversion has persisted.

Finally, although it’s more than a year off, uncertainty surrounding the U.S. presidential election has begun to impact markets already, particularly health-care stocks. Internationally, Brexit still has not been resolved, and Italy is again fighting with European regulators about its deficit spending.

Reducing Earnings Estimates

Despite the agreement with Mexico over the weekend, the odds of a prolonged trade war with China have increased. Whether companies pay the tariffs or shift supply chains to other countries to avoid them (we have seen plenty of evidence in economic data that this is already happening), costs could rise and profit margins could narrow. As long as the tariffs remain in place, earnings growth will be tougher to come by.

We think a reasonable worst-case scenario for tariffs in 2019 is in the $8–10 range of S&P 500 earnings per share. That implies a three-month delay could be worth $2–2.50 per share. Factoring in tariffs, ongoing trade uncertainty, and the related drag on business confidence and economic growth, we are reducing our 2019 S&P 500 earnings forecast from $172.50 per share to $170 [Figure 2].

Importantly, our forecast is still above consensus estimates of $168 per share (source: FactSet), and we still see upside potential depending on the path of China negotiations.

We have not changed our year-end fair value target on the S&P 500 of 3,000. We expect a slightly lower earnings figure will be offset by a marginally higher price-to-earnings ratio.