The S&P 500 hit a record high of 2,945 early last month, but has since slipped to 2,843 amid trade tensions between the U.S. and China, and now between the U.S. and Mexico, and as fears grow around the slowing global economy.
But according to Jim Paulsen, Leuthold Group’s chief investment strategist, stocks could return to record highs if the Federal Reserve fixes the upside down yields in the bond market.
“The Fed needs to take out the inverted curve fear more than they need to address the fundamental fallout from the trade war,” Paulsen said on CNBC. “If they do that, then I think the underlying economy is going to be OK and the stock market goes on to new highs.”
While an inverted yield curve has historically signaled an incoming recession, “fundamentally, the economy is in not that bad of a shape,” Paulsen said. And he says investors are “overblowing the negative impact of the trade war” between the U.S. and China.
The Fed said earlier this year that it would hold on further interest rate increases, and just this week hinted that it might cut rates this year.
That news lifted stocks this week making Tuesday the second-best trading day of the year, and pushing the S&P 500 to just 5% below its all-time high reached at the beginning of May.
Paulsen believes that the U.S. played its cards well and couldn’t have chosen a better time to increase tariffs as price pressures are so low that the Fed would welcome any signs of inflation.
According to Paulsen, U.S. tariffs on Chinese imports would have to continue for a “considerable period of time” before the price increases would spur any troubling inflation.
Treasury yields have been falling as investors have been piling into the safe haven amid uncertainty spurred on by rising trade tensions. But the fall of longer-term bonds has been more rapid, with the rate on the 10-year Treasury falling below that of the 3-month note. Typically, investors can expect to get a better return for holding debt for longer periods of time.
In May, both the U.S. and China increased tariffs in the tit-for-tat trade war as resolution discussions have stalled. The stalemate has spooked markets, which have been further rattled by the new threat of a trade war with Mexico.