There's only one thing that can rescue stocks from a trade war disaster
US stock valuations are at historically high levels by most measures. According to Jurrien Timmer, director of global macro for Fidelity Investments, the possibility of higher trade tariffs could put pressure on valuations. Timmer writes, "Historically, tariffs levied on trade have been inflationary, and we know that there is a consistent inverse relationship between P/E ratios and inflation."
Of course, when valuations compress, stock prices generally go down. Stock price is the numerator in a P/E ratio, so the relationship is baked in. Even though the correlation is strong, there are times when the total return on stocks has been positive, even as the valuation multiple declined. In fact, according to Fidelity's analysis this has happened 22% of the time over the past 100 years. Though, these periods, which he refers to as "benign valuation-compression regimes" require strong earnings growth.
Historically, valuation compression has been part of the late-cycle playbook and that may be where we are headed for the next 6-12 months. It is difficult to pin down what stocks will do in late cycles, according to Timmer. He thinks stocks are in OK shape for now and concludes "maybe a prolonged sideways chop with the occasional 10%-15% drop is where we are headed for now."