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U.S. tariffs on China goods bring short-term pain, possible long-term gain

A decision Friday by the U.S. to boost tariffs on $200 billion in imports from China to 25% from 10% punctured a market consensus that a bilateral trade deal was all but in the bag.

Even so, most observers remain convinced that a deal is likely to be reached, possibly in a matter of months, and any short-term sell-off between now and then should prove to be a buying opportunity.

Salman Ahmed, London-based chief investment strategist with Lombard Odier Investment Managers, said the strength of the market's conviction that a trade agreement was about to be announced has set the stage for sharp correction.

For investors and analysts in the run-up to this week, a successful outcome was a "slam dunk," Mr. Ahmed said.

A research note he penned together with Didier Rabattu, Lombard Odier's head of equities, said the unexpected flare up of trade tensions could prompt a correction for Chinese and emerging market stocks of 15% or more.

In a research note Wednesday, Thomas Poullaouec, T. Rowe Price Inc.'s Hong Kong-based head of multiasset solutions for Asia-Pacific, called a 5% to 10% drop for stock prices in the region "a real possibility."

Any sharp retreat would be an opening to step in and buy, Mr. Ahmed said. "Both sides have incentives" to reach an accord and "ultimately we're optimistic there'll be some type of deal by September," he said.

Mr. Poullaouec said T. Rowe likewise remains "constructive on the Asian stock market," and any sharp drop in Chinese stock prices would "create a more conducive environment to buy back in."

Investors in Asia should have a long-term perspective and resist being swayed by the dramatic ups and downs that often mark the final stages of contentious trade negotiations, said Andy Rothman, investment strategist with San Francisco-based Matthews Asia.

"It would be foolish to make investment decisions based on how you think Friday's trade negotiations are going to work out," he added.

Market veterans said a U.S. decision not to apply the markup in tariffs to goods already en route from China to the U.S. effectively provides a window of two or three weeks for talks to continue before Friday's decision begins to bite.

Still, observers conceded there's room for miscalculation and significant potential damage should tit-for-tat tariff hikes ensue — and persist.

Should President Donald Trump follow through with a threat to extend a 10% tariff on another $300 billion of annual imports from China, and China retaliates, the hit to Chinese gross domestic product could exceed 1%, Lombard Odier's Mr. Ahmed said.

If most market players expect a truce at some point in the coming months, the steady market gains that came from faith in smooth U.S.-Chinese relations earlier this year are likely a thing of the past.

"Volatility is here to stay," Mr. Ahmed predicted.

A deal in the coming months would be more of a "cease-fire" than a grand resolution of major problem areas such as intellectual property protections and technology transfers, said T. Rowe's Mr. Poullaouec, who sees reasons why Mr. Trump will be motivated to see a truce.

"With tariffs likely to hit the U.S. consumer harder and with an upcoming U.S. presidential election, it would appear that time is more on China's side as President Trump comes under increasing pressure to show tangible results from these trade negotiations," he said.

Some underlying trends — like moving elements of the global supply chain from China to other countries in the region, such as Vietnam, could accelerate, Mr. Rothman said, but that process will continue one way or the other.