After more than a year of tariffs, a U.S.-China trade deal is still out of reach.
Yet markets have taken it better than expected. The S&P 500 has roared 20% higher this year, tracking for its best annual performance since 2013, and has hit records as recently as Monday.
CFRA Research investment strategist Lindsey Bell says this is what the markets are getting wrong about trade, and she sees the biggest detachment from reality showing up in an unexpected place.
"I see the risks primarily in the fourth quarter of this year," Bell told CNBC's "Trading Nation" on Tuesday. "The consensus EPS is looking for over 6% growth in that quarter. I think it assumes that a trade deal is going to be done sooner rather than later, and I think that's the major risk that the market really is just anticipating that, and not anticipating the risks that are associated with that."
President Donald Trump reminded markets on Tuesday that distance between negotiations and a deal is still vast and that additional tariffs are on the table. However, markets barely reacted — the Dow ended the day down just 9 points.
"You see [Chinese] President Xi and President Trump going back and forth with each other. These are big issues that need to be resolved, and I don't think it can be resolved overnight," Bell said. "And we haven't gotten indication that they're making major progress yet."
Bell says a reset of second-half expectations could materialize in companies' outlooks as the earnings season progresses.
"Corporations are going to bring guidance down as they release second-quarter earnings. We've already heard from a couple industrial companies who have highlighted the risk in that, and even the banks I would point to today. Their underwriting business was very weak," said Bell.
As trade expectations are tempered, Bell sees more of a consolidation occurring in markets rather than a sell-off. This, she says, should benefit stock pickers.
"You're going to see is the digestion at these high levels. The market is trading at 18 times and you can argue lower interest rates and lower inflation means that multiple can continue to expand. But I think companies that do miss on earnings and revenue, and guide down, are really going to get hit hard," said Bell. The give-and-take of "good earnings and bad earnings [is] just going to keep this market in line at these high levels."
The second-quarter earnings season is in full swing this week — Citi, Bank of America, Goldman Sachs, J.P. Morgan and CSX reported earlier this week, while Netflix, eBay and Microsoft are coming up. With just 6% of S&P 500 companies reporting earnings so far, blended earnings have contracted nearly 3%.