Just as fears of inflation and slowing growth are starting to hold back markets , another risk is lurking in the background: rising tensions between the U.S. and China. There have been back and forth sanctions between the world's two largest economies over national security and human rights issues as of late. Meanwhile, China has vowed to crack down on overseas listings, threatening a $2 trillion market highly popular in the U.S. For many, the tit-for-tat is reminiscent of the 2019 trade war that sent the stock market tumbling into a major correction. "It's very clear that the path that we are on is a path of continued escalation," Ed Mills, Washington policy analyst at Raymond James, told CNBC. "There was an expectation of a reset with Biden, but what we are seeing is a slow boil of the tensions heating up. Essentially, every policy decision that was made by President Trump has been continued by the Biden administration." The Biden administration this week warned businesses with supply chain and investment ties to China's Xinjiang province that they could face legal consequences. On Friday, President Joe Biden said his administration will issue an advisory to warn American companies about the risks of doing business in Hong Kong. A conciliatory tone "was expected from President Biden and that is not what has happened so far," Edward Moya, senior market analyst at Oanda, said in a note. "It seems the U.S. is mounting a case against China that will likely lead to tense moments over the coming months." On China's side, Beijing is stepping up its oversight of the flood of Chinese listings in the U.S., which are overwhelmingly tech companies. The country also said it will tighten restrictions on cross-border data flows and security. The moves have spooked some big name investors, including star manager Cathie Wood, who's been selling Tencent Music and other Chinese stocks recently. Goldman Sachs CEO David Solomon said China's recent moves boosting oversight of its technology industry surprised him and will likely delay "a large number" of companies from listing shares in the U.S. More importantly, many on Wall Street wonder if this could be the catalyst to finally tip over a market that has been largely ignoring emerging risks like inflation, marching to record high after record high. Valuations are stretched to historically high levels. After the S & P 500's 15% gain so far in 2021, the benchmark is trading at 21.6 times forward earnings. China is still struggling to reach the agreed-upon purchases in the phase-one trade deal. The two countries signed the agreement in January 2020, just weeks before Covid-19 began to spread rapidly in China and subsequently turned into a global pandemic. There's little optimism about an extension of the trade deal right now. However, if the talks resume again, many expect to see heightened volatility. During the 2018-2019 trade war, the stock market was extremely sensitive to the progress toward an agreement, moving on virtually every U.S.-China trade headline for nearly two years. "It's hard to see an expansion or a phase two anytime soon because we are not talking," Mills said.
The U.S. and China flags stand behind a microphone at the U.S. Embassy in Beijing on April 9, 2009.
Frederic J. Brown | AFP | Getty Images
Just as fears of inflation and slowing growth are starting to hold back markets, another risk is lurking in the background: rising tensions between the U.S. and China.