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The risk of a breakdown in U.S.-China trade talks agitated global financial markets on Tuesday, dragging Canadian stocks down to their lowest level in nearly a month.

The S&P/TSX Composite Index, considered the main barometer for the Canadian stock market, fell by 0.8 per cent on Tuesday. The losses in U.S. equities were considerably higher, as the S&P 500 index dropped by 1.7 per cent.

U.S. President Donald Trump seemed to provide the catalyst for the sell-off, with a pair of tweets on the weekend threatening additional tariffs on Chinese imports. Those threats were backed up late Monday by U.S. Trade Representative Robert Lighthizer and Treasury Secretary Steven Mnuchin accusing China of failing to honour its trade commitments.

That all ended a period of unusually low market volatility, which saw strong investor sentiment lift U.S. and Canadian stock indexes to record highs in April.

“The average investor became complacent,” said Craig Jerusalim, a portfolio manager at CIBC Asset Management. “The tweets were just a sharp reminder of the risks.”

Should the world’s two largest economies fail to reach an agreement, an escalating trade war could hinder growth, raising the risk of a global recession and an end to the bull market in stocks.

Fears of that worst-case scenario were apparent in Tuesday’s sell-off.

The sectors that led the Canadian stock market lower included those considered most sensitive to economic activity, such as consumer discretionary stocks and industrials.

Specific stocks with considerable exposure to the Chinese market were also put under pressure. Manulife Financial Corp., for example, which relies on its Asian operations to generate about one-third of its profits, declined by 3.1 per cent over the past two days.

Canada Goose Holdings Inc., which opened a flagship store in Beijing in December, saw its stock decline by 5.7 per cent over that same time.

Meanwhile, oil prices extended their losses on Tuesday, with West Texas Intermediate having now declined by nearly US$5 a barrel, or 7.4 per cent, over the past two weeks. Oil and gas stocks within the main Canadian stock benchmark, meanwhile, are down by 6.9 per cent over that period.

Up until this week, the consensus was that progress was being made on trade discussions.

So when Mr. Trump raised the possibility of hiking tariffs on US$200-billion worth of imported Chinese goods to 25 per cent from 10 per cent just as Chinese trade representatives were set to arrive in Washington, the market was caught by surprise.

“Week after week, we’ve heard there has been progress and that a deal would be reached,” said Kate Warne, an investment strategist at Edward Jones. “Now the goalposts have moved. There’s been quite a shift in expectations.”

Some market observers, however, are skeptical about the U.S.’s tariff threat. “We believe these are part of President Trump’s tactics to influence talks with China,” Desjardins Securities analysts said in a note.

A protracted trade war ultimately hurts all participants, Mr. Jerusalim added. “I don’t think that’s in the best interest of the U.S. economy heading into an election year.”

Despite the heightened rhetoric, China’s trade delegation is still headed to Washington. A round of talks is scheduled to begin on Thursday.

The relatively dramatic market reaction, meanwhile, can be partly explained by the long stretch of upward momentum that preceded it. In the year to date up to Friday’s close of trading, the S&P/TSX Composite Index posted gains of 15 per cent, while the S&P 500 index was up by 18 per cent.

“The news comes at a time when the U.S. equity market has already become vulnerable to bad news again, due to excess euphoria,” Lori Calvasina, head of U.S. equity strategy at RBC Dominion Securities, said in a note.

With a report from Reuters

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