Geopolitical Risk and Stock Market Volatility: Pre-Emptive ETF Positioning Ahead of U.S.-China Diplomatic Events

The U.S.-China trade war under the Trump administration (2017–2020) serves as a critical case study for understanding how geopolitical tensions amplify stock market volatility and reshape sector dynamics. For investors, the key takeaway lies in pre-emptive positioning in sector-specific ETFs, leveraging historical patterns of sector rotation and investor behavior during high-impact diplomatic events.

Historical Context: Trump-Xi Trade War and Sector Volatility

The trade war, marked by escalating tariffs and retaliatory measures, created a volatile environment for global markets. According to a report by the Cambridge Journal of Business and Politics, U.S. industries deeply integrated into Chinese supply chains—particularly technology and consumer discretionary sectors—experienced sustained declines in imports and market value[Bilateral Tensions, the Trade War, and US–China Trade Relations]^[1]. For example, the VanEck Vectors Semiconductor ETF (SMH) and iShares MSCI Emerging Markets ETF (EEM) faced significant headwinds as export restrictions and tariff hikes disrupted supply chains[3 Big-Name ETFs Being Hurt by U.S. Trade War With China]^[2]. Conversely, sectors like energy and financials thrived under Trump's pro-business policies. The Energy Select Sector SPDR (XLE) surged over 6% post-2024 election, reflecting optimism around deregulation and fossil fuel expansion[ETFs see 'monumental' flows after U.S. election]^[3].

Sector Rotation and ETF Inflows: A Trump-Xi Pattern

Investor behavior during Trump-Xi engagements revealed clear sector rotation trends. In the lead-up to the 2018 tariff announcements, equity ETFs faced outflows, while fixed-income and volatility-focused ETFs attracted capital. Morningstar data indicates that U.S. ETFs recorded $2.96 billion in net outflows in March 2018, driven by equity sell-offs and a shift toward safer assets[ETFGI reports that US-listed ETFs and ETPs suffered $2.96 Bn net outflows during March 2018]^[4]. However, during periods of trade truce, such as the temporary tariff reprieve in May 2025, tech and chip stocks rebounded, with SMH seeing inflows as investors anticipated reduced tensions[3 ETF Strategies to Follow on Temporary U.S.-China Trade Deal]^[5].

The 2019 Phase 1 trade deal further exemplified strategic ETF positioning. In the weeks preceding the January 2020 agreement, defensive sectors like utilities and consumer staples saw outflows, while industrials and financials gained traction. The Financial Select Sector SPDR (XLF) attracted $1.6 billion in inflows post-2024 election, reflecting expectations of deregulation and tax cuts[XLE, XLF, and TAN ETFs: Sectors to Watch Under Trump]^[6]. Similarly, the iShares U.S. Aerospace & Defense ETF (ITA) rose 8% post-election, underscoring investor confidence in increased military spending[5 Sector ETFs To Gain Under Trump Presidency]^[7].

Pre-Emptive Strategies: Hedging and Sector Selection

To navigate geopolitical risks, investors adopted a dual approach: hedging volatility and capitalizing on sector rotations. Volatility ETFs like the ProShares VIX Short-Term Futures ETF (VIXY) and JPMorgan Equity Premium Income ETF (JEPI) became critical tools during Trump's tenure. For instance, VIXY surged 42.9% in Trump's first 100 days of 2025 as trade tensions spiked[The Best and Worst ETFs in Trump’s First 100 Days]^[8]. Meanwhile, JEPI's covered call strategy generated income in high-volatility environments, aligning with the uncertainty of Trump-Xi negotiations[3 ETFs for the Trump Presidency]^[9].

Sector-specific ETFs also played a pivotal role. Energy and small-cap stocks, represented by XLE and IWM, benefited from Trump's infrastructure and deregulation agendas. Conversely, clean energy ETFs like the Invesco Solar ETF (TAN) faced outflows, as policy shifts prioritized traditional energy sources[Trump Trade (The Sequel): 6 ETFs To Buy & 3 To Avoid]^[10]. A “barbell strategy” emerged as a favored approach: balancing high-growth sectors (e.g., industrials, energy) with defensive assets (e.g., bonds, utilities) to mitigate downside risks[How investors can position to navigate the US-China trade war: expert explains]^[11].

Lessons for Future Diplomatic Events

The 2018–2020 Trump-Xi period underscores the importance of proactive ETF positioning ahead of geopolitical events. Key takeaways include:
1. Monitor Policy Signals: Trump's tweets and tariff announcements historically amplified market volatility, necessitating rapid sector adjustments[Trump’s Market-Moving Announcements (2017–2021)]^[12].
2. Leverage Sector Rotation: Energy, financials, and industrials historically outperformed during Trump-era policies, while tech and renewables faced headwinds[How Did S&P 500 Stock Sectors Perform During Trump's First Term?]^[13].
3. Hedge with Volatility ETFs: Instruments like VIXY and JEPI provide downside protection during periods of uncertainty[Sector Rotation Strategy: How to Time Market Cycles]^[14].
4. Diversify Geographically: Emerging market ETFs (e.g., EEM) require caution during trade tensions, while developed market funds (e.g., VEA) offer relative stability[January Flows Stay Strong, But Will It Last?]^[15].

As U.S.-China relations remain a focal point of global markets, investors must remain agile, using historical patterns to inform pre-emptive strategies. By aligning portfolios with anticipated policy shifts and sector rotations, ETFs offer a flexible and liquid pathway to navigate geopolitical risk.