By Avantika Chilkoti , Chong Koh Ping and Gunjan Banerji
U.S. stocks pared losses Friday as President Trump's responded to China's push for tighter security controls on Hong Kong, which could reignite tensions between the world's two largest economies.
The S&P 500 rose 0.3% as of 3 p.m. ET. The Dow Jones Industrial Average rose less than 0.1%. The Nasdaq Composite swung between small gains and losses and recently traded about 0.8% higher.
Despite Friday's moves, major U.S. indexes are on track to end the month with gains. The S&P 500 has added 3.7% in May, while the Dow is up slightly less. The Nasdaq has risen 5.8% this month.
The latest leg of the rally has been underpinned by shares of companies that were considered the stock market's laggards just weeks ago. This week, investors turned to shares of financial companies and cooled toward the tech giants that had propelled the market higher since its lows in March. Financial companies in the S&P 500 have jumped 6.6% this week, while the information-technology sector has inched up 0.1%.
To many observers, the climb in value stocks, which typically trade at low multiples of their book values, was a sign that investors are bracing for a broader economic recovery ahead.
"People keep rotating back and forth" between shares of companies that will do well if the economy continues to reopen and stocks that will thrive if people stay at home, said Ilya Feygin, managing director at WallachBeth Capital. "That's the major issue that people are grappling with."
But the sharp rally in stocks this week came to a stuttering halt on Thursday after Mr. Trump said he would hold a news conference on China on Friday.
China and the U.S. have been on a collision course in recent days following Beijing's moves to clamp down on antigovernment protesters in Hong Kong by imposing national-security laws on the city. Fresh U.S. measures targeting trade and Chinese companies could weigh on both economies at a time when they are already struggling with the coronavirus pandemic, analysts said.
Mr. Trump could review Hong Kong's special status and leave the city facing the same tariffs as mainland China, according to James Athey, a portfolio manager at Aberdeen Standard Investments. Washington has signaled this week that it may declare that it no longer considers Hong Kong autonomous from Beijing.
"It would essentially change the business environment for U.S. companies operating in Hong Kong, so that would be a significant step and not one that we could discount," said Mr. Athey.
Mr. Trump could also take broader punitive measures against China, he said. "He can saber rattle and increase tensions with China directly, rescinding the phase-one deal and going back into the playbook of 2019."
Any U.S. measures on trade or against Chinese companies, and any Chinese retaliation, could have a greater impact than previous actions taken before the new coronavirus battered both economies, according to Colin Low, senior macro analyst at FSMOne.com in Singapore.
The pan-continental Stoxx Europe 600 dropped 1.4%. Most major Asia-Pacific equity benchmarks closed lower, while the Hong Kong gauge lost 0.7%.
Bond markets reflected the erosion in investors' risk appetite. The yield on the benchmark 10-year U.S. Treasury note edged down to 0.664%, according to Tradeweb, from 0.703% Thursday. Yields fall as bond prices rise.
Shares of some individual companies recorded bigger moves. Dell Technologies rallied 5.7%. The computer maker on Thursday said the pandemic has boosted its business in certain sectors. Software maker VMware, which is majority owned by Dell, climbed 7% after its earnings topped Wall Street's expectations.
Salesforce.com dropped 4% after the business-software maker cut its full-year earnings outlook.
Fresh data Friday showed that U.S. consumer spending fell by a record 13.6% in April during coronavirus lockdowns. But there are signs that purchasing is starting to pick up as states start to reopen businesses and Americans return to work.
The University of Michigan's closely watched survey showed that a measure of consumer sentiment rose in May from April.
Market sentiment could be shifting on a realization that government support won't be enough to prevent job cuts, and that reinfection rates could rise as people get back to work, according to Mike Bell, global market strategist at JPMorgan Asset Management.
"If you do see infection rates reaccelerate, then that could call into question the existing market narrative that we're now on the path of sustainable reopening," said Mr. Bell.
In the Asia-Pacific region, Japan's Nikkei 225 closed 0.2% lower, while Australia's S&P/ASX 200 retreated 1.6%.
Write to Avantika Chilkoti at Avantika.Chilkoti@wsj.com, Chong Koh Ping at email@example.com and Gunjan Banerji at Gunjan.Banerji@wsj.com