US economy

Equities endure a repetitive trade cycle


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Wash, rinse and spin runs the trade negotiation cycle but this endless repetition, while deeply frustrating, has yet to take its toll on bullish equity sentiment.

The latest US and China headlines extend a run of conflicting messages that churn across markets while investors await an official nod from either Beijing or Washington about the true status of a trade agreement. Attention now turns to Donald Trump and whether he signs the Hong Kong bill (that has overwhelming bipartisan backing in Congress) and then the likely response from Beijing.

A further escalation in tariffs on $156bn worth of Chinese consumer goods on December 15 will chip away at the consensus view that a cyclical upswing beckons.

The market price action on Thursday, with a modest rise in Treasury yields and a small loss in the S&P 500, indicates that the December levies are delayed, regardless as to whether a deal is signed this year.

Line chart of Annual % change in world trade volume showing Trade flashes amber

As Unigestion remind us:

“Historically, contractions in global trade are reliable recessionary indicators. In 2001, global trade contracted by 6%, by 20% in 2008 and by 2% in 2015.”

Between October 2018 through to June of this year, the Swiss investment house estimates a net contraction of 3.5 per cent in global trade has occurred.

One barometer of the global trade slump comes via the latest export data from South Korea. While there is some improvement, the overall tone in the east Asian nation remains poor. The country’s exports fell 9.6 per cent during the first 20 days of November, after a 14.8 per cent drop the prior month.

The risk asset consensus is that surely a deal is struck given the damage already wrought by slowing global trade, but there are cracks showing.

Sébastien Galy at Nordea Asset Management says “the consensus for a cyclical upswing driven in parts by the hope of a phase one trade deal” between the two countries “is getting squeezed”, but he believes an agreement is “likely to be signed in January as both parties need it to boost their economies”.

The importance of trade progress between Washington and Beijing for the global economy is highlighted by the global macro strategy team at Citigroup:

“A year ago, global growth was decelerating faster than the consensus had expected and today Citi’s hard data change index remains negative. With that in mind, an overlay of the 2019 SPX [S&P 500] rally over 2016 is equally compelling. YTD we have outperformed 2016 by 5% and back then at this time we were pricing in Trumponomics, not insurance easing.”

Capital Economics is also wary about the equity market rally and consensus of an eventual trade deal. The consultancy believes “that the global economy will remain stuck in a low gear for some time to come, and that the trade war between the US and China will not end”.

Still, equities are holding up with losses relatively contained as faith in a deal persists.

Playing a major role is the sharp decline in government bond yields, as highlighted here by BCA Research.

Its strategists argue:

“The cause of the stock market multiple contraction and re-expansion [in 2018 and 2019 respectively] was the dramatic swing in bond yields. This is hardly surprising given that the prospective return on bonds drives the prospective return on competing long-duration assets, like equities and real estate.”

Contained sovereign yields and accommodative central banks leave investors looking at equities in 2020.

Or, as Christopher Dembik at Saxo Bank, notes:

“In a world of QE infinity and lowflation, there is no other alternative than stocks for investors seeking yields.’’

Higher equity valuations also have time on their side before both a bounce in data and firmer earnings growth is required. While some investors may think it’s a good time to dial back on risk exposure to equities, the price action for now suggests there’s more fear about missing out on a year-end rally should a deal emerge.

Quick Hits — What’s on the markets radar

Eurozone data and the first major speech from Christine Lagarde, the new president of the European Central Bank, tops the bill for markets on Friday. Flash Purchasing Managers’ indices are forecast to show a modest bounce in both services and manufacturing activity. Ms Lagarde addresses a banking conference in Frankfurt where the focus for investors will be for any hint of a deviation from the policy trajectory set by her predecessor, Mario Draghi. The latest ECB meeting minutes released on Thursday revealed that Super Mario called for unity on its main aim of boosting inflation, even as some policymakers pleaded for a “wait and see” approach.

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I’d love to hear from you. You can email me on michael.mackenzie@ft.com and follow me on Twitter at @michaellachlan.





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