US economy

Investors try to filter out Sino-US trade war noise


When 2019 dawned, a comprehensive trade agreement or grand bargain between Washington and Beijing scored high on the wish list of investors. The subsequent months of hard ball negotiations, marked by the imposition of new tariffs and harsh language, has whittled expectations down to a “skinny” interim phase-one deal at best.

The drawn-out saga of tariffs, trade and the “art of the deal” has rattled market sentiment at various times during 2019, with another bout registering this week. No matter, investors have propelled Wall Street into record territory and measures of global shares such as the FTSE All-World index loiter just shy of their all-time peak set in early 2018. In the pecking order of global share markets, investors view Wall Street as having the least to lose from a trade war, followed by Europe, and then emerging markets.

The performance of financial markets in aggregate this year highlights the importance of looking beyond the political and protectionist noise. True, the easing efforts of many central banks and a pronounced decline in government bond yields have played a crucial role in offsetting a global manufacturing slump. Against that backdrop, investors have rotated across equity sectors and regions, with an eye firmly fixed on the undulations of the current economic cycle that many believe is poised to gather steam next year.

In a recent conversation with Andrew Milligan, head of global strategy at Aberdeen Standard Investments, he counselled this approach for the coming year: “Politics creates short-term volatility that you can either ignore or try and trade around. At the end of the day the business cycle matters above all.”

Line chart of Household saving rate in the EU (%), four-quarter average showing European savings climb

Investors will focus on their primary task of putting money to work unless trade protectionism torpedoes business confidence and spurs job losses that imperil consumer spending and a service sector that for now remains in expansionary mode.

To some extent, consumers have shown signs of risk aversion. US money market holding has recently edged back after a steady climb since April from $3tn to $3.5tn, the highest level since 2009. This, in effect, is stockpiling cash. Eurozone savings have also been rising, reflecting how negative interest rates and a manufacturing slump in Germany have clipped consumer sentiment.

Still, employment in major economies is high, wages have been rising, while households also benefit from low interest rates courtesy of central banks, as highlighted by the recent acceleration in US housing data.

Line chart of Indices rebased in local currency showing Trade war winners and losers

But there is the danger that unless business confidence and investment rebounds, a resilient consumer and easy global central bank policy face a tougher time nurturing economic activity. An extended period of falling investment saps productivity and limits the potential growth for the economy and, by extension, corporate earnings.

That remains a longer-term worry given the growing drumbeat of trade protectionism. Negotiations between the US and China continue before an important deadline: planned US levies on Chinese consumer goods from mid-December. Market expectations for an interim deal are that these tariffs are delayed, while others are rolled back in time. President Donald Trump has also broadened his trade war, with plans to hit exports of steel and aluminium from Brazil and Argentina, while the US administration has proposed imposing 100 per cent tariffs on up to $2.4bn of French goods.

Many investors view the tougher language from the US as the usual high-stakes negotiating strategy with a growing array of trading partners. The threat of tariffs is not seen as fading anytime soon.

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Thinking that markets can live with this “weaponisation” of tariffs may prove a false comfort. Investment outlooks for 2020 tend to stick with highly valued US equities or advocate much cheaper areas of EMs. One discordant note is that China’s share market has gone sideways in recent months and peaked for the year back in April. Credit strains are becoming more notable in China, and beyond. Financials constitute a quarter weighting in the MSCI EM equity index and are up just 2.5 per cent for the year. It is never a good sign for economies and equity markets when lenders are struggling.

Beijing’s measured stimulus efforts this year also cast a lengthy shadow over trade-focused economies such as Japan, South Korea and Germany and the rebound in cyclical equity sectors. As for the high-flying US market, which has trounced rivals since the China trade war began in 2018, such a performance requires validation from stronger earnings growth and macro activity.

Lisa Shalett at Morgan Stanley Wealth Management notes that “more than a third of the companies have year-over-year earnings contractions’’, and warns: “Profit pullbacks of this breadth in 2002 and 2009 coincided with broader economic recessions.”

Not surprisingly, there remains strong appetite for buying insurance against a sharp drop in the S&P 500 over the next year via equity options, with one measure of 12-month demand at a new high for the year and just shy of its record peak set in late 2017.

michael.mackenzie@ft.com 



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