The “trade truce” concluded by the US and China at the recent G20 meeting is supportive of markets in the short term, but in the longer term, the risks from the power struggle between the world’s two leading economies are likely still to oscillate as they continue on the medium to long-term path towards de-globalisation.
As such, trade tensions are among the risks that we believe justify the label ‘fragile goldilocks’ when it comes to describing the current state of the global economy. In terms of asset allocation, this underpins our view that building robust portfolios is absolutely key and that these should include defensive trades and hedges.
Sino-US tension spiked in late May as the Trump administration imposed a 25% tariff on Chinese goods, threatened to put a levy on more US imports from China and curbed tech company Huawei’s access to the US market. China then cut its US supply of rare-earth metals, put on hold US soybean orders, restricted US gas purchases, and drew up a list of “unreliable” foreign organisations damaging Chinese interests.
US trade policy was then extended beyond China to Mexico to pressure the government to stop the flow of migrants entering the US. However, in early June, after an agreement, the planned levies were suspended. Later that month, there was more good news for markets when at the G20 meeting, presidents Trump and Xi agreed a ‘truce/ceasefire’ on further tariffs and fresh negotiations and the US lifted restrictions on Huawei.
While the ‘goldilocks’ sweet spot has appeared to prevail in and among the trade ruckus, with growth stabilising and monetary policy turning dovish, it would be naïve to expect that trade tensions will no longer rock markets.
Supportively, the domestic backdrop in the US has remained sound, but trade-related sectors such as manufacturing are the clear soft spot and they have been and are at risk from Sino-US tensions. Encouragingly for markets, China has been easing policy and indicators such as the credit impulse have recovered. Furthermore, absent an escalation of the trade fight, the stars may be aligning for emerging market assets on the back of China’s economic stimulus. This could also be an important driver for developed economies.
We note that there are issues between China and the US that extend beyond trade and involve a struggle for global power over the medium to long-term trend that could lead to a reversal of the globalisation forces of prior decades. Clearly, following the G20 truce, we are currently in a short-term de-escalation phase of the trade war (see exhibit 1). This should support risk assets in the short term, but a truce is not a deal. Further negotiations need to be monitored closely in the months to come.
Source: BNPP AM, as of 28/06/2019
Interestingly, the market perception of trade war risk has broadly followed our stylised oscillation template. Exhibit 2, comparing Bloomberg news articles mentioning the trade war and the VIX equity volatility index, shows that as the market focused on trade risk, volatility spiked, but equally, this abated as the focus shifted.
As the situation between the US and China remains fluid, we suspect this tendency to continue in the foreseeable future and we are thus inclined to use these oscillations to tactically trade markets on the basis of our key beliefs. Last month, for example, we added market risk via a long in developed market equities in a dip caused by trade war fears.
Source: Bloomberg and BNPP AM, as of 28/06/2019
Relief on the trade front can unlock value. Accordingly, we bought developed market equities in a dip induced by trade war angst. This summarises our modus operandi for risky assets – we are buyers on dips, but intend to reduce market risk in excessive rallies. A tactical approach to risky assets is warranted, in other words.
Since we see ‘old China’ as being challenged by protectionist forces that are here to stay, export-driven economies can be expected to face strains. With the trade-dominated German economy more exposed than France’s to de-globalisation, we are limiting our exposure to a significant escalation in tensions by being long the French CAC 40 equity index and short the German DAX.
As another hedge to an escalation in tensions, we are short a basket of Asian currencies against the US dollar.
This article has appeared in The Intelligence Report – 17 July 2019
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