Trade tensions ultimately extend the bull market
In the latest Chief Investment Officer (CIO) Call, CIO and Head of Investment Management Yves Bonzon is joined by the Head of Economics and Next Generation Research Norbert Ruecker to discuss the macroeconomic, policy and financial market implications of the recent trade war escalation. In this article we summarise their key points and conclusions. You may also listen to the podcast in the 'downloads' section.
In the past month, trade tensions have escalated as Donald Trump ramped up tariff measures against China, shattering hopes of a timely sino-american agreement on trade. The American president further resorted to administrative measures, restricting the sales of products and services to Chinese telecommunications. giant, “Huawei”. As the markets were digesting these developments, on May 31st Mr. Trump threatened the taxation of Mexican imports in retaliation for the Mexican authorities’ inaction in containing the flow of illegal immigrants to the US.
Macroeconomic and policy consequences
According to Norbert Ruecker, the following macroeconomic and policy consequences are to be expected as a result of the recent turmoil:
- Similar to last year, unpredictable politics remains the markets’ tune and the US sledgehammer policy provides the beat.
- In recent weeks, the trade dispute story has evolved beyond tariffs and now includes bans and rising consumer nationalism.
- While tariffs are a digestible burden, trade bans break global supply chains and erode business confidence. These effects are more elusive and more detrimental, like sand in a gearbox.
- Announcing trade agreements at the upcoming G20 meeting is unlikely to restore confidence. The trade dispute story has slipped out of the control of politics.
- Consequently, we have lowered our growth forecasts, called off the rebound, and adjusted our scenarios. At 40% likelihood, the trade war bear case has become a towering threat.
- What are the possible ways forward? The Fed moves into focus, putting its policy at odds with rising inflation. With regard to US politics, at least until the elections, only a stock market sell-off might rein in the excesses.
Market implications and positioning aspects to consider
In the opinion of Yves Bonzon, a number of market implications and positioning aspects should be taken into account:
- The revival of US-China trade tensions is an external shock of extended duration (Regime 2 Julius Baer Asset Allocation approach).
- The extra risk premium, which compensates investors for slower growth and lower earnings risks, is unlikely to reverse as it usually does after such shocks.
- Cumulated tariffs imposed in 2018 and 2019 might erase 0.5% GDP growth in the US and 1% growth in China, excluding second order effects from declining investor and consumer confidence.
- “Ceteris paribus”, S&P500 earnings might decline by 5% to 6%.
- Such external shocks, similar to the Asian crisis in 1998, extend the market cycle.
- Corporate management will be extra careful with Capex.
- Stimulus will be increased in the US and in China.
- The investigations into US tech giants by US authorities are another external shock, blurring the underlying liquidity signal embedded in the relative performance of this group (FAANMGs, meaning Facebook, Apple, Amazon, Netflix, Microsoft, and Google).
- The US bond market is schizophrenic. We are testing the breakout level on US 10-year Treasuries.
- There is no need yet for the Fed to cut rates as both domestic demand and asset prices are at supportive levels. The Fed has no reason to cut rates above 2,400 on the S&P500.
- We have sold our 3- to 7-year US Treasury holdings.
- The equity risk premium is high and de-equitisation continues.
- Chinese equities remain our core allocation in emerging market equities.
- We have implemented half of our strategic allocation to REITs (or 2.5% in a balanced portfolio).
- Trump is a symptom of a major inward shift in the US, ending the post-WWII world order.
In conclusion, recent external political shocks have pushed up risk premiums. Trade tensions will inevitably affect economic conditions, prompting governments and their respective central banks to stimulate growth. The prudence of corporate management with regard to new investment spending will slow growth in the short-term, but prevent the formation of harmful imbalances in the medium-term. These factors will prolong the market cycle.
Listen to the podcast
The audio file of Norbert Ruecker and Yves Bonzon’s analysis can be found in the ‘downloads’ section below.