Intensifying Trade Tensions Are The Catalyst For Short-Term Pressure On Equity Markets

Trade tensions continue to intensify

During the weekend, President Trump said that China had one month to agree to a trade deal, failing which he would slap tariffs on all Chinese exports to the US. Robert Lighthizer, the US Trade Representative, said that details on tariffs on approximately $300bn worth of imports from China might be unveiled today.

China has not disclosed the details of its retaliatory measures since the decision was taken last week to hike tariffs from 10% to 25% on $200bn worth of exports to the US. However, China said that the US must remove the additional tariffs, align Chinese imports with real demand and seek a “balanced” deal that safeguards the “dignity” of both nations.

We also learned through a communication from Larry Kudlow, Trump’s top economic advisor, that China has invited Robert Lighthizer and Steven Mnuchin, the US Treasury Secretary, to pursue negotiations in China, but nothing is known about the dates. He also indicated that it could take several months before additional tariffs take effect.

Equity markets were in need of a catalyst to take a pause

We recently turned neutral on equities for the short term but decided to keep a positive medium-term stance. The key arguments were that the recovery since the fourth quarter were based on central bank dovishness (particularly the U-turn made by the Federal Reserve), positive macro data from China and a positive view on trade negotiations.

Meanwhile, consensus economic growth forecasts and earnings estimates were revised down significantly, hence the need for a pause in equity markets. In time, fundamentals should improve gradually, thus confirming expectations that the world economy will grow over the next 12 months. We expect this positive trend to continue.

Equities have lost nearly 3% since their recent highs.
 

A deal is still expected

The weekend’s news flow had a small impact on financial markets. The CSI 300 index lost 1.8%, the MSCI Asia Pacific index 0.6%, futures in the S&P500 index 1.1%, the Euro Stoxx index less than that and the yuan fell 0.7% to 6.90 against the dollar. Safe-haven assets have not benefited from the uncertainties: the yen has gained a mere 0.2% to 109.8 and gold is slightly lower, trading at $1283.

These reactions comfort the conviction that a trade deal will be signed eventually.

We share this opinion for three reasons:

i) failure to reach an agreement would have a negative impact on the economic cycle;

ii) the next US presidential election is looming on the horizon, thus raising the stakes and,

iii) China would prefer not to increase stimulus too much due to high indebtedness. Even though we expect a deal, we also consider that it would leave many issues unresolved and we need to accept that many uncertainties would linger over the medium and long term.

We keep our cautious stance on equities in the short term and our positive conviction in the medium term

Beyond the aforementioned reasons for expecting a period of consolidation, we add the technical considerations, such as divergences, and the fact that short positions on the Volatility index (VIX) have reached a record low, which is a clear sign of complacency.

Given that both parties in the trade negotiations have many reasons to want to reach a deal, we expect the global economy to remain on a moderate growth path and earnings to keep expanding at a low single-digit pace.

Moreover, we maintain a positive stance on equities in the medium term, and believe that in the meantime, stock markets are unlikely to post a sharp correction but rather a consolidation.

Conclusion

We stick with the view that in the second half of the year equity markets should be able to slightly exceed the recent highs. We keep our preferences for pro-cyclical markets.