The deal due to be signed on Wednesday will see China commit to buy $200bn worth of US agricultural goods and the US will, in return, reduce some of its tariffs already acting on Chinese imports. A significant clause within the terms of the deal is that the US will also not introduce new tariffs that were due to come into effect. The more pessimistic traders can still point to the array of outstanding issues such as intellectual property rights (IP), but few can disagree that the world’s two largest economies have at least reached a ceasefire – or, as Adam Posen, president of the Peterson Institute for International Economics, described the situation when speaking with BBC News:
“It is reducing the amount of self-inflicted damage.”
Source: BBC News
Another positive feature of Phase One, and one that is possibly being under-priced by the markets, relates to the translation of the actual terms of the deal. Efforts to come to an agreement in May 2019 stumbled as they approached the finishing line. The two sides experienced a ‘lost in translation’ episode as the final text failed to mirror what each had thought had been verbally agreed – fuelling mistrust on both sides.
“If anyone today regards China as the China of old, prey to dismemberment, as a ‘soft persimmon’ that can be squeezed at will, their minds are stuck in the 19th century and they’re deceiving themselves.”
Source: NY Times
The aftermath of the breakdown was a considerable scaling up of tariffs and animosity, which the Phase One agreement halts but does little to reverse.
This week has also seen the US drop its charge that China is a “currency manipulator.” The charge made by the US Treasury in August 2019 opened the door to utilise the US Trade Enforcement Act of 2015 and the International Monetary Fund protocol.
“Take specified remedial action against any such countries that fail to adopt policies to correct the undervaluation of their currency and trade surplus with the United States.”
Source: US Trade Enforcement Act 2015
The summit in the US that will see Phase One officially signed off has, however, led to a range of analysts urging caution.
The second half of 2019 saw the US posting strong jobs data, which in turn supports consumer spending. The US Fed also adopted a dovish approach to interest rates and reversed the rate hikes that it put in place in 1H 2019. Stimulating consumption-driven growth can only temporarily mask the fact that uncertainty relating to the trade dispute has been a drag on the global economy in ways that take longer to filter through. Despite the rallying equity markets, business confidence has been draining out of both the US and eurozone economies.
United States ISM Purchasing Managers Index (PMI)
Euro Area Business Climate Indicator
The trimming of US interest rates to 1.75% means that Fed chairman Jerome Powell has fewer silver bullets to use if the US does take a downturn. The US is not alone in having limited policy tools at its disposal, and the eurozone currently operates in an environment of negative rates.
United States Fed Funds Rate
There has been a significant and long-term downward trend in terms of investment. Q2 US business investment declined at a 1.0% annualised rate. This was the steepest decline in year-on-year GDP since Q4 of 2015. The Q3 figure saw investment drop by 3% year on year. This reversal in sentiment was largely attributed to the US-China trade war as prior to that, scaling up annualised investment data had been positive, and as high as 4.8% in Q4 of 2018.
The trade-war ceasefire may take the brakes off business investment, but the negative data points for 2019 could feed through the system in early 2020 as lower corporate earnings.
Also in play is the historical performance of stock markets in January. The track record for returns in this month to be higher than average is so well-established that it is known as the ‘January effect.’ Justifying the undeniable back data with fundamental analysis involves explaining portfolio composition being adjusted by the big players in the market. Investors can take advantage of tax breaks by selling their losing positions in December and buying them back in January. Institutional investors can follow the same process to remove bad bets from their books before the year-end reports are sent to investors. The reasons are plausible, but nothing is ever certain – and recent years have bucked the long-term trend.
The January effect tends to play out in US markets somewhere between six and eight years out of 10. This leaves room for 2020 to be a year when it doesn’t, and the US-China trade negotiations are of such significance that they could be a geopolitical anomaly that overrides the technical analysis. Statistically speaking, January is also a more volatile month for the stock markets.
Investors face a tricky situation. US equity indices are at record highs and many see further returns in 2020. Noting that the good news may already be priced in and that it’s better to travel than arrive, Sonja Laud, chief investment officer for Legal & General, said:
“There’s clearly a lot of relief … that we have at least reached a milestone. In terms of the market reaction … we have seen the positive reaction already.”
Source: BBC News
Bulls and those suffering from FOMO can also point to Posen’s reiteration of the disconnect between economic and market performance.
“The stock market is very, very, partially related to the US economy.”
Source: BBC News