October 18, 2019
When dissecting the latest tweets about China and the US managing to agree on the ‘first phase’ of a trade deal, the ancient Chinese proverb ‘A bird does not sing because it has an answer, it sings because it has a song’, comes to mind.
While markets lapped up the news and priced it in very quickly, there are still no clear answers as to how to move forward from here towards a holistic agreement. Nor are there any answers to key questions such as how to enforce a deal or how to safeguard intellectual property. Both sides are reluctant to make concessions that could be seen on their home turf as comprises and what we have today is a tentative, verbal truce and little more. Trump tweeted that it will take several weeks to put this preliminary deal on paper. If they manage to agree on the fine print, it may be signed at the APEC summit in Chile which Xi and Trump will both attend mid-November.
It is easy to get caught up in wishful thinking, given that so much hangs on a resolution. Tensions are already putting the macro economy under pressure and the IMF estimates that “US-China trade tensions will cumulatively reduce the level of global GDP by 0.8% by 2020.” In Bank of America, Merrill Lynch’s October survey (covering 175 global organisations that manage some $507bn of assets), 75% of respondents said “an end to the trade war would be the most bullish catalyst for stocks in the next six months.” Desperate for a return to normality, it seems investors were happy to believe in a deal, buy the good news and save questions for later.
What did the deal include?
- China will increase its purchases of US agricultural produce to $40-50bn (it spent $24bn in 2017 before trade tensions flared up). Skeptics say that this has more to do with feeding a Chinese population reeling from the African swine fever that has wiped out 40% of the country’s pigs over the past year.
- US financial companies will be given greater access to China’s domestic market.
- There was agreement on a currency pact that will ensure a market-based and transparent CNY exchange rate (though no details were provided).
- The US will suspend tariff increases planned for October 15th (25% to 30% tariff on $250bn of Chinese imports).
Details about the December 15th tariffs (15% tariffs on an estimated $160bn worth of Chinese goods) were left off the table and the major structural issues at the heart of the dispute seem to have been kicked down the road, especially with regard to technology. The US is critical of China’s apparent lax approach to intellectual property rights and forced technology transfers imposed on US companies in China. On top of this, the US has blacklisted Huawei, viewing it as a global security threat, and US Trade Representative Robert Lighthizer had said the firm is “not part of this agreement.”
Resolutions to those deeper issues are notably absent and it’s likely that China will drag its feet in changing technology policies which are central to its future growth strategy (i.e. Made in China 2025).
Crowning it all, the potential impeachment of President Trump, as well as ongoing unrest in Hong Kong bring an added layer of complexity to the proceedings.
Then, even if a deal is struck, how to implement it will be the next major challenge.
It’s not to say that we don’t think a deal will eventually happen – both sides have a lot at stake. However, the road to a full deal, is likely to be long and arduous and on top of that, reversing the impact already inflicted on confidence and the economy will be slow.
The global economy is amidst a cyclical slowdown. Historically speaking, this phase has proven fruitful for risk assets. However, with the world’s two largest economies head-to-head, and where a few menacing tweets could push them over the edge into a cataclysmic, full-blown trade war, investors have been forced to err on the side of caution. Portfolios, instead of being laced with risk assets to take advantage of a late-cycle upswing, are laced with safe haven assets as shock absorbers, should tensions heighten.
Market participants are acting like magpies, clasping at anything that glitters which might represent resolution. Indeed, the same might be said about Brexit, whereby the sentiment reversal in markets has been one step ahead of the talks.
We don’t prescribe pessimism, but at the same time, it is important not to get beguiled by fool’s gold.
Author: Group Investment Office