December 09, 2019
Markets fell into (a somewhat false) sense of security in the fourth quarter. With central banks churning out liquidity, inflation still sleeping, data (albeit of the high-frequency variety) showing that manufacturing activity was bottoming out, a hard-Brexit less probable and US-China trade discussions adopting a constructive tone, everything appeared to be just right – we were seemingly in another so-called Goldilocks environment.
Risk-on sentiment took hold and investors lapped up equities, sending the trifecta of key US indices, as well as the MSCI World, to new heights. At the same time, rates ticked upwards.
But last week markets got an abrupt memo that trade tensions are far from resolved. Goldilocks hasn’t come up against the three bears yet, but let’s say she has seen some footprints in the garden, that served as a stark reminder that trade risk is still hanging around, casting a shadow over the outlook.
Markets have baked in a lot of hope that the US and China will sign a preliminary trade deal before year-end, averting a fresh round of tariffs on $156bn worth of Chinese goods, due for implementation on December 15th. However these hopes were called into question with Trump tweeting that he is prepared to wait until after the US elections on November 3rd next year to reach a deal. He stated: “In some ways I like the idea of waiting until after the election.” While we do not know if this a real possibility or another negotiation ploy, this could signal that trade tensions – and the resulting uncertainty – are here to stay through 2020. Adding to the complex stew of tactics, is Trump’s endorsement of a bill supporting the rights of protestors in Hong Kong, and the fact that the House has passed a bill concerning the treatment of Uighur Muslims in China. China will soon publish a list of “unreliable entities” that could prompt sanctions against the US. In light of the news flow, markets recalibrated their expectations with equity bourses pressured down and core bonds resuming their safe haven role.
With President Trump seemingly trying to ‘do something’ while proclaiming that the Democrats ‘do nothing’, his protectionist gaze stretched beyond China (levying tariffs is one of the few things the US President can do alone without having to receive consent from other branches of government).
In defence of US farmers, Trump re-instated tariffs on all steel and aluminium imports from Brazil and Argentina, whom he accused of deliberate currency devaluation, making their agriculture produce more competitive on international exchanges (the currency moves were more likely driven by a range of factors, including rising social unrest in Latin America and politics). The US administration also proposed 100% tariffs on $2.4bn worth of French goods such as champagne, cheese and handbags, in retaliation to a new digital service tax introduced by President Macron. The law is designed to prevent tax optimization and ensure that tech companies (including US behemoths like Facebook, Amazon, Apple and Google) pay relevant taxes in the countries where they do business. The US trade agency said it would collect public comments through January 14th on the proposed tariffs, with a public hearing penciled in for January 7th. Furthermore, it warned that other countries which operate digital services taxes, including Italy, Austria and Turkey, could face similar action.
We were well-positioned amidst the decline in stocks. Built into our strategy, was an acknowledgement that we were seeing a bit of a ‘hope rally’ in markets. Without concrete confirmation of a trade deal and a tangible uptick in PMI data, the porridge was still looking a bit lumpy and was, for us, still a bit difficult to swallow. We have a very slight underweight on equities believing that this allocation is ‘just right’ for the time being. This is especially so when considering the vertigo-inducing earnings expectations for 2020 which leave ample room for disappointment, should we not see an improvement in macro data. With that said, our outlook for 2020 does envisage a mild economic upturn and we remain on the side-lines, ready to add to our equity exposure – if and when – it is warranted by fundamentals.
Author: Group Investment Office