Deja-Vu, Again
From our perch, the rolling headlines on the Sino-US trade dispute feel like something out of a Monty Python film. The Black Knight’s “only a flesh wound” springs to mind. Alternatively, risk assets “always look on the bright side of life” from the Life of Brian. Equally, the Donald is “not the messiah, he’s just a very naughty boy.” Also from the Life of Brian. We could go on. The big-picture point is that the negotiation process would have comedic value if it was not so serious for the global economy and asset markets.
On June 30 (see “Another Truce”), we wrote: while we would all agree that a truce is more desirable than further escalation of the trade dispute between the United States and China, recent developments also suggest that a comprehensive and sustainable deal remains elusive in the foreseeable future. Developments since suggest that the observation is still appropriate, despite efforts today to re-schedule talks in October. Since June 30, further tariffs have been applied on both sides and there does not appear to be any concession on key issues like restrictions on Huawei. Clearly these issues might be resolved, however as we noted last week, the recent softening in rhetoric from China over the past few days and stronger-than-expected fixing of the CNY likely reflects a desire for stable economic and market conditions ahead of the October 1st 70th anniversary of the foundation of the People’s Republic. However, the proximity of that event also suggests that China is unlikely to cave to American demands or willingly suffer a loss of face over the next few weeks.
From a fundamental perspective, the critical point is also that the damage to business sentiment, capital spending plans, confidence and risk perceptions evident in the August ISM manufacturing index is also no longer trivial. While the trade dispute was not the primary cause of the downturn in global growth since 2018, recent developments in the trade dispute have clearly exacerbated the weakness in sentiment and real economic activity. On the positive side, from a risk asset perspective, recent developments have contributed to further declines in short and long term interest rate expectations or the discount rate. Of course, our sense is that broad indices have priced the fall in the cost of capital without the corresponding impact on profits. That probably still lies ahead. On the positive side, further policy support like RRR cuts in China or preferably fiscal easing, could be a legitimate positive development for risk assets.
The final point to note is that the price action today highlights the importance of positioning and risk perceptions. Following the breakdown in major equity indices in the first week of August, markets have been in a relatively narrow consolidation range. If we use the S&P500 as a global risk proxy, that range is between 2800 on the downside and 2950 on the upside. Following the headlines today, price itself has broken to the upside in the futures. It is probably consistent with relatively cautious positioning or risk perceptions, particularly in cyclical sectors of the equity markets. Nevertheless, US employment data which is important for the Fed’s policy reaction function lies ahead this week. Moreover, as we noted yesterday, the ISM manufacturing new orders are probably consistent with further downside revisions in earnings. In contrast, the major indices are still priced for a material second-half recovery. That appears less likely given recent macro news flow in the absence of more policy easing.