A promising outcome, but many questions remain unanswered

Thought of the day

by Chief Investment Office 14 Oct 2019

On Friday, the US and China agreed in principle to a partial trade deal. Prior to the meetings, our base case was for modest progress, with some combination of an agreement to continue talks, China to agree to purchasing more agricultural products, and the US postponing tariff increases. The result of the talks is broadly in line with this view. The S&P 500 finished 1.1% higher on Friday, but below the day’s highs made ahead of the announcement.

While a positive development, we are not absolutely certain that this marks the start of a clear de-escalation of the trade dispute. Chinese media struck a cautious tone, and Bloomberg reports Beijing is seeking more concessions before signing on to the deal. There may now be a clearer pathway to de-escalation, but not enough was achieved to alter meaningfully the fundamental global economic outlook, in our view. Global growth is slowing, and below trend, there is scope for earnings disappointment, and still sufficient uncertainty to keep weighing on business investment. That may change with a formal interim trade deal, but for now we continue to recommend a modest underweight to equities versus fixed income in our tactical asset allocation.

At present, specific details on the agreement remain scarce. We know that China has promised to buy more agriculture imports from the US (potentially up to USD 40–50 billion annually); the increase in US tariffs from 25% to 30% scheduled for 15 October is postponed; and negotiations on completing a phase 1 deal will continue.

But a number of issues that would make us more positive on the economic and market outlook were either left unresolved or unclear. A delay to the scheduled December tariffs was not announced, although that’s likely if a deal is reached; restrictions on Huawei were not addressed and will be treated separately; and the state of provisions on intellectual property, forced technology transfer, and Chinese state subsidies, the most difficult aspects of the negotiations, are still unclear.

President Trump stated that a formal document may be ready for signing at the APEC Summit in Chile on 16–17 November, and that this will include agreements on intellectual property rights, financial services, and FX transparency. This would be the first stage of a multi-phase process. Progress on these issues would give us more confidence that a more comprehensive formal interim deal is possible, but based on what is currently known, the market and economic outlook hasn’t materially changed, in our view.

Geopolitical uncertainty remains high and the credibility of the trade deal will be in doubt initially. Consequently, business sentiment may improve modestly, but not enough to change capital investment plans in the near term. Thus, while the recent deceleration of global growth may abate, we currently expect it to only stabilize below trend, until an interim trade deal signals a clear de-escalation in trade tensions. Furthermore, consensus expectations for global corporate earnings growth remain too optimistic, in our view.

We maintain a modest underweight to equities versus fixed income in our tactical asset allocation. In the weeks leading up to the November APEC summit we will be watching for signs of progress on the unresolved trade issues. A multi-phase process could signal a shift in the US approach toward seeking incremental agreements, rather than a grand deal. If, as a result, a formal interim deal appears increasingly likely, this could set the stage for a more positive outlook on equities. We will also be looking for signs of a response in the economic, earnings, and business investment data that might lead us to reassess our positioning.

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