Focus remains on trade tensions.
Global stocks ended the week 0.4% lower, as trade continued to dominate the news agenda. While we think the US and China will ultimately reach some deal, market turbulence looks set to continue. Where markets move from here will depend on 1) whether trade negotiations continue or break down completely; 2) how swiftly the US follows through on President Donald Trump's threat to impose duties on an additional USD 300bn of Chinese goods; 3) whether China retaliates any further; 4) whether the US goes on to raise tariffs on auto imports; 5) the monetary and fiscal policy response; and 6) the spillover, if any, for global economic growth. On the positive side, the US is delaying the imposition of tariffs on EU and Japanese auto imports. But the US moved quickly last week to list USD 300bn of Chinese goods that would face additional tariffs if talks fail, and China announced retaliatory tariffs slated for 1 June. In addition, we will monitor the risk that US President Donald Trump begins to view the political benefits of a tough stance against China as more than offsetting the economic risks.
Takeaway: We maintain our risk-on stance through overweights in emerging market and Japanese stocks. However, we balance these positions with an overweight to long-duration Treasuries, which should perform well if there is a growth scare or substantive pick-up in volatility.
US measures underscore wider conflict with China.
The US unveiled new measures effectively banning Chinese telecom giant Huawei from the US communications network-although the executive order did not mention the firm by name. In addition, the US Commerce Department added Huawei and 70 affiliates to its so-called “entity list,” forcing US suppliers to apply for a license to transfer technology to Huawei and others on the list. Reports of US companies complying with the new restrictions prompted weakness in IT hardware stocks on Monday, as the impact rippled through the global supply chain. The Trump administration’s measures are in line with our view that the US-China dispute is not just about trade, but is a longer-term conflict in which technology plays a vital part. Washington has also warned allies like Germany and the UK that use of 5G Huawei gear could lead to limits on US intelligence sharing. Although flare-ups in tensions between the US and China look poised to continue, we think investors can benefit from enabling technologies over the long term. Our view is that enabling technologies-AI, AR/VR, big data, cloud computing and 5G-will facilitate tech disruption and we expect revenues in the space to grow in aggregate by an average of 12.8% annually through 2025
Takeaway: Rash and costly investment decisions can be avoided by positioning for the longer term, and investors can gain exposure to secular trends through diversified equity exposure and alternatives.
Increased volatility not a reason to exit US stocks.
The S&P 500’s 2.4% fall on 13 May was its second-biggest of the year, highlighting how market volatility has increased since Trump’s tweet announcing a tariff hike this month. But we expect stocks to reach 2,950 over the next six months in our base case. The recent earnings season demonstrated that earnings growth remains resilient and is trending at 2.5% year-on-year for the first quarter. We anticipate 3% growth this year and 7% in 2020. Recession risks are low, and—in the context of a positive economic backdrop—stocks are not overpriced, in our view. The S&P 500 currently trades on a 12-month forward multiple of 16.6x, versus an average of 20x during periods of such low inflation and unemployment. Trade is the main risk. If all tariffs take effect, we would expect a 4.5% hit to earnings growth and a 0.75%–1% reduction in US GDP—translating into potential downside of 10%–15% in US equities.
Takeaway: We have a constructive outlook for US stocks. We continue to see the S&P 500 trading at 2,950 in six months in our base case, with a positive scenario of 3,225 and a negative scenario of 2,375. We are tactically neutral to US stocks, preferring to express our overweight to stocks through emerging market and Japanese equity markets, which are more geared to benefit from a cyclical acceleration in global growth under our base case forecast.
Has the Fed settled on a neutral stance?
Investors largely took a hawkish interpretation of remarks at the Fed’s last meeting—with US equities marking the ninth decline out of 10 on “Fed day” under Chair Jerome Powell’s tenure. The latest meeting's minutes will be released on 22 May.
Will trade tensions abate?
Markets have been receiving conflicting signals over the outlook for US-China trade talks. While we do not foresee significant progress ahead of the G20 meeting in late June, officials and politicians can be expected to provide continued guidance. Such indications will likely take precedence over economic or earnings news.
Will global sentiment pick up?
Safe haven flows to the Japanese yen, gold, and 10- year US Treasuries have picked up, amid worries that trade escalations could hurt the global economy. This week’s Eurozone and US flash PMI readings should give a sense of how sentiment is responding to heightened uncertainty surrounding trade, particularly after last week’s weak US industrial production print.