Key messages

Our main takeaways from the last week, plus investment considerations and economic events in the week ahead.

Navigating the near-term trade uncertainty

US President Donald Trump followed through with his threat to increase tariffs from 10% to 25% on USD 200bn of Chinese imports. China retaliated with plans of tariffs on USD 60bn worth of goods. Since the US duties will apply only to Chinese goods shipped from 10 May onward, and China's proposed tariffs kick in on 1 June, this could allow time for further negotiation. But the heightened tensions have left US and Chinese markets down over 3% and 6% since the start of last week. The likelihood of a US-China deal being reached in the near term has been reduced, and the imposition of tariffs may have marked the start of a period of more heightened volatility. In anticipation, we make two changes to our asset allocation to manage portfolio risk, as trade tensions could weigh on near-term sentiment. We close our overweight to emerging market hard-currency sovereign bond and add back to US government bonds. We also introduce an underweight in the Australian dollar versus the US dollar. The former is a cyclical currency that tends to suffer in periods of increased risk aversion. Since Australia is also heavily exposed to Chinese trade flows, this is a good hedging position if a risk-off scenario materializes. In addition, in a risk-on scenario AUD is unlikely to appreciate much, as we think the Reserve Bank of Australia may be preparing a rate cut to help support the country’s slowing economy.

Takeaway: We close our overweight to emerging market hard-currency bonds and add an FX strategy underweight to the Australian dollar versus the US dollar.

Finding protection from the storm

Escalating trade tensions and market uncertainty have led to increasing demand for downside hedges, with the VIX volatility index jumping to its highest level since January. Our long-duration Treasuries overweight has rallied about 1.3% as the S&P 500 has dropped about -2.6% from its 30 April all-time high.

Takeaway: Our overweight to long-duration Treasuries should continue to help manage equity market volatility. Find out more in our video on Be prepared: Plan, Protect, and Grow.

German recovery hasn’t yet come to the fore

Roughly 70% of the decline in advanced economy manufacturing in 4Q18 can be attributed to Germany. But there are still mixed signals on whether the soft patch is coming to an end. German industrial production increased by 0.5% month-on-month, well above market expectations, with construction and consumer goods production accounting for the rebound. German export figures also unexpectedly bounced back in March. But the nation’s economic ministry cautioned that the outlook for industrial manufacturing remains subdued, while new factory orders data – at 0.6% in March – came in well below expectations for an increase of 1.5%. We think Eurozone stocks have already largely priced in a macro recovery. Renewed uncertainty over trade, which could weigh on corporate investment and demand for manufacturing goods, and potential tariffs on autos could both present risks to that recovery.

Takeaway: Within international developed stocks, we underweight Eurozone stocks. We overweight Japanese equities in our tactical asset allocation.

Week ahead

How will markets respond to tariff hikes?

Stocks recently hit a record high, partly on the back of signs that the US and China would reach a trade deal. But the apparent return to tit-for-tat tariffs between the two countries may represent a threat to markets. After China outlined plans to raise tariffs on USD 60bn of US goods from 1 June onward, we will be watching whether the US follows through on a threat to impose duties on an additional USD 325bn of Chinese goods, and whether talks continue, or break down completely.

Is the global economy robust enough to handle a trade shock?

In recent months global manufacturing has slowed, in part due to previous trade tariffs that led companies to delay their investment decisions. This week’s Eurozone and US industrial production data will give an indication of how the economy was faring before the latest round of tariff escalation.

Is China’s economy responding to stimulus?

Chinese stocks are now down 6% since the start of the month. With industrial production, fixed asset investment, and retail sales data all due this week, investors will be keen for signs that policy stimulus is trickling through into the economy. We combine an overweight to MSCI Asia ex-Japan equities with a collar option.

Recommended reading

  • 13 May 2019 Multimedia features

    CIO thought leaders explain our House View and market outlook through podcasts, videos, and live-streamed conversations. More

  • 19 Apr 2019 Our preferences

    We remain risk on but also continue to hold counter-cyclical positions that can help protect portfolios against downside risks. More

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