Market Comment 12/12/2018
US versus China - is trade friction easing?
Hector Kilpatrick, Chief Investment Officer at Cornelian Asset Managers, assesses the increasing likelihood of a trade deal.
The renewed risk off sentiment has been driven by fears that the United States may be overplaying its hand concerning trade tariff negotiations with China (following the arrest in Canada of a senior Huawei executive). There were also concerns that OPEC and Russia might not follow through with large enough oil production cuts to reverse the abrupt decline of the oil price.
We believe that the Chinese will do enough to satisfy the Americans on trade, as it is in their interests to do so, given that the Chinese economy is vulnerable.
Whilst both are certainly risks, we believe that the Chinese will do enough to satisfy the Americans on trade, as it is in their interests to do so, given that the Chinese economy is vulnerable. It is interesting that in recent days the Chinese have stated that the two sides have reached agreements on numerous sectors, the outcomes of which will be implemented ‘immediately’. Given this messaging from a Chinese government spokesman was issued several days after the arrest of the Huawei executive, this suggests that the arrest itself is unlikely to derail trade tariff negotiations.
It was notable that the October sell-off in equities was not replicated in the credit markets and other indicators of financial stress (such as the interbank lending rate) were equally disinterested by the equity market moves. However, the sharp decline in the oil price during November did result in credit spreads widening and the interbank lending rate rising. Concerns increased that companies in the US that produce oil onshore may start to exhibit financial stress if the oil price continued to fall. Under this scenario, default rates would increase which, if sustained, might undermine the bank sector’s confidence to lend to businesses more generally.
The Chinese have stated that the two sides have reached agreements on numerous sectors, the outcomes of which will be implemented ‘immediately’.
It is, therefore, reassuring that in early December Opec and Non-Opec countries were able to come to an agreement to cut oil production meaningfully, such that the oil price should be underpinned going forward.
Significant falls in the share prices of economically sensitive stocks points to an increased probability that global economic growth forecasts will disappoint in the near term. Importantly, however, policymakers are beginning to take note and the messaging from the Federal Reserve is becoming more dovish by the day. As inflation expectations remain well anchored, the room for manoeuvre is high, be it fewer than expected interest rate rises or, if need be, the suspension of the quantitative tightening program.
Whilst we remain of the view that US economic growth will surprise positively in the medium term, should the US economy revert to a sustained low growth and inflation environment, the low interest rates which would result would support asset prices and ameliorate the lack of earnings growth. However, this will come at the expense of further political polarisation.
Sources: Bloomberg, FTSE, Federal Reserve, Morningstar.
Chief Investment Officer