Truce, for now: What does it mean for investors?

The outcome of the Group 20 (G20) summit in Osaka will likely provide a temporary respite to equities but, eventually, improving macro data and a dovish policy will be required to sustain market rallies. We believe that the trade issues are not over yet, and remain cautious that US growth may disappoint expectations, especially in Q3 2019.

At the G20 meeting over the weekend, US President Donald Trump and Chinese President Xi Jinping agreed to resume trade negotiations, and the US agreed to delay any further tariffs on Chinese imports. Specifically, the tariffs on USD300 billion of goods, which were supposed to come into effect in early July, have now been delayed. The existing tariffs (including the increase to 25% on the USD200bn of goods upon which tariffs were imposed in May), will remain in place.

According to Trump, the meeting with Xi went “far better than expected”, which will come as a relief to markets that have been jittery since trade talks broke down in early May. In return for no further imposition of tariff, China has agreed to buy more agricultural produce from the US, although details are still unknown. Trump also mentioned that US chip producers will be allowed to sell parts to Huawei, with more details to be disclosed over the coming weeks.

The meeting appears to indicate a temporary resolution to the trade talks but does not imply that the two countries have agreed on the broader trade or national security issues, or that the trade overhang is now behind us.

Whilst President Trump mentioned that talks with China are progressing he said “[he is in] no hurry” to strike a deal. In fact, both leaders believe they are negotiating from positions of strength and an ideological perspective, thus making a lasting resolution difficult at the moment.

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Our take

Since trade tensions are unlikely to escalate further for now, we maintain our view that global growth will gradually slow over the rest of the year.

We do not expect the US to slip into a recession as consumer spending is still holding up. Business sentiment, which had deteriorated significantly over the past few months (see Fig. 1), may well stabilise and recover modestly following the positive trade news.

Fig. 1: US manufacturing sentiment has deteriorated significantly over the past year1

fig1-Truce-for-now

Uncertainty remains

That said, we do not expect a significant reacceleration in US or Chinese manufacturing growth, given that the existing tariffs are still in place, and uncertainty on future trade talks remains. The trade overhang will continue to weigh on capital expenditure decisions and eventually limit the upside in economic data until a trade deal is reached.

With that in mind, US growth in the third quarter (see Fig. 2) may disappoint expectations due to a slowdown in export growth, as this tends to lag movements in ISM manufacturing.

Fig. 2: US growth may disappoint consensus expectations in Q3 20192

fig2-Truce-for-now

Supportive policies

Given this macro backdrop, we expect both US and China policy to remain supportive of growth, with the aim of prolonging the current economic cycle. Specifically, we expect the Fed to deliver a pre-emptive rate cut in July or September, whilst leaving later decisions on rate cuts as data dependent.

The deterioration in Chinese activity data seen last year has stabilised somewhat this year following policy support (see Fig. 3), and we expect both monetary and fiscal policy easing to continue over the next few months and cushion any sharp slowdown.

Fig. 3: Chinese manufacturing sector weakened in 2018, but has stabilised since3

fig3-Truce-for-now

Investment implications

The outcome of the G20 will likely provide a temporary respite to equities but, eventually, better macro data and a dovish policy will be required to sustain market rallies. We believe that the trade issues are not over yet, and remain cautious that US growth may disappoint expectations, especially in Q3 2019.

If the Fed underwhelms market rate cut expectations, we may see a pullback in equity markets after the positive trade news is priced in. We would use such episodes as an opportunity to add to beta risk, as we still believe the probability of a recession in the next 12 months is low.

In the meantime, we maintain our broadly neutral equity position (with a preference for the US over other regions). We are overweight duration and credit given the dovish macro backdrop and gradual slowing of growth.

We like idiosyncratic trades in emerging markets including Indian equities, the Russian rouble, the Indonesian rupiah, Argentina USD bonds and Indonesian bonds. We are also long Asian high-yield credit as it should perform well under a benign global monetary policy environment.

Sources:
1 Thomson Reuters Datastream, July 2019. US Empire State Mfg Survey Diffusion Index, US ISM Purchasing Managers Index, US Philadelphia Fed Manufacturing Business Outlook Survey Index, July 2019.
2 Bloomberg and Multi Asset Solutions (MAS) at Eastspring Investments, July 2019. Quarter-over-quarter (qoq).
3 Thomson Reuters Datastream, 3-month moving average, July 2019.