Both yields and equities fall as US-China trade war escalates

Market Update

With slow progress in US-China trade talks prompting the US President to confirm a hike in tariffs on a further $300bln of Chinese goods to 25%, it was no surprise that equity markets suffered last week. All regions were down, although as often happens when concerns rise about trade, Emerging Market equities bore the brunt of the falls, down -3.6% in Sterling terms. Japan, another country which relies heavily on exports, was also down -3.3%. UK equities were down -2.3%, European equities -1.9%, while US equities fell -1.2%. Materials and IT stocks were most affected globally.

Government bond yields fell across the board, with UK 10Y Gilt yields down -8.4bps and US 10Y Treasury yields down -5.8bps. In the UK concerns that Labour and the Conservatives are unlikely to settle on a cross-party deal on Brexit sent Sterling lower, down -1.3% vs the US Dollar and -1.6% vs the Euro. The risk-off environment was good for Gold, which gained +0.5% in USD terms, however Oil fell -0.5%.

CIO Analysis

Trade wars continue to dominate the news, however stock markets remain relatively unfazed, with the S&P 500 just 2% below its all-time highs. Some attribute this to investor complacency and predict that talks will collapse. While this may well be the case – there are very few if any scenarios under which both governments can plausibly declare victory – we have argued time and again that global supply chains adjust to tariffs and that it is really Donald Trump’s internal pro-cyclical stimulus and Dollar repatriation policies which threaten to unbalance the global economic cycle.

At this point we believe that investors sagely see the resolution of the US-China trade spat as a potential catalyst for new highs, but it is hard to argue that absence of a deal would sink indices over the long term or upend the cycle, especially in an environment of significant monetary accommodation.

Therefore we continue to treat trade as “a” risk, on the same page as risks such as fresh Eurozone worries, a Chinese crash-landing, a US monetary policy mistake and, for British investors, Brexit, which has acquired a rather unhealthy habit of becoming news only on the eve of a deal deadline.

David Baker, CIO

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