Equities: New extremes and a challenging opportunity set
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Summary: Uncertainty is still the name of the game but it looks like SP500 can break out of the tight range that has persisted over the last month
Markets are quick to celebrate a fresh cycle of on-gain-off-again trade tensions, with no promise of any near-term resolution of the uncertainty and chaotic political environment that hangs over businesses investment and hiring decisions, and investors risk allocation decisions. The real problems are still unresolved, meanwhile gyrations in trade headlines aside, the business cycle continues to slow, dollar liquidity is tight, and the risks of a bleed of recessionary dynamics in the manufacturing an industrial sector into services, jobs and the consumer are building. These are reasons to remain cautious despite tactical bounces in sentiment.
Risk thawing into golden week
That said, risk assets which have been struggling for clear direction have taken stock from a bout of trade optimism. E-minis are on the move and risk is firmly on in the Asian session, although that upbeat sentiment is being chastened somewhat as I write by soggy German factory orders.
Developments in Hong Kong and trade talks in Washington in early October is enough to give the market some confidence, however brief the de-escalation may be, there is enough positive sentiment for risk to consolidate here. With a sense of déjà vu equity indices are moving higher today in keeping with the ongoing thematic of risk sentiment gyrating between positive and negative trade headlines as they unfold. The commitment to continue talks after the National holiday marking the 70th anniversary of the PRC will no doubt spur risk on moves in the short term at very least. The moves are also fuelled by better risk appetite cleaning out pessimistic positioning, particularly in currencies like the AUD where positioning has been overtly one sided.
Markets have been in a state of flux and trading in tight ranges throughout the past month as competing themes have taken to the stage, each striving to dictate global risk sentiment. As risk appetite is fuelled it looks like SP500 can break out of the tight range that has persisted over the last month and risk appetite can recover in the run up to golden week.
However, pardon the cynic, but it is hard to believe that this agreement for talks in Washington is motivated by anything other than wanting calm into the National Day Golden Week and 70th anniversary of the PRC. China have been crystal clear in wanting tariffs rolled back and now will send a senior trade delegation to Washington with threat of October and December tariff increases looming, something doesn’t stack up. The events unfolding in Hong Kong can also be interpreted as a move to deescalate tensions ahead of golden week.
In general risk assets pre-conditioned to run higher on central bank stimulus may stage another leg higher this month as the ECB and Fed deliver on stimulus in the coming weeks, given the perceived ability for central banks to supply the markets continual liquidity demands and supress volatility, whilst pivoting the economic cycle placates. The problem, central bankers by their own admission are now losing confidence in the efficacy of monetary policy. Lamenting at the Jackson Hole Economic Symposium that lower rates will not only be insufficient in countering global risks, but worse, may exacerbate structural problems currently inhibiting growth. This means as growth continues to slow, the global economy is far more defenceless than in prior cycles.
If the planned US tariff hike goes ahead on October 1st the current de-escalation is likely to be short lived and it would be hard to see the Chinese trade delegation uphold the plan to travel to Washington for trade talks. Delaying the October 1st tariff hikes crucial for this dialling back of tensions to be long lasting and that hasn’t happened yet, on this basis the current optimism seems irrational.
Talks don’t mean the two sides are any closer to a deal or that their stances have softened. There is no deal at present and investors need to tune out the noise/rhetoric and look at the path of continued escalation in actions which saw tariffs hiked September 1st.
Investors/businesses should be coming to terms with the fact that a comprehensive trade deal is a long way off and the fight is about more than just trade, so the marginal impact of each positive headline should be less. The current dynamics create an environment where the likely path for bilateral relations between the US and China is one of escalating tensions, despite any intermittent hiatus. The true nature of the relationship between the US and China has fundamentally changed and even a trade deal will not solve for that problem.
At present our base case is for prolonged trade tensions with intermittent off ramps, but a deal remains a long way off. The likelihood of a comprehensive trade deal is slim as China are playing the long game and unlikely to kowtow to US demands. This means any deal would be politically motivated on the part of the US administration, falling within President Trumps re-election strategy. For the US to accept a superficial and less comprehensive deal the S&P 500 likely must be a lot lower as a correction in the US equity markets would be highly unpalatable for a President who views financial markets as a real time indicator of his success. The US strategy will also deviate based upon President Trump’s calculus of what will please his voter base, this is a rolling target and means the entire negotiation process is subject to a huge degree of unpredictability. Hence why volatility is likely to remain part of the picture. Investors should also keep in mind even in the face of a future ceasefire on trade, the battle for tech dominance and hegemony will rage on.
Without real gamechangers like a weaker USD, a comprehensive and finalised trade deal (unlikely) or a coordinated fiscal stimulus package from global policy makers there is little reason to view bullish moves as sustainable over the longer term and anything less than periodic unwinds of pessimistic positioning being squeezed.
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