Quarterly Outlook
Macro outlook: Trump 2.0: Can the US have its cake and eat it, too?
John J. Hardy
Chief Macro Strategist
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The equity landscape with trade war on the horizon
Peter Garnry
Chief Investment Strategist
On June 19, President Trump ordered the US Trade Representative to prepare additional tariffs on $200 billion worth of Chinese goods in retaliation to China’s response to the initial US tariffs on $50bn of Chinese goods on June 15. These days likely mark the end of the rebound trade that started in early April and ended by taking the S&P 500 to just 3% from the January all-time-high at 2,878.50.
The June events came after the May 31 announcement that the US would put tariffs on imported steel and aluminium from Canada, Mexico, and Europe. In a retaliation move, the European Union announced tariffs on selected US goods such as motorbikes, jeans, yachts, bourbon, and cigarettes. We have dedicated our Q3 Outlook, which will soon be published, to the ongoing trade war as this will become a defining moment for the world if it spins out of control. But with equity markets under pressure and several emerging markets having entered a bear market, we want to provide a teaser to our Q3 Outlook with our view on equities during this trade war scenario.
While US equities are rolling over, they have performed much better than Chinese and European equities. The US equity market outperformance is driven by two forces:
1. The US economy and earnings growth is much stronger than the rest of G10.
2. By being a trade deficit country, the US stands to lose less initially in a trade war escalation.
Our recommendation is to be underweight (short) countries with trade surpluses against the US, the largest such countries being China, Canada, Mexico, Germany, Japan, and South Korea.
In addition, the semiconductor and car industries are particular vulnerable to further escalation, so investors should stay underweight those industries. The industries and sectors that seem to be doing the best relatively are software, health care, consumer staples, utilities, and telecom.
The table below shows our equity model’s top-ranked software companies.
Chinese equities are down 23.5% from their peak in January and down 10% during the period from when the trade war escalated to the recent alarming level. While the Chinese government is signalling its willingness to fight back, the real facts are that China is losing much more from this fight than the US, at least in the short-term.
With the Chinese economy already weakening ahead of the US tariff announcements due to slowing credit growth and lower investment levels, the US government has initiated this trade war at the worst possible time for China. On 19 June, the People's Bank of China communicated that banks’ reserve requirement ratios should be cut, increasing the likelihood of monetary easing coming soon.
Making the situation worse for China is the fact that its currency is falling against those of its its trading partners, most notably USD, as the relative wealth of Chinese consumers declines. Typically the equity market reaction to a falling currency is positive, but this time we see pressure coming from both the equity market and the currency, which is a classic sign of growing stress in the economy and financial system.
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