Without the threat of December tariff hike removed a partial deal is unlikely to be signed by China so tariff hikes remain a very real risk. The two leaders, President Xi and Trump meet in November at the APEC summit, previous meetings between the two leaders has rendered a positive outcome so we can’t rule out the possibility that President Trump caves and delays the December tariff hike out to 2020 month in a bid to ink a partial deal if China maintain Yuan stability and step up agricultural purchases over the next. Trump’s actions will be a rolling calculation of what most appeases his voting base and keeps the equity market elevated so delaying the December tariffs will be a moving target, but appetite for a partial deal and claiming a small win seems high on both sides. At any rate the partial and limited deal is just window dressing in a bid to bolster confidence as both US/China now more visibly slowing, behind the scenes the seismic rift between the US/China is ever expanding.
Regardless, the unsigned partial deal has not brought any meaningful concessions to the table and represents a true can kicking exercise, December 15th tariff increases remain a threat and previous de-escalations have proved to be fleeting, this time is no different. If we tune out the noise on a mini deal and look at the actions, we clearly see bilateral tensions escalating – NBA clashes, supply-chains relocating, tech blacklists, and visa restrictions all leave the relationship in a difficult place. And it is evident that frictions between the US and China go well beyond just trade. The thornier issues of industrial policy, state subsidies and enforcement of agreements reached remain unresolved and a comprehensive deal is still a long way off, if ever. China are unable to make concessions on more hawkish demands. The partial “not actually a deal yet” deal IF reached will only provide temporary relief from long-term bilateral tensions.
For the global economy, a pause on tariff hikes will not have a meaningful impact on growth and we still have the cycle to contend with. There is nothing on the horizon to suggest that already implemented tariffs will be rolled back anytime soon and tariff escalation remains a real risk. Uncertainty remains and an interim deal will not be enough to reignite business confidence and investment that would be needed recalibrate global growth expectations higher. When we cut through the noise and trade headlines to the economic data, the message is clear that the global economy continues to slow and the low point in growth is ahead of us not behind. On a trending basis the leading data is still deteriorating, and the direction of growth is still trending lower as we await hard data catch up to soft. We may be getting closer to approaching a cyclical turning point and we don’t rule out a stabilisation in growth in 2020 but believe it would be too early to position for, risks still remain, and further stimulus measures will be needed to precipitate a recovery in growth.
Equity markets may have some upside upon removal of uncertainties, but it is difficult to see equities breaking significantly higher over next 6 months without a clear bottoming in global growth and the risk of recession taken off the table. The is not yet a big enough upside catalyst and we don’t have enough evidence to rotate into assets highly leveraged to growth trending up so defensive strategies still make sense. Once valuation models are recalibrated with lower long-term rates, then sticking with defensive positioning across bond proxies with consistent and growing low-risk earnings streams, minimum volatility and quality factor exposures remains justified. Whilst we may not have passed the Rubicon in terms of the current cyclical downturn manifesting into something more severe, it remains a real risk and until we see more data indicating we are on the cusp of a growth recovery then the corresponding rotation into cyclicals is not something to position for.
For this quarter, consensus estimates remain optimistic against a backdrop of elevated uncertainties, strong dollar, margin degradation and the lagged effect of tariff hikes. There is a big risk that companies are unable to meet even the lowered bar this quarter. But the big test is companies reporting a more sombre outlook into 2020 which is not in keeping with the consensus expectation of a recovery in FY2020 EPS growth. Highlighting the continuation of falling margins, weak capex and potentially culminating in layoffs down the track which has vital implications for the US consumer. Risk/reward for risk assets is skewed to the downside with the S&P flirting with ATHs and the synchronised global slowdown extending into Q4 as Q3 earnings kick off. Leading indicators are declining, the soft data is still deteriorating, and hard data is yet to catch up (down). Earnings misses could be the catalyst for another Q4 drawdown although this year, unlike last, the supportive policy response is already in play globally so unlikely to be so severe.
The clock is ticking, and an extension looks more likely than not, as the path to a deal remains questionable. But stranger things have happened and if you judge the likelihood on the last 24h the tone from those involved seems to be fairly optimistic perhaps a deal can be reached/fatigue has set in but given the history of so many failed Brexit hopes laid to rest, we can safely say it’s not over yet! Details of Johnson’s concessions/nature of deal are light so the probability that it is some rendition of May’s deal full of stale proposals with lipstick on is high. In that instance, it is difficult to see how the DUP get on board and consequentially parliamentary ratification remains a sizable hurdle. Don’t forget we have had a deal before, but it was voted down 3 times! On that basis, optimism looks misplaced, but price action and headline risk will be hazardous down to the 11th hour.