After a surge in trade optimism over the month, Chinese officials confirmed over the weekend that the US and China are close to finalising the highly anticipated “phase one” deal expected to be signed by Trump and Xi in the coming weeks. Investors had hoped that this deal would make way for the development of a more significant, long term deal, however looking at the detail, it appears that the interim deal is essentially little more than a trade truce at this stage.
Key Elements of the deal:
The deal details a pause in the tariff escalation, but not an end to them. This means that the tariffs scheduled to come into place in October were foregone, however the existing tariffs in place before October have not been removed, nor the threat of tariffs on another $160 billion in goods on 15th December (which are expected to hit popular consumer items).
- Intellectual Property
Trump’s big target in his fight against China was based on forcing an end to what the US sees as being a systematic and state-backed Chinese theft of American intellectual Property. In this interim deal, concessions made by China have been listed, however these are not new, and are largely actions China has taken already, as always with China, the key is whether authorities actually enforce the rules.
As members of the G20, both sides have agreed not to manipulate currency, however now they will have a bilateral commitment to do so, allowing the US to remove the “currency manipulator” label given to China by the US in August. Effectively, this does not change a great deal.
- Farm Concessions
China has resumed purchases of American farm produce in large quantities, with President Trump setting doubling purchases as a goal. Despite this, after satisfying built up demand, indications are that China will simply be buying at levels seen before the trade war started. Trump will phrase this as a great win in a bid to win over an important political constituency, however not a great deal of progress has been made here.
- Failure to address key issues
The deal does not encourage greater transparency over industrial subsidies, the role of the state in initiatives such as “Made in China 2025”, any resolution for Huawei from the US tech blacklist, or a plan for an eventual end to the trade conflict.
The lack of significant progress made by this “phase one” deal suggests that optimism has been overdone, with trade uncertainty likely to continue into next year. Earlier today, Chinese officials confirmed this observation, casting doubts about reaching a comprehensive long-term trade deal with the US despite nearing the finalisation of the interim deal. This suggests that uncertainty over trade is likely to remain, muddying the outlook going into the final two months of the year.
While optimism over a meaningful US-China trade deal abates, developments in the UK also suggest that optimism over a Brexit resolution in recent weeks has been overdone, with the Brexit deadline being extended to the 31st January, and an early General Election now expected on 12th December. In the lead up to the December election, UK markets are expected to display a significant amount of volatility, as the competing political rhetoric intensifies. For this reason, we expect continued uncertainty while the path forward for the UK leadership and Brexit outcome becomes clearer.
In the US, corporate earnings season continues to gather momentum, with the S&P 500 reporting a 3.7% decline in earnings in Q3 (based on reported earnings and estimates). According to Factset Earnings data, for companies that generate more than 50% of sales inside the US, the blended earnings decline is -0.8%. For companies generating less than 50% of sales inside the US, the blended earnings decline is -9.1%, indicating that companies which are more exposed to global revenues are really starting to suffer as a result of lower global growth and trade uncertainty.
Also in the US, the Federal Reserve announced a third reduction in interest rates at its October meeting yesterday. The cut was widely expected, however guidance slashed expectations for a further cut before the end of the year. For more information on Fed rate expectations and what the recent rate cut means for markets, please see the attached Market Update document.
Developments over the week now suggest that the optimism and risk on sentiment observed in markets in recent weeks has been overdone, with key risks remaining while the economic data deteriorates, reinforced by declining corporate earnings. This has been observed in market movements today, with investors moving towards safe havens and bonds as risks increase, reinforcing our view that the decline in portfolio performance seen in recent weeks is a temporary factor, with bonds gaining while equities decline, as we expect given current market conditions.
At this stage, it is important to highlight that everything is happening as we expect it to. The economic data is deteriorating, feeding into lower corporate profits, with central banks struggling to effectively stimulate economies. All the factors are in place, however markets are not yet reflecting this. As the end of this cycle comes nearer, it is important to hold steady and resist the urge to invest in choppy and volatile markets, with a lack of data or opportunities to support a return to equities. Instead, we will allow the lemmings to get caught up in market euphoria, and watch from the side-lines in a more defensive position as they allow that euphoria and herd behaviour to carry them off the cliff. We must focus on the data, and the markets will follow.
Key Events This Week:
- Friday: US Labour Market Data, ISM Manufacturing PMI for October
- Monday: Eurozone Manufacturing October PMI
Model Portfolios & Indices
Most global equity markets gained over the week on the back of optimism over a US-China trade and a positive resolution to Brexit uncertainty. Markets remained highly volatile over the week as the data continued to indicate a deteriorating economic backdrop while trade, central bank movements and Brexit developments dominated the headlines.
Safe haven assets such as gold remained relatively flat over the week as bonds declined earlier this week on risk on sentiment owing to trade optimism, before gaining as optimism abated. It is clear that significant risks remain, and the economic data continues to illustrate weakness in the global economy, with risks now firmly tilted towards the downside. The OBI portfolios remain defensively positioned with limited equity exposure and a downward tilt which seeks to benefit when equities decline, and our portfolios remain well positioned given current conditions. The portfolios declined over the week owing to a temporary risk-on shift, however it is key to note that we view this as short-lived euphoria over trade and political developments which will be reversed in the coming weeks.
As we progress from here, it is important to recognise that we should not let benchmark performance make us feel like we have missed out on anything, because although we have in the short term, recent performance shows how quickly this can be reversed given current levels of risk and uncertainty. Additionally, we remain broadly in line with benchmark performance in the 1 month, 3 month and 6 month periods, however expect to quickly regain ground on the 12month benchmark performance as the market begins to reflect the economic data and deteriorating outlook for equities.
Overall, it is our view that equity markets will continue to decline before adjusting to the new norm based on lower global growth and weaker corporate profitability. The key point here is to take a long-term view, look at the current level of uncertainty in the global economy, and remember that the portfolio is designed to minimise your exposure to risk and preserve capital. Markets are behaving irrationally, therefore the most sensible strategy is a defensive one given current market conditions.
The data above will not directly correlate to the indices as there is always a delay in pricing because the US markets close significantly later than the European markets and the Asian markets. The data set above reflects the last close and much of the day’s movements will not yet be reflected in the portfolios due to pricing delays. You cannot therefore directly correlate indices to the portfolios. The value of investments may fluctuate in price or value and you may get back less than the amount originally invested.
Past performance is not a guarantee of future performance. Performance figures quoted include the fund manager charges but exclude other fees such as adviser, custodian, switch and/or discretionary investment management fees. Unless otherwise instructed and accrued, income is reinvested into the portfolio.
This Day in History
On this day in 2019, Brexit did not happen… again!
Have a great week,
Jason & Gina