Are we or are we not on the cusp of resolution of two of the issues that have been dogging markets – for more than a year in the case of the US trade sanctions and for more than 3-1/2 years in the case of Brexit?
Deals on both fronts would lift some of the pervasive uncertainty – some would say ‘Mexican standoff’ – that has been holding back equities, helping to drive bond yields to lows and causing safe havens to fill up with unnerved investors. [A Mexican standoff is a deadlocked confrontation in which no one emerges a clear winner.]
And even if there is actually a – partial – Sino-US deal on (fairer) trade and intellectual property and an (outline) agreement on Britain’s exit from the EU, is a full-blown Q4 relief rally on the cards? Signs of progress at the latest Sino-US trade talks and the possibility of a reworked EU-UK withdrawal agreement tickled markets in recent days. Are we there yet?
Exhibit 1: Can the good news for the markets last?
Data as at 14 October 2019. Source: Bloomberg, FactSet, BNP Paribas Asset Management
Political and economic incentives – US
The market pendulum has always had a tendency to swing too far in the sunny direction after a spell of profound gloom. The inevitable reality check means a possible Sino-US deal would be at a “phase 1” level. Further talks would be needed on complex topics, such as verification of what was agreed, where a fresh stalemate could emerge, creating room for disappointment in the markets.
Equally, a track record of erratic actions from the White House and re-election campaign tactics might mean that markets are bound to treat optimistic noises with a healthy dose of scepticism. Will the US president take what he can get from China now and crow over his “victory” or will he see China as being on the ropes offering a partial deal and decide to go all the way?
Political and economic incentives – China
On the Chinese side, one could see a clear incentive to do a deal in the drop in exports to the US caused by the US trade tariffs and the resulting pressures on manufacturing in China, and by extension the services sector, as well as overall growth. The US accounts for more almost 40% of China’s net exports (with Asia at almost 25% and Europe at just over 20%).
Caveats apply, though. Up to a point, Chinese exports not going to the US could be sent elsewhere in the world. That would work were it not for a wider slowdown in global trade in goods, even as consumer sentiment and demand, both in the US and Europe, has proven resilient.
Another question is whether China would care much about slower domestic growth, both in manufacturing and overall, as it seeks to structurally shift its economy towards a more consumer-led, and hence services-focused, model on the one hand, and to deleverage – and de-risk – its debt-laden economy on the other.
Finally, Beijing might feel it can accept a certain amount of ‘economic pain’ as it persists with its fight-again/negotiate-again tactics in trade talks with the US. Given this overall context, any Chinese concessions in such talks might need to be taken with a pinch of salt.
On again, off again
Significant challenges remain when it comes to resolving the issues surrounding Brexit, even as the UK and the EU engage in what are seen as last-ditch talks to produce the UK’s orderly exit from the bloc by the end of October. The focus is on the future position of Northern Ireland in EU-UK trade and the complexities of working out practical and durable solutions that Parliament can approve.
Failure would likely leave sterling, and with it the UK economy, on the ropes.
What all that means for the currently oh so sentiment-driven markets is unclear. Any damage from the uncertainty that has dogged them for a while now, and affected current economic growth as well as the – now muted – prospects for 2020, has been done already.
A contrarian investor might want to dust off their ‘bottom-fishing’ tools to assess any buy-on-the-dips opportunities as and when the gloom lifts.
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Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients.