The trade war has intensified. We recommend investors stay underweight in equities.
Financial markets caught off guard regarding trade agreements
Global trade had already lost noticeable momentum in recent quarters. The exporting nations and the manufacturing industry in particular suffered. In January, world trade contracted by around 8% year-on-year. The likelihood of a trade agreement was "talked up" by China and the USA, and the financial markets believed it. As a result, financial markets remained optimistic despite deteriorating data, with various stock indices, including the NASDAQ, reaching all-time highs.
Trade conflict between USA and China came to a head
Contrary to the expectations of the financial markets, no "grand bargain" was reached last week. According to statements by the US president, China wanted to renegotiate and reverse what had already been agreed. In response, the U.S. increased tariffs on imports from China worth 200 billion U.S. dollars from 10 to 25%.
US administration threatens further tariff increases
U.S. Trade Representative Lighthizer has been tasked with preparing tariffs of 25% on additional goods worth around $330 billion. If these were imposed, virtually all Chinese imports into the USA would be subject to an import tax.
Chinese reaction so far moderate...
China has announced plans to raise tariffs on around $60 billion worth of US imports to as much as 25%. However, these tariff increases are not to take effect until June 01. Thus, the Chinese reaction has so far been quite moderate.
...because
First of all, China has kept a low verbal profile compared to the USA. Presumably, China wants to present the U.S. as the culprit to the world public. China has not yet hinted at raising tariffs on U.S. auto imports again. These were lowered in December after a friendly meeting between President Trump and Xi Jinping. China has so far refrained from completely halting purchases of U.S. agricultural products. Similarly, China refrained from restricting strategically important exports on which the U.S. relies (e.g., rare earths). It is a good sign that China's retaliatory measures have been so restrained.
Further talks planned at G20 meeting in Japan
There is also reason to hope that the talks between the US and China at the G20 meeting in Japan will bring relief to the trade war.
Forecast of verbal fine-tuning of the US president by financial markets possible
The U.S. equity markets on Monday recorded the largest price declines since the beginning of the year. The S&P500 plunged by 2,41% (NASDAQ: -3,41%), the MSCI China Index fell by almost 4%.
Based on the pronounced price declines of the U.S. stock markets, the following forecast could be made: the next statements of the U.S. president will be more conciliatory. The verbal part of the trade war is thus a function of the development of the US stock markets. The stronger they recover, the more aggressive the next verbal attacks will be.
If the U.S. stock markets continue to slide, the U.S. president's next tweets could be closer to a gentle cat purr. If, on the other hand, the bull market were to accelerate and a meltup were to "threaten" (a rather unlikely scenario), the verbal attacks would become much more aggressive and would probably have little resemblance to "gentle cat purrs"...
What next?
Investors have the much more difficult task of assessing the real economy and financial markets compared to forecasting future presidential tweets.
Difficult to reach agreement in trade dispute
A far-reaching agreement, a "grand deal," seems difficult to us. We have the impression that China will insist that the text of the agreement is "balanced" and must be "face-saving" for head of state Xi Jinping. The communist party will not want to be seen as a perceived loser from the trade war by the world public and its own people. Thus, the hurdles from the Chinese side are high, especially with regard to the changes in the law demanded by the U.S. side. Xi Jingping is likely to insist that Chinese laws are made by the Chinese and not by the White House, however justified the changes in the law demanded by Washington may be from the point of view of the necessary protection of intellectual property.
US President Trump tries to score points with tough China policy in election campaign
The Trump administration and Trump regular voters still seem to favor tough negotiations with China. Should (re)election strategists advise the president to continue to focus on this campaign issue because it resonates well with the electorate, Donald Trump will continue to play the tough dealmaker in the interest of "America first." Thus, global trade will remain a playground of the U.S. presidential campaign, at least until the election at any rate.
Auto import tariffs in focus
This leads to the next topic: the US trade war is unlikely to be limited to China. The US is planning to increase tariffs on car imports from the EU, which could hit the German economy in particular hard. The EU Commission is already working on "retaliatory measures".
Big Picture: Rivalry between the U.S. and China due to struggle for "world power status" for decades to come
Investors should not lose sight of the big picture. As emphasized here several times, the struggle between the U.S. and China for "world power number one" status will shape the world for decades to come. Therefore, investors should always watch the military news, such as the "Freedom of Navigation" operations around Taiwan.
Timing for trade war favorable from US perspective
One last thought: The U.S. is currently in an excellent economic position (lowest unemployment rate in almost 50 years!), especially compared to China. The time for a "trade attack" is therefore very favorable from the U.S. point of view. If not now, when?
The simplest forecast is...
That volatility is likely to remain elevated. The volatility of volatility will also remain above average.
Maintain equity underweight
We maintain our cautious stance and currently hold a slightly underweighted equity allocation. We advise underweighting Asian markets and emerging markets in particular, and overweighting quality stocks. The escalating trade war is just one reason for our cautious stance. High valuations and the Metusalem age of the economic and stock market upswing also call for caution.
Contact: Thomas Härter, CIO, Investment Office
Telephone: +41 58 680 60 44
Disclaimer: Produced by Investment Center Aquila Ltd. Information and opinions contained in this document are gathered and derived from sources which we believe to be reliable. However, we can offer no under-taking, representation or guarantee, either expressly or implicitly, as to the reliability, completeness or correctness of these sources and the information pro-vided. All information is provided without any guarantees and without any explicit or tacit warranties. Information and opinions contained in this document are for information purposes only and shall not be construed as an offer, recommendation or solicitation to acquire or dispose of any investment instrument or to engage in any other trans action. Interested investors are strongly advised to consult with their Investment Adviser prior to taking any investment decision on the basis of this document in order to discuss and take into account their investment goals, financial situation, individual needs and constraints, risk profile and other information. We accept no liability for the accuracy, correctness and completeness of the information and opinions provided. To the extent permitted by law, we exclude all liability for direct, indirect or consequential damages, including loss of profit, arising from the published information.
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