Two Important Trade War Votes and A Lurking Threat
We have had a few weeks of relative respite from the 2019’s constant headline generator: trade wars. That hiatus is past, however, as we are expecting key updates on global trade relations over the next few weeks. In an unusual twist though, the developments may be positive ones. Dead ahead on Wednesday January 15th we are expecting two opportunities to improve the collective growth trajectory. The most prominent of these is the planned signing of the Phase 1 trade deal between the United States and China in Washington DC. Though this deal was proposed back in October in an effort to ease the crush on business sentiment, we are only now coming to signatures. It is still unclear exactly what is entailed with this agreement besides the deferred tariff escalations due this past December, and it is likely the details are left ambiguous even though the two sides will declare it a black-and-white improvement. If we go back global indices or the USDCNH, the market is taking an optimistic view which will make it difficult to ‘impress’ while broadening the potential scenarios that ‘disappoint’. Easing more of the painful tariffs and seeing progress towards increased purchases as well as intellectual property rights policing is a matter for Phase 2 which President Trump waffles between commitment to steam ahead on and wait until after the election.
Another update that was on the docket for Wednesday – but for which doubt has been revived – was the Senate vote on the USMCA accord, which is the proposed replacement to the NAFTA agreement. This is one of the final hurdles to restoring tangible trade program in North America, one of the largest trading blocs in the world. Despite what it represents, the market is remarkably sanguine on this topic from global sentiment to Dow to USDCAD or USDMXN. Speculative interests started discounting the risk in this regional spat some time ago when the White House started to show a different path towards negotiation than it was taking with China – not a ‘favorable’ approach but ‘not as bad’ as the US-China trade war. Similar to the situation with the aforementioned countries’ discussions, assumptions are set with heavy skew to discount an improvement and wide open for deterioration.
As established as these trade negotiations have been with significant market attention along the way, the trouble brewing between the United States and Europe remains underappreciated. Perhaps due to the distraction of open economic warfare or the side effects of complacency, there has been little active discounting taken as the two largest developed economies have moved from threats to actions. After 2018’s metals tariffs by the US, the WTO ruling on Airbus subsidies by the EU spurred the White House to charge forward with more than $7 bln in tariffs on European imports. France decided late last year to apply a digital tax on large tech companies’ revenues in its country which raised the ire of the US, urging threats of reprisal all while the country remarked that it was considering further tariffs for an updated ruling by the WTO saying Europe had not yet fully halted unfair support for Airbus. France the US have reportedly set a commitment to find a compromise by the Davos Economic Forum next week. Further, the WTO is due to make its ruling on US support of Boeing sometime in the coming weeks.
Will Growth Retake the Crown of Most Market Moving Theme…for the Week?
Geopolitical risk was an unexpected top concern to open 2020 on thanks to the situation between the US and Iran which boiled over on escalating tensions between economic sanctions and an attack on a US embassy. Though the two countries have openly attacked counterpart’s key people and installations and their rhetoric is openly hostile, it seems that the situation is back to an uneasy suspension. Despite the market’s blasé attitude towards the situation, it is worth keeping a close eye on the situation. Further escalation towards outright war between the two can have substantial economic and financial implications – not to mention draw attention to the exposure to risk the markets have built over time.
As we move forward with little appreciation for the threat in the backdrop, there is a theme that may find more reliable traction in the week ahead. Since the surge in fear of an impending global recession peaked in August/September, we have seen concern over the health of the economy all but vanish. That is not to say the situation has improved measurably. All that has happened is the developed world economies’ service sectors have generally avoided contraction and the US-China trade war averted steeper tariffs. Sentiment seems to be content with this situation, but it is difficult to gauge when interest will start to go down hill quickly – it certainly isn’t just a matter of an obscure Treasury yield curve event to decide. Data, while not always reliable for the seismic influence necessary to charge the markets, is at least a threat with a time stamp. There are a run of growth-related indicators on tap this week, but few of them has a ready claim to global influence.
A monthly UK GDP, Japanese eco sentiment survey and US retail sales are just a few indicators that will carry local weight but seriously struggle to reach global proportion. The Chinese 4Q GDP on the other hand is a big picture update from the second largest individual economy in the world as well as a key trade war milestone. That said, this report has a tendency to see very little change nor does it surprise meaningfully relative to economist forecasts. Nevertheless, don’t fully discount it. Another event to take stock of is the start of the US 4Q earnings season. Banks are the focus with liquidity a more frequent topic of conversation given the Fed’s short-term funding efforts of late. I will also keep tabs on CSX, the railroad corporation, given its influence on trade and proxy nature to growth. Here too, the interpretation of a global growth concern would require a jump.
An Appetite for Momentum Rather than Value
Last week, I discussed the importance of knowing the collective motivation of the market whether you are a fundamentally-inclined traders or not. When we know that the financial system is on a course set by views of growth, rates of return, unorthodox monetary policy or some other unique but systemic influence; it is easier to spot when market movement will pick up, separate a short-term jolt from a true trend and recognize which scheduled event risk will gain traction versus that will be readily overlooked. An extension of this consideration is the separation between a market that is motivated by a clear drive or one that is otherwise fed by outright speculative appetite. Impetus doesn’t have to be a traditional measure of value like the outlook for growth. It can be the easing of potentially disastrous economic pressure as with the trade wars. Also, there can be a temporary convergence of influences (e.g. Fed cuts, trade tension easing and Brexit breakthrough) that tips enough momentum to look like a singular cause – though such runs usually peter out far earlier as one or more nodes falter.
Alternatively, there are situations in which a climb or tumble from the market has no basis in fundamental perspective – whether singular or a patchwork. That is more properly defined as a market driven by either greed (when bullish) or fear (when bearish). These phases are not always so overt as to be a universal tacit agreement that we will let our collective enthusiasm or pessimism carry us undisturbed. There is often fundamental justification that is made to give a sense of greater conviction behind the self-indulgent trend, whereby events or themes that challenge the prevailing trend are downplayed and tepid measures of support are given much greater prominence. It is this market type that I believe we are in with risk-leaning assets – particularly US indices. There are various ways to establish this – capital flows, divergences in key assets, erosion of economic potential, etc – but I am currently partial to the reach of specific risk-leaning benchmarks. When base risk appetite is the foundation for investment appetite, there is less interest in seeking value for long-term potential and far more interest in the immediate return to be found in priced-based established momentum. One of my favorite examples of this is the relative performance of US equities relative to their global counterpart. The ratio of the S&P 500 to the VEU is just off a record high, and EPS potential I certainly not that remarkable.