Market Overview August 2018
The trade war rhetoric became pertinent as China and the US implemented more tariffs on each of their economies. Despite this escalation, global markets continued to push forward as Trump’s trade war was shrugged off by increasing corporate earnings and a generally positive global backdrop. The UK raised interest rates to 0.75%, the highest level since 2009, indicating their belief that the underlying economy is strong enough to support this action.
Donald Trump is still pursuing his battle with China as he attempts to alleviate the trade imbalance between the two largest economies of the world. The key question for investors is how this is going to affect the global economy and at present the tariffs look as if they will have a minimal effect on global gross domestic product (GDP). At present, Trump’s US tariffs are affecting £64.9bn worth of goods across the world. The retaliatory tariff measures from Canada, China and Europe affect a further £39.8bn, which in total is £104.7bn. The levy placed on these goods ranges from 15% - 25% and therefore, on a worse case scenario, that is a maximum tariff of £26.17bn on these imports/exports. If you relate this to global GDP (totaling £60 trillion) this amounts to a mere 0.04% reduction. Whilst this illustrates the relatively small impact this could have economically, investor sentiment will be sensitive to these aggressive tactics, inevitably leading to volatility in equity markets.
Many have also argued that most of the tariffs will not be collected as savvy businesses find sophisticated alternatives of bypassing essentially what will be a new tax. Firms will aim to avoid tariffs by shipping products through third parties or other countries. A typical example is American soyabeans, which have now been hit by a 25% tariff from China. However, many US farmers have never sold directly to Chinese buyers, preferring commodity brokers based in Turkey who act as the middleman and sell the soyabeans to China, therefore avoiding the tariff. This example could potentially replicate itself across many sectors.
Why is Trump employing this tactic? A key event in November will be the US mid term elections which is seen as the acid test for the strength of a US presidency. Many political analysts have argued that Trump is attempting to boost his nationalist vote by promoting his ‘America First’ rhetoric. The US President also uses the performance of the US economy as a barometer of the success of his presidency and therefore it is unlikely they he will implement a policy which could derail growth. Whilst we are mindful of the potential risks a trade war can cause, we are also aware that the US President wishes to consolidate the Republican position in the Congress and Senate and therefore it is improbable that he is going to attempt to halt global growth.
The Federal Reserve decided to raise interest rates for the seventh time since the end of 2015. Tighter policy reflects expectations that US growth and inflation will prove stronger than officials anticipated in March, while the unemployment rate continues to fall. Federal Reserve Chair Jerome "Jay" Powell said job gains are boosting income and confidence, while tax cuts support additional growth. Despite the trade war tensions, the Fed's monetary policy highlights their belief that economic growth in the US is strong and can withstand higher interest rates.
The European Central Bank (ECB) declared an end to its three-year quantitative easing stimulus programme, announcing it will halt the activity credited for reviving a crisis-wracked Eurozone economy. However, interest rates will remain at record lows and the ECB suggested they were unlikely to rise before September 2019 — later than some analysts had previously predicted. The ECB will gradually taper the stimulus programme through the rest of the year, cutting its monthly asset purchases in half to €15bn after September and phase it out entirely by the end of the year.
Mario Draghi has stated that geopolitical risks from a trade war and higher oil prices all weighed on the outlook for growth. However, wages across Europe are beginning to pick up at a faster pace, not only in Germany but in France too. This would boost consumption and lead to higher inflation in the years ahead which, combined with the end of quantitative easing, highlights some positives in the Eurozone economy.
The Brexit negotiations continue to rumble on albeit at a frustrating pace. Further political drama in the Conservative Party is making it difficult for the Prime Minister to get key decisions over the line. October’s meeting with the European Council is likely to be an inflection point in this process as pressure mounts on both sides of the negotiating table for an agreement. Michel Barnier, the European Union’s chief Brexit negotiator, specified that progress had been made on negotiations with the UK, but that there were major issues still to be addressed.
The increase of the Bank of England’s base rate 0.75% is testament of Mark Carney’s belief in the underlying strength of the UK economy, recently stating that he believes that we are well placed to deal with any outcome. Despite the Brexit uncertainty, it is comforting to know that Britain’s biggest banks are able to withstand a series of economic shocks including a no-deal Brexit. The Bank of England measured this through stress tests which examine if banks have enough capital to handle a sharp fall in UK and global growth, a surge in consumer bad debts, a plunge in the pound, and a jump in unemployment caused by higher interest rates. The results illustrated that all seven lenders tested had sufficient capital to cope with extreme economic circumstances. This will, to some extent, relieve concern relating to the severity of a no-deal scenario.
Asian equities are being affected by Trump’s trade negotiations and this is likely to continue until a concession has been made from either side. There are pockets of value still to be found in the Asian region especially in some of the well established technology companies. In Japan, the central bank made it clear that they would not be joining the world’s other central banks by rolling back crisis-era stimulus policies. Haruhiko Kuroda, the Bank of Japan governor, stated that interest rates would remain at low levels “for an extended period of time”.
The world economy looks set to grow robustly in 2018, but the differences between faster and slower growing countries are becoming more apparent. The most positive news comes from the US, where tax cuts, government spending and business confidence are supporting employment and investment suggesting a strong recovery into the summer and solid growth into 2019. This is assisted by lower unemployment in many developed economies, resulting in increased consumer spending. Consumer confidence is also high across the US and Europe, encouraging companies to invest, which in turn leads to earnings growth. That said, with the possibility of a trade war, we continue to favour fund managers that have a flexible active approach and with a global remit, so they can asset allocate across the entire investment world as diversification is key.
Please note: The opinions expressed in this update are those of A&J Wealth Management Limited only, and are subject to change. The update is for information purposes only. Source: Financial Times.