US-China Talks Deadlocked
June 2019 Summary
May proved to be a frustrating month for equity markets as US-China trade talks stalled due to a disagreement over intellectual property. In addition, there has been much controversy in relation to the Chinese smartphone maker Huawei, with accusations of spying and claims that they are a national security threat to the US. This has amplified the trade tensions which could lead to a protracted trade war stalemate. In Europe, we saw an election where the populist parties did not achieve the groundbreaking results predicted, except for the UK where the newborn Brexit party won 32% of the vote and the two main parties achieving exceptionally poor results.
Market sentiment in 2019 has been heavily influenced by the trading relationship between the US & China, the world’s two largest economies. Investors were hopeful that a deal could be made as talks seemed to be going smoothly, resulting in a very good first quarter in terms of equity performance. The breakdown in talks began when China supposedly returned a draft agreement with changes that undermined its pledges to address US demands on issues such as intellectual property rights and currency manipulation. Trump has stated on several occasions that intellectual property theft has been a key component of this trade deal and therefore any disagreement on this matter would have naturally antagonized the US President.
This has led to an escalation in talks and consequently a tariff increase on imported Chinese goods to the US. Originally, tariffs on $200bn of Chinese goods were supposed to rise from 10% to 25% at the start of the year but that was postponed as negotiations advanced. As discussions have now turned sour, the US President has implemented this tariff hike and warned that he could raise tariffs on a further $325bn of Chinese goods. Retaliatory measures from China are now in progress. The contentious issue of Huawei (with claims that the Chinese telecoms company has been using their smartphones to spy on the western world) has caused many countries such as the US to ban the sale of their smartphones. However, Trump has stated that if a trade deal can be agreed then Huawei can form part of this agreement. Donald Trump and Xi Jinping are set to meet in Japan during the G20 meeting on 28th – 29th June and markets will be hoping for a positive outcome.
The US economy remains robust, though the Federal Reserve suggested that they could look to cut interest rates if the outlook takes an unexpected turn for the worse as the central bank looks to be “nimble” to continue US expansion. At present, the Fed Chair Jerome Powell has stated that he does not see a case for moving rates up or down, but if inflation forecasts continue to be sluggish then the central bank may decide to change their stance.
The political turbulence in the UK continues, with the resignation of Theresa May and the evident division across the country illustrated by the European election results. May’s resignation has triggered a leadership contest with as many as thirteen MPs (at time of writing!) battling to become Prime Minister. The favourite appears to be the bombastic Boris Johnson, though he has recently been summoned to court over allegations he misled the public during the EU referendum (in relation to the claim that the UK pay £350m per week to the European Union for membership). The frontrunner for the Tory leadership rarely wins the race and therefore it is quite possible that an underdog could become our new Prime Minister. The new leader will be decided by the end of July with nominations for leadership to close by 10th June.
The House of Commons is likely to be in session, including the summer recess, for about fifty days between now and the next Brexit deadline of 31st October. Only about half of those days will be under the leadership of a new Prime Minister. This does not give the Government much time to pass legislation for a deal with the European Union (EU) and the default position is for the UK to leave the European Union without a deal. As we have seen, Parliament has already voted against a ‘no deal’ Brexit and this stance is likely to remain consistent as we move closer to 31st October. If Parliament cannot come to an agreement, then it is probable that another general election will take place to attempt to elect a Leave or Remain coalition to break the Brexit impasse.
The Eurozone economy is currently struggling with pressures from Brexit uncertainty and the slowdown in global growth. The European Commission has cut its growth forecast as pressures from a potential US-EU trade war, the trade conflict between the US and China, and political uncertainty across the region are all pointing towards the balance of risks leaning towards the downside. These factors are causing concern for European leaders and the European Central Bank.
In Italy we saw Matteo Salvini, leader of the right-wing Lega Nord, win 34% of the vote. This has put pressure on the strength of the coalition government in Italy. This result has bolstered the position of Lega Nord who have put forward fresh fiscal plans for Italy and demanded that their coalition partners in government - the Five Star Movement - agree to this new tax structure, otherwise they will allow the government to collapse causing fresh elections and a disruption of the budget process. Italy is the third largest economy in the eurozone with a staggering 131.2% debt to GDP, so any political instability is likely to cause some apprehension for the European Union.
China’s slowest GDP growth in nearly three decades highlights how the trade war has dampened the economy. Weaker economic growth has prompted the Chinese government to initiate a series of stimulus measures, as well as discussions around potential tax cuts. The breakdown in the US-China trade talks has reawakened the concerns we experienced in the final quarter of 2018 and this will continue until a deal is struck. We still believe that the most viable solution for growth in this area is for China to make an agreement with the US to remove the restrictive trade barriers.
Macro events such as the breakdown in US-China talks, Brexit and the slowdown in Chinese growth are all influencing the direction of markets. The US-China talks continue to be protracted but we are hopeful that both world leaders will come to an amicable agreement to provide more certainty within the world economy. Despite the Federal Reserve dampening their outlook on domestic growth, the US is powering ahead when compared with other developed economies and we are still seeing business confidence improve which is supporting investment. The UK market will remain uncertain until the Brexit ambiguity has been resolved. The outlook for Europe is negative at present with Brexit uncertainty and US-China trade tensions being clear factors affecting this, which we believe will continue in the short term. We continue to favour fund managers that have a flexible, active approach, with a global remit, so they can asset allocate across the entire investment world (as we believe diversification is key). However, most importantly we will endeavour, on your behalf, to identify fund managers that invest in underleveraged companies with strong balance sheets as we believe that highly indebted companies will be punished in 2019, if there are any unexpected events.
Please note: The opinions expressed in this update are those of A&J Wealth Management Limited only, as at 3rd June 2019, and are subject to change. The update is for information purposes only. Source: Financial Times.