Market fragility highlighted by US-China breakdown in talks

Friday, 10th May 2019 08:13 - by Shant

For a number of weeks, if not months, I have been highlighting the global risks which at the very least, should prompt investors to position a little more defensively with the major US indices testing record highs once again.  Last weekend's proclamation from president Trump that the US is to raise tariffs on $200bln of Chinese goods was indeed a bolt from the blue, in light of the consistent rhetoric from both sides that talks were making good progress.

Trade representatives have issued a note since, that tariffs will be raised on the stroke of midnight on Friday unless Thursday's meeting between the two sides can persuade the US otherwise. Talk as they say is cheap, and this latest development has made it even cheaper, so optimism alone will naturally carry less weight going forward.  

The impact on stocks has been clear to see, tempered only by China's conciliatory response as they return to the US to engage in fresh talks.  Even so, their stance will be a little less compromising than perhaps the US would hope it to be, with the Chinese Commerce Dept reaffirming its position on safeguarding its national interests.  To date, China continues to refute allegations of intellectual property theft, calling the accusations 'unreasonable', so there remain clear barriers in the way of compromise as this is one of the key issues that the US want to address.  What we have now is a set of negotiations not so much with a view to close a deal, but more so to keep talks alive.  

We also have the sanctions on Iran, with the US having pulled out of the nuclear deal.  Here also, China has committed to maintaining trade relations with Iran, further widening the chasm of disagreement and blighting geopolitical tensions.  Europe has also expressed its regret at unilateral US action, and this will no doubt detract from its trade talks with the US, which have yet to take place.  Global trade is already facing headwinds from natural cyclical factors (ie, regional business cycles), and the current political landscape is doing it no favours.  As it stands, the trade input to US growth in Q1 was and is expected to moderate significantly, so as a bastion for global growth, we should also take note of the projections for Q2 which are currently in the 1.2-1.4% range according to the highly regarded Atlanta Fed model.  A far cry from the 3.2% reported in the flash estimate in the previous quarter. 

Gains in the Shanghai Composite put in a strong recovery at the start of the year having dipped below 2500 amid the broader sell-off in Q4 2018.  Since then, the index managed to recover to a little shy of 3300, but since late April, we have seen half of 2019's recovery wiped out - a large chunk of which was this week alone.  The Hang Seng also fell back sharply this week, so far shedding 6.5% from its highs posted this year.  Similar losses have been suffered on the Nikkei and the Korean Composite, but all eyes are now on the US indices, where many leading pundits continue to view aggregate valuations as overstretched.  

Losses on the leading S&P 500 are now in excess of 100pts off the highs, reflecting the level pricing in the trade talks (with China) had and have impacted in on markets.  The Dow Jones - president Trump's favoured measure it seems - has shed some 400pts on Thursday alone.  Events later today - and more specifically overnight, when the tariffs kick in at midnight - could have a significant impact on Asia markets, which can accentuate the snowball effect permeating through global markets as I write.  It is worth noting that the Dollar is still finding an element of support as part of its safe haven function, and this looks to be enough to suppress some of the stronger gains we would have expected to have seen in precious metals - ultimately Gold.  Under the circumstances, and given the propensity for the Fed to react to any fresh material weakness in financial markets (thereby weakening the $), the yellow metal looks to provide a strong portfolio hedge based on the balance of outcomes to these latest events. 

The Writer's views are their own, not a representation of London South East's. No advice is inferred or given. If you require financial advice, please seek an Independent Financial Adviser.