Rhetoric from all sides points to a lengthy trade war - fund seek protection rather than reversal as yet

Wednesday, 15th May 2019 08:52 - by Shant

Over the past week and a half, the markets have been turned on their head with the news that the US was to, and did, raise tariffs on $200bln of Chinese goods as of 10th of May.  President Trump first surprised the markets some 9 days ago, sparking fears across the financial markets with a tweet which has since proved to have significant consequences for the global economy.   

Since then, and despite a reconvening of talks between the two superpowers, China has duly retaliated, announcing (yesterday) its own tariffs on $60bln of goods from the 1st of June.  Fresh losses in equity markets responded quickly to the move, with this impasse doing little other than to point to a full-scale trade war unless the US relents on its posturing.  China - it seems - will not be bullied, and its response this week was clearly a testament to that.  

All this points to one of the familiar adages in the market - sell in May and go away, though into the North American close last night, we saw Wall Street moderate its losses, with this tempering the losses that were later suffered in the Asian session.  At this stage, markets are still counting on the talks to produce some kind of resolution given that the logic suggests both sides would lose out in a major escalation in protectionism.  There is validity in this argument, but one which blindly disregards the political elements within the standoff.  We not only have a fundamental power struggle where the US has recognised the prominence of China, but also that of Trump's presidential promise to end the imbalances in the trading relationship - not just with China, but with all its major counterparts.  Let's not forget, the EU and Japan are also potentially in the line of fire as the US administration mulls upping tariffs on autos and auto parts.  European leaders have also suggested they will reciprocate on any levies charged on its exports. 

So while the key investment decision of the day may seem binary in terms of how the US conducts the negotiations ahead of us, the multi-pronged attack could turn the current ripples in the market into dangerous choppy waters - or worse(?).  Given that financial markets have the a propensity to view the outlook in an optimistic way - not a bad thing in itself - the fledgling recovery (if we can call it that) comes as little surprise, though the traditional safe havens have also gained ground in the meantime - not least of all the Japanese Yen - as well as precious metals, where Gold has risen back to the $1300 level in recent sessions.  

However, looking at the latest BAML Fund Manager survey, the numbers highlight that among the most crowded trades in May, US tech names are top of the list.  The US Dollar is third in the list, followed by emerging markets.  Short European stocks come in second on the list, though rather unsurprisingly given the slowdown in Europe which looks to have a vice-like grip on the regional economy, as exporters struggle in the low aggregate demand environment.  Even so, numbers 1 and 4 on the list highlight the degree of ongoing optimism among hedge funds, though the report also highlights increased demand for protection which is partly reflected in the safe haven buying mentioned above.  According to the report, the proportion of investors preparing for falls in stock markets was at its highest in the survey by BAML, with the bulk of rationale pointing to the breakdown in the US-China talks, though China's economic slowdown was also one of the factors cited in taking out protection at the present time. 

One of the key takeaways from the report is also that funds are not actively looking to change their outright stance on the equity markets.  Protection is different to positioning for a sell-off and by the look of the survey, longs remain in place with a view to riding out the storm of global tensions led by the trade dispute between the US and China.  With the US also under fire for abandoning the nuclear deal with Iran, while North Korea is also unsettling recent calm with fresh missile tests (as well as demanding the US release a seized cargo ship), optimism is going to be seriously tested in the coming weeks and months, and as noted above, the stabilisation across the major indices is tentative as yet.  Were it not for the strong performance of the US economy, we would surely be in the full throes of a bear market - again(?).