Insight multi-asset weekly update: US-China trade concerns returned to the fore, affecting risk sentiment
Market and economic review
US-China trade concerns returned to the fore and weighed on risk sentiment last week. Equity markets fell 2-6% over the week following the unexpected announcement of additional tariffs on Chinese exports into the US on Thursday. Unsurprisingly, returns from Chinese and eurozone equities were notably weaker over the period while sterling depreciation helped offset some of the broader weakness from UK equities.
Developed government bond yields fell sharply reflecting in part the poor risk sentiment as monetary policy across major economies remains accommodative and inflation below central bank targets. The yield on 10-year US treasuries fell 23bp to its lowest level since October 2016. German government bonds had a negative yield until 25-years maturity and the 10-year yielded an all-time low of -50bp. Returns from investment grade credit were a small positive while local currency denominated emerging market and high yield credits underperformed. Returns from the commodities complex remained on the back foot after oil prices fell over 7% on Thursday.
US unexpectedly announces further tariffs
The US president proposed to levy fresh tariffs of 10% on $300 billion of Chinese imports from 1 September. If implemented, all Chinese goods except for pharmaceuticals and select exempted items will be subject to tariffs, providing additional headwinds for growth. We understand the majority of newly tariffed goods to be consumer products, unlike the previous rounds, which were aimed at capital and intermediate goods.
This somewhat abrupt announcement follows on from a visit by the US trade representative and treasury secretary to China for trade discussions earlier in the week. The two countries had announced plans to have ‘intensive discussions’ in August. China has vowed to retaliate with counter measures against the proposed tariffs.
Lacklustre global growth outlook amidst elevated trade uncertainty
The ratcheting of trade uncertainties comes against a backdrop of already fragile global growth dynamics. Last week’s global manufacturing PMI reading contracted for the third month and fell to its lowest level since October 2012 (49.3).
PMI readings remained in contractionary territory for the second month in China, the eurozone and key economies within it (Germany, Spain and Italy), although the readings improved marginally from the poor outturns observed in June. In China, growth in new orders, output and employment components contributed to the modest improvement, likely benefitting from a sentiment boost following a temporary truce in US/China trade tensions after June’s G20 meeting.
Growth dynamics remain relatively better in the US with the manufacturing PMI signalling marginal growth in output at 50.4. However, the reading grew at the slowest pace since the height of the financial crisis in September 2009.
Central banks maintain accommodative monetary policy
Also in the news last week, the Federal Reserve reduced policy rates by 25bp in response to uncertainties with the global economic outlook and muted domestic inflationary pressures. Further, Chairman Powell indicated that the central bank was not in a long rate-cutting cycle and that the cut was not necessarily a one-off. This implies that the path of future monetary policy could depend on whether global uncertainties affect domestic growth and inflation. The central bank also confirmed that it will end the reduction of its aggregate securities holdings in the System Open Market Account i.e. ending quantitative tightening two months earlier.
In contrast to the US, the Bank of England (BoE) maintained current policy rates this week
However, the BoE reduced its forecast for UK economic growth for 2019 and 2020 to 1.3%, down from 1.5% and 1.6%, respectively, on uncertainties affecting businesses and investment. It also added that there is now a 33% chance that the economy will contract at the start of 2020 if interest rates remain unchanged. The BoE forecast assumes that the UK will avoid leaving the European Union (EU) without an agreement on its future trade relationship with the EU even though political developments this week, outlined below, may suggest otherwise.
In aggregate, near-term global monetary policy is expected to remain accommodative as inflation remains low, growth appears fragile and trade tensions represent an additional source of uncertainty.
US labour market remains relatively strong
The details of the US employment report released towards the end of the week pointed to relative strength in the labour market with non-farm payrolls gains of 164,000 for the month of July, which was in line with expectations. June employment growth was revised down from 224,000 to 193,000. With an unemployment rate of below 4%, average hourly earnings picked up at 3.2% year-on-year, marginally ahead of expectations of 3.1%.
US Q2 EPS growth moves positive as earnings season reaches nadir
Last week marked the tail end of the 2019 second quarter US corporate earnings with releases from 168 companies representing 28% of the S&P 500 Index market capitalisation.
The headline earnings-per-share (EPS) growth rate now stands at +1.2%, running ahead of pre-season expectations of -2.8%. As almost 80% of US firms have now reported. This rate is unlikely to change meaningfully and thus we expect US corporate earnings to be less of a market driver in the weeks ahead. Revenue growth currently stands at +3.5%, in line with the quarter, and the fact that this is slightly higher than EPS growth highlights modest margin pressures.
As discussed in previous notes, our main focus ahead of this season was on management guidance and market reaction to surprises. These elements have both continued to be generally positive. This was typified this week by Apple’s earnings report on Tuesday. The share price rose 4.5% after hours after the firm beat earnings and revenue growth expectations and delivered upbeat guidance for rest of 2019. It was interesting to note that CEO Tim Cook was positive on China, explicitly mentioning the benefits of VAT cut stimulus measures boosting demand.
Outlook
With trade tensions dominating market sentiment last week, focus will remain on an announcement expected from the US president on trade relationships with the EU on Friday.
The start of this week we will get PMI services and composite releases across major economies including China, US and the eurozone. These together with manufacturing releases will provide a gauge for near term economic activity. In addition, US PPI and Chinese CPI data would also be helpful for monetary policy outlook.
By Adam Kibble, Investment Specialist, Insight Investment Australia
