Last week, the
US and China signed their Phase 1 trade agreement. This trade deal is a paradox
— in my view, it is both inconsequential and yet extremely important.
inconsequential for two reasons: Tariffs will remain in place on a large amount
of goods traded between the US and China, and the deal doesn’t tackle many of
the most important trade issues between the two countries. However, it is extremely important because
of what it symbolizes: This trade deal suggests that friction between the two
countries has peaked and is moving lower. The
psychological effect is very significant, as it means that economic policy
uncertainty has fallen. And, when companies believe economic policy is more
certain, they typically spend more, especially on capex.
flies in the ointment
Now, there is a small chance this deal may
not hold. I don’t believe China will be able to purchase US goods at the level it
has committed to, based on its history of purchases as well as the deeper trading
relationships it has formed with countries such as Brazil. And I believe that’s
why the US has not rolled back many tariffs. In fact, it has been reported that
the US will not roll back any more tariffs until after the US presidential
election, and that a roll back would be contingent on China adhering to its
commitments in the Phase 1 agreement. However, I think the Phase 1 deal will
hold, regardless of whether all commitments are honored as it’s in the best
interest of both parties.
I should also underscore that I do not
expect a Phase 2 trade deal between the US and China to be signed this year. A
Phase 1 deal was relatively easy to achieve because it tackled a lot of the low-hanging
fruit — easier issues such as trade imbalances. Now that all the easy issues
have been resolved, we have to expect that Phase 2 will be far more difficult
Perhaps most sobering was a recent post in Taoran Notes (a blog affiliated with China’s official Economic Daily newspaper, which can
reflect official government views). It cautioned that “We must bear in mind
that the trade war is not over yet —
the US hasn’t revoked its tariffs on China and
China is still implementing its retaliatory measures. There are still many
uncertainties down the road.”1 And
so I believe that continued talks around Phase 2 are all we can hope for, and
we are likely to see such talks — but it is highly unlikely that we get a deal.
However, I think that the conversation will be enough to satisfy stocks.
a US-EU trade war be on the horizon?
There remains one key risk that I have
worried about for a while: Now that the US has signed the trade deal with China,
will it now turn its attention to the EU and escalate a trade war there? The
tension between the two has been clearly building: Last week, the EU’s chief
trade negotiator visited Washington, DC, in an attempt to avert US trade
aggression toward the EU. And talks will continue on the sidelines of Davos
this week. However, I believe there is a good chance of an escalation in trade
tensions — this could be politically popular in an election year for the US,
and I believe a trade war with the EU would be less damaging to the US economy
than a trade war with China. However, it could be psychologically damaging to
companies, raising economic policy uncertainty and tamping down capex spending.
So we will want to follow the situation closely.
And so economic
policy uncertainty has, for now, declined. I expect we will see capex spending
increase. We are anecdotally hearing that Chinese household sentiment has
turned much more positive in particular, which should be good for the Chinese
economy and Chinese stocks. Chinese stocks could also continue to benefit from
the end of balance sheet normalization, which occurred last September and is
beginning to inject some liquidity into markets.
1 Source: South China Morning Post, Jan. 13, 2020
image: d3sign/ Getty
spending (or capital expenditures, or capex) is the use of company funds to
acquire or upgrade physical assets such as property, industrial buildings or
referenced above are those of Kristina Hooper as of Jan. 21, 2020. These
comments should not be construed as recommendations, but as an illustration of
broader themes. Forward-looking statements are not guarantees of future
results. They involve risks, uncertainties and assumptions; there can be no
assurance that actual results will not differ materially from expectations.