Taal selectie


Trade War 2.0

Pascal Blackburne & Luc Synaeghel 2019-02-01

A look at the recent performance of shipping stocks – or the Baltic Dry index (BDI) for that matter – would suggest that the end of the world is nigh. After all, transportation is typically considered a leading economic indicator, with shipping its most volatile segment. Should we really be readying for a disaster scenario?


2 years low on the Baltic Dry Index. Source: Bloomberg

Bulk shipping companies are currently trading at less than half their net asset value and barely three times cashflow. Only in the event of a global trade collapse, which would also mean a Chinese economic collapse (given the country’s weight in bulk imports), could ship values actually halve and cashflow evaporate. So, if shipping investors are correct, then all other investors are wrong – and hell is about to break loose. Fortunately, the underlying situation in the shipping industry is not as dire as stock prices suggest. Most companies charter their vessels on term contracts, rather than at the spot freight rates that are reflected in the BDI. And term pricing has remained relatively steady.

As regards the Chinese outlook, while recognising that the pace of growth is (quite naturally) slowing, we are confident that the ongoing stimulus will keep the economy on policymakers’ desired track. The impressive set of – mainly fiscal this time round – measures should deploy its effects during the second half of 2019. By that time, indeed perhaps already in the coming weeks, we should also get some good news on the trade front. Rebalancing US-China trade figures is not an impossible task. It would seem that both parties agree on what needs to be done, with China notably to up its oil and soya bean imports from the US, but disagree on the time frame. And we take President Trump’s recent message that nothing will happen until he meets with counterpart Xi Jinping to mean that there will be an agreement – providing him with the “moment de gloire” that he so badly needs in the current US political context.

This is not to say that the trade dispute will be over. Rather, it will take on a new dimension, more akin to a cold war. Under specific US target is the “2025 made in China” program, through which Chinese authorities intend to move their country up the value chain. The hitherto manufacturer of low-cost goods wants to become the world’s technological leader. Hence the pressure being put on Huawei by the US, furious that it be the only company actually able to roll out large scale 5G mobile networks.

What, finally, to make of the Federal Reserve’s (Fed) recent U-turn? We find it difficult to attribute this only to stock market jitters. Had that been the case, a pause in the rate hike process would have sufficed. Instead, the Fed suggested that it might cut rates or restart quantitative easing (QE) if need be. Effectively, we have gone back to the pre-QE world, in which central banks did not provide guidance. In turn, this means greater market volatility, and less visibility on the future trajectory of long rates.

Slower Chinese growth but no collapse


Source : Bloomberg

Officially, the growth target for the Chinese economy remains 6.5%. But most analysts expect policymakers to bring it down closer to 6% – which would still be a very strong pace considering the size of China’s GDP (second only to that of the US).

Future growth will come in part from investment in neighbouring countries, per the “One Belt One Road” initiative (or new Silk Road). But domestic consumption will also be key. On that front, recent concerns about a broad-based slowdown appear unwarranted. It is really only the auto component of retail sales that took a hit during the second half of 2018, for reasons that are unclear but could involve potential car buyers awaiting a probable 2% VAT reduction, newly imposed tariffs on US cars, a trend towards greater car sharing and some general weakening of worker sentiment amid the trade war with China. Excluding the auto segment, retail sales growth remained stable in 2018, at around 11%. Meanwhile, service consumption (not included in retail sales) continues strong.

Investors can also rest assured that Chinese policymakers will do the utmost to support their economy. Numerous easing moves have already been implemented since the summer of 2018, on the tax, government spending and monetary conditions fronts. And the annual Central Economic Work Conference held last December clearly advocated further counter-cyclical measures, alongside a continuation of structural supply-side reforms.

As such, the ongoing Chinese stimulus is very different to that undertaken after the Great Financial Crisis or during the 2015-2016 emerging market slump. Financial regulation and housing policy are seeing little change, in order to avoid further fuelling the credit boom. Rather, monetary policy is increasingly focused on interest rate transmission, while fiscal policy is clearly taking the lead, with tax breaks targeted at both the household and corporate sectors.

The official China Daily recently suggested that tax cuts could total 2 trillion yuan, or 2% of GDP, in 2019 – on top of the 1.5% afforded in 2018. Expenditure consolidation and more vigorous tax collection could, however, partly offset these tax benefits. Their diffusion to GDP growth is also unclear, with the multiplier likely smaller than that of government spending and possibly a longer lag. Still, Chinese GDP growth should be lifted by at least half a percentage point in 2019 and surprise investors positively.

Note finally that, although more oriented towards the domestic economy this time round, Chinese stimulus will have positive spill over effects on the other economies, reducing the risk of a global recession.

Towards a cold trade war

How the trade dispute evolves obviously also matters considerably to the global economic outlook. What began with the US President stating that he wanted to do away with his country’s trade imbalances, particularly vis-à-vis China, has now taken on a much broader dimension. At stake is not just the current US trade deficit, but longer term global technological domination.

In fact, as regards purely the trade deficit, a solution seems achievable, within a not too distant future. Since the 90-day tariff truce was agreed, high level negotiations have been proceeding between US and Chinese officials. Although little has been revealed publicly about these discussions, President Trump’s recent suggestion that he will meet with Chinese Premier Xi Jinping does suggest that an agreement is in the making. On shaky grounds domestically, the US President could certainly do with the positive hype that would come from announcing “the biggest deal ever made”. This will likely involve a Chinese commitment to buying more US oil and soya beans.

But that will not appease (justified) US concerns about China not playing a fair game, having little respect for intellectual property rights and hindering foreign company access to the local market. Such practices have played an important part in the rise of companies such as Huawei, which is presently in the direct line of US fire. For Huawei epitomizes China’s leap over the past years from assembler to engineer, from being simply the world’s producer of low-cost goods to offering the most advanced technological prowess – for a lower price than western competitors.

Not content with having had Huawei’s Chief Financial Officer arrested, the US have since filed other charges against the Chinese company and are pressuring fellow western countries not to roll out its 5G technology, on grounds of national security. Realistically, though, given the tens of thousands of employees engaged in Research & Development, derailing the Huawei engine will be an impossible task. Rather, we expect a technological divide to gradually form between the East and the West, with separate developments and leading companies on either side of the “wall”. Just consider, the famed US FAANG companies already have their Chinese counterparts – whose names may sometimes remain less familiar to us, but for how long (e.g. Alibaba, Tencent, Baidu…)?

In essence, the trade dispute is slowly evolving into a cold war. This suggests that a Trump-Xi Jinping agreement will provide only temporary relief. The technological competition between the US and China will live on for years to come, flaring up periodically and fuelling market volatility.

FED U-turn: implications for asset allocation

Also making for a more uncertain environment going forward is the Fed’s sudden U-turn during its first meeting of 2019. After lifting rates just six weeks ago and warning of further hikes to come, the Fed decided not only to leave rates unchanged but even opened up the possibility of a cut, as well as renewed balance sheet expansion. Chairman Powell cited a number of “cross-currents” for this radical change in stance, notably slowing growth outside of the US, the trade dispute and the US government shutdown.

YielsUS Bunds

US Treasury yield on the LHS, Germany Bunds Yield on the RHS. Source: Bloomberg

Many of these concerns were, however, already present when the Fed met in December. They certainly served to rock financial markets during the final weeks of 2018 (which some actually view as the real reason behind the Fed’s U-turn) but, as far as we can judge, the US economy remains on a solid path. Although growth should well slow down this year, recession is not an imminent prospect.

Particularly worrying to us is the fact that the Fed has relaxed its grip just when US wage pressure is building up. Between 2000 and 2017, the corporate sector captured an increasing share of national income, at the expense of labour. Real worker compensation effectively stagnated, with labour bargaining power constrained by globalisation and technological innovation. BCA Research calculates that the gap between the returns to capital and those to labour moved four standard deviations away from its historical mean – “an extraordinary divergence”. With an ever-tighter US labour market, this trend appears to have come to an end – and higher wage-driven inflation is a distinct possibility going forward.

In any event, we are now forced to do away with central bank guidance and revert to the investment world as it used to be before the era of QE. By this we mean more specifically that the assumption of a gradual rise in US long-term interest rates towards their “neutral” level can no longer be used as the basis for our portfolio positioning. Is being underweight the fixed income space still appropriate? If not, what segments of the bond market should be favoured, recognising that keeping part of the portfolio in cash is an expensive proposition and that corporate debt levels have reached worrisome levels? Similarly, we can no longer count on a continued US-Europe rate differential to sustain the dollar against euro, which has implications for currency allocation.

And then there is the Brexit saga, on which no predictions can frankly be made at this stage. What is does illustrate though, is the time and energy that Europeans leaders have been putting into managing crises across the region during recent years, rather than focussing on broader geopolitical and technological developments. With the consequence that Europe is clearly losing ground on the international chessboard.

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