On Friday the regular Dividend Café for the week went out, and it included as much of an update as possible around the UK elections and the China trade war … But within hours of the submission there was more news, and then the next day even more, and then over the weekend even more still. I don’t want to wait until Friday to provide the latest….
Here is our Investment Committee’s special podcast on the recent events:
Dividend Cafe – Investment Committee Podcast
Dividend Cafe – Vidcast
But essentially, the following points need to be made:
- The text of the “phase one” China trade deal has not been released, as a “bilingual, legal” version is being constructed and is expected to be released in January.
- That said, the deal has been reached and for the first time the two country’s reports about the deal seem to match each other (there had been several somewhat contradictory reports on our way to this level)
- The $160 billion of imports set to be tariffed in December will not be (this had been pretty priced into markets, so not getting this done would have created downside pressure in markets; getting it done is not much of a market event)
- $120 billion of imports that have been taxed at a 15% tariff rate will now incur a 7.5% tariff rate (this is a positive for the market)
- And $250 billion of imports will continue to be taxed at a 25% level (from tariffs imposed in 2018). China says there is a “formula for reduction” on this, but the U.S. has not made that clear.
- The areas the deal mostly focuses on are:
- (1) trade deficit reduction, primarily through China Ag purchases
- (2) yuan in a bounded range
- (3) IP protection; forces technology transfer protection
- (4) greater access to China’s financial markets
- The bulk of the deal focuses on, essentially, “export restraints” for China, similar to the impositions on Japan in the 1980s. The $200 billion of purchases China has pledged to make from the U.S. over the next two years will be primarily in agriculture
- We still want to see how the deal holds up after its full release when critics and hawks (in both countries) lay into it. What political pressures will exist and how will the deal sail at that point?
- And because there is a “snap-back” provision that tariffs can be hiked again for non-compliance, will markets accept at face value that China will comply with the new deal, or will a “wait and see” period be necessary?
- The technology war with China is not really improved in this deal, as most of the structural change is left for a potential phase two deal. Our view is that incremental changes are embedded in phase one (positive changes), but a lot of work is to be done here with a myriad of options in how it will play out.
The most encouraging elements of this deal going into 2020 are, of course, the de-escalation of destructive and distortive taxes (tariffs), along with the potential re-stabilizing efforts in global currency markets (more on this in a moment). That said, there really is a question mark as to whether or not this deal went far enough to allow for capex to pick back up in 2020. If uncertainty from the trade war caused the decline in business confidence and business investment (it did), does the likely “pause/truce” for 2020 create enough certainty to allow a reversal of that dynamic?
As for the currency angle, it is difficult to fully assess the impact of the currency commitments because so few people have properly understood what the real lay of the land was, to begin with. The popular refrain has been that China is weakening its currency artificially to boost their export advantage. The renminbi advanced 1% on Friday alone relative to the U.S. dollar. But the fact of the matter is that China has been intervening (artificially) to strengthen its currency for years now, not to weaken it, and what many have called “interventions to weaken” have really been “lessening their interventions to strengthen” – a distinction with a difference! The People’s Bank of China has had to prop up the Yuan since 2015 (at least), and the multiple factors at play here do get simpler with decreased trade tensions. Since September, I have been reasonably confident that the U.S. threats around currency retaliation (from August) were going nowhere. The currency silo of this phase one deal solidifies that assertion, thankfully.
I do agree with chief White House economic advisor, Larry Kudlow, that these trade deals getting done is worth an extra half a point to GDP growth in 2020 (i.e. if we were going to grow at 2% the number is now closer to 2.5%; if it was going to be 1.5%, the number is now closer to 2%, etc.). The problem is that what baseline GDP growth was tracking to be is not clear to me. But in any dissection of economic growth the headwinds removed by these deals improve economic growth prospects.
What you have between the glorious outcome of the UK election last week and the reasonably positive outcome on this phase one China-trade deal is a diminishment of left-tail risk. What this means is that some out of the outlier risk of “really bad” things has been diminished [a great deal] but not eliminated. The lower risk-headwind environment bodes well for risk assets and justifies a higher risk asset valuation. UK sterling shorts were decimated last week and the short-covering rally has been something to behold. The path for the negotiated Brexit is extremely visible and likely at this point, again eliminating a major factor in global markets volatility (note: I say volatility, not substantive health, as I never believed a no-deal Brexit was a real threat to the health of UK markets).
The NAFTA 2.0 deal (USMCA) has been agreed to by the House Democrats and the White House, though there is chatter over the weekend that Mexico and Canada each have small points they are pushing back on (from new revisions). We will watch this but expect it to be ratified by all parties in short order.
If it feels like a lot of the conversation topics in financial media of 2020 are coming to an end, it is because they are. Fear not, new topics will surface, and if they don’t, the media will find some. But the overall conclusions we would offer is that:
A very good economy has seen a few disruptive risks diminished in the last 72 hours. Yet some questions still exist.
If that seems ambiguous, I would just point out that it is close to the lowest level of ambiguity we’ve had in quite some time. It is hard not to conclude that emerging markets will be a big beneficiary in all of this (weaker dollar, reduced global trade risk, improved global economic outlook, diminished tail risk, enhanced currency stability picture, etc.). Our emerging markets confidence is enhanced by these developments, and our U.S. equity confidence is modestly enhanced, but still with some trepidation as we wait for the “written deal.”
The Bahnsen Group wishes to close out this special Dividend Café with wishes for restful peace to central banking giant (literally), Paul Volcker, who passed away at age 92 last week. Volcker served as Fed chair in the late 70’s and most of the 1980s and is accurately credited for having broken the back of inflation in an era now incomprehensible in central banking (where high-interest rates were deemed acceptable to stem off asset and price bubbles). Additionally, investment banking legend, Felix Rohatyn, passed away Saturday at age 91. Few people off Wall Street could appreciate what the famed pioneer of Lazard did for M&A, investment banking, and American financial markets. Few people on Wall Street did not have their careers impacted by his work (at least indirectly). RIP.
