The Perils of Betting on a Quick End to U.S.-China Trade War
(Bloomberg) -- If you’re an investor who believes, as many obviously do, that the U.S.-China spat will be resolved mostly because any alternative would be catastrophic, the recent history of international trade rifts is probably not something you want to think too hard about.
While parallels between the Trump-Xi showdown and Britain’s secession drama are imperfect and the forces not quite a match, equity bulls pinning their hopes on common sense and mutual self interest should take heed. Just because something should be resolved, doesn’t mean it will.
“The logic is that it has to, because it’s so bad on both ends if we don’t. But my only concern is we used that exact same logic with Brexit numerous times,” said Samantha Azzarello, global market strategist for JPMorgan ETFs. “When there’s group-think and everybody is thinking this, the repercussions, at least in the shorter-run, can be even more magnified for market reaction.”
Which explains Monday. After a fitful week in which major averages repeatedly fell and recovered, resigned investors decided not to test the market’s resilience. The result was the worst tumble for the S&P 500 in four months.
Plenty of people predict the trade war will be short-lived. JPMorgan Chase & Co.’s Azzarello says the most likely outcome is still that a deal is made. Bank of America Merrill Lynch’s Jill Carey Hall told Bloomberg Television last week that the firm’s “base case view is we do get a deal on trade.” Oxford Economics expects “a deal over the summer months.” At UBS Group AG, the belief holds that the “U.S. and China will eventually reach some kind of accord.”
The reason? As Mark Haefele, UBS Global Wealth Management’s chief investment officer, wrote: “Both the US and China have strong incentives to reach a deal and we do not expect a complete breakdown in negotiations.”
To that, it might be observed: neither did the U.K. and the EU. The reality has been different. After spending years deluded into a belief British voters would never elect to leave, investors gasped when they did. In the three years since, virtually every hope pinned on cooler heads has unraveled. Politics has proved too fickle a force to model.
Too much can be made of the similarities. But anyone watching American stocks rattle around for the last six sessions has gotten a lesson in the hazards of being over-confident and counting on what seems like logic.
Take last Monday, when weekend tweets from President Trump sent the S&P 500 down 1.6%, only for the benchmark to stage a midday rally and recover when everyone decided it was a bluff. After the close, U.S. Trade Representative Robert Lighthizer reiterated the tariff threat, and the S&P 500 fell 1.7% the next day.
A similar pattern took hold Friday. Higher tariffs went into effect at midnight, and U.S. stocks spiraled 1.6% through the morning hours. Then Treasury Secretary Steven Mnuchin characterized negotiations with China as “constructive,” and the whole drop was reversed. Three days later, after more Trump belligerence and China’s retort, half a trillion dollars got erased from U.S. shares.
“People thought, OK, there’s still plenty of time, but then we had the delayed response because the tweets over the weekend and the communications coming out -- the war of words has clearly been raised,” said Larry Adam, the chief investment officer for Raymond James, which has $796 in client assets, noting that the firm still believes a deal will get done. “They’re going to get a deal. The problem right now for me is what does the deal now mean?”
To be sure, Brexit’s impact on U.S. and European assets ended up being negligible -- both are up since the June 2016 vote. Will the same be true for the trade spat? Many investors are dubious. Mike Wilson, Morgan Stanley’s chief equity strategist, says the escalation has increased the likelihood for a prolonged economic downturn. JPMorgan Chase & Co’s head of cross asset fundamental strategy, John Normand, warned that stocks could fall another 10%.
“We had all these rallies on, ‘Oh, we’re working on a deal, we’re getting closer to a deal, we’re getting closer to a deal,”’ said Michael O’Rourke, JonesTrading’s chief market strategist. “Well, here we go. And what happened in the past week is not only do we not have a deal, we’ve been going in the exact opposite direction.”
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