A Trade Deal Is Nigh. The Question: How Much Is Priced in?

(Bloomberg) -- A U.S.-China trade deal may just be the icing on the cake that’s the $10 trillion global equity rally since Christmas.

The Stoxx Europe 600, MSCI Asia Pacific and S&P 500 futures are all up less than 0.5 percent on Monday -- not too shabby but a little mild following news that the two bickering superpowers were near a deal that could lift most or all U.S. tariffs on Chinese goods.

But with global equities rebounding sharply in 2019, the question has gone from deal-or-no-deal to the extent to which an agreement has already been priced in. In addition to the Federal Reserve’s dovish tilt, growing optimism over U.S.-China trade talks has fueled much of the new-year rally -- as evidenced by gains in the most trade-sensitive market segments.

A Trade Deal Is Nigh. The Question: How Much Is Priced in?

“While this morning’s optimism is all well and good, it does beg the question as to how much is already baked in to the price, given that most of the rebound this year has been predicated in a dialing down of trade tensions,” Michael Hewson, chief market analyst at CMC Markets U.K., wrote in a email.

It’s obvious if you look at what has outshone markets this year: Chinese shares, cyclical stocks, and European companies with large exposures to emerging nations. It’s all the more remarkable given the dip in economic momentum, with a Citigroup Inc. gauge of global economic surprises falling to the lowest since 2013.

A Trade Deal Is Nigh. The Question: How Much Is Priced in?

Part of this is also driven by expectations for a Chinese recovery underpinned by stimulative policies. And of course valuations flattened by late 2018’s sell-off have also helped.

There’s still a bullish case to be made, and plenty of strategists are predicting further upside should a substantive deal be reached. The 2019 stock rally has been, as Morgan Stanley strategists put it, “overbought but underowned,” with equity funds posting outflows and hedge funds remaining cautious in their positioning. A trade compromise could be the catalyst for luring money back into the stock market.

UBS Group AG strategists argue that global stocks are still trading at a 10 percent discount owing to the trade war -- a gap that could eventually close.

Global equities might indeed see a relief rally when the deal is finally inked, but that will bring forth fresh worries, including the return of Fed tightening and the possibility that U.S. President Donald Trump will target European trade next, said Ben Kumar, a money manager at Seven Investment Management in London.

“The sentiment shift -- that a deal might be done -- kind of happened over the last two months,” he said. “Add into that my view that a trade deal and a market rally might lead to a shift in the Fed -- back to rate rises -- and I think the lack of reaction makes sense.”

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