Weekly Market Review - 20 May 2019


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This week has been all about tariffs and Iran. Although concerning, equity markets are more or less flat on the week but bond yields are down a little. However a lot is happening below the surface.

To quote the Nobel prize winning economist Paul Krugman: “The short term costs of a trade war tend to be overstated but the long-term consequences of what is happening are bigger than most people seem to realise.

It is hard to justify claims that the trade war will cause a global recession but the Trump tariffs, should they all take effect, could still roll back at least 20-30 years of tariff declines.

Globalisation has been a key factor driving US profit margins higher by depressing US price and wage inflation and by boosting offshore earnings of US companies. This is particularly true for US technology; the sector has the highest percentage of non-US sales, at some 50%. So while US economic data may not be impacted much by the tariff war, the impact on US industrial and tech earnings could be larger. This means there is scope for further market downside if current tariffs remain in place permanently.

However, it does feel like the tariff saga has the makings of an actual tech war now that Trump has issued an executive order laying the ground for US companies potentially being prohibited from using telecoms equipment made by the Chinese company Huawei.

It is increasingly likely that the Chinese will see the trade dispute as a US effort to contain China economically as opposed to an effort to level the playing field. Unfortunately for markets, China bashing seems to be very popular with the US electorate and there is a presidential election next year. On the other hand, Trump also wants a strong stock market – or at least not a falling one with the election in mind. Therefore, some analysts have assigned a 60-70% chance that meetings between Trump and Chinese President Xi at the G-20 summit in Japan on June 28th get the trade talks back on track. However, this is no longer a near certainty and between then and now investors are at the mercy of presidential tweets.

On Iran, it is noteworthy that the nuclear accord is at risk of collapse after Tehran announced it would cease to implement some of its commitments under the 2015 agreement. This move came amid rising tensions as America ramps up pressure on the country one year after Trump withdrew the US from the nuclear accord. This move increases the likelihood of a military accident happening in the Middle East, which if it were to occur would be bad for risk assets except for oil. This could also benefit gold (a risk-off asset), which has provided a real return to investors over the last 10 years, 20 years and 30 years.

The bottom line is that without a positive catalyst, the global growth backdrop is not very supportive for further substantial gains in risk assets from here, given current valuations.

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