The last week’s market highlights:
Quote of the week:
“If you must play, decide on three things at the start: the rules of the game, the stakes and the quitting time.” – Chinese proverb
Each week, we present our featured topics in the context of the major themes listed below from Nuveen’s 2020 Outlook :
- U.S. economy: No recession in sight.
- Global economy: A clearer path for growth.
- Policy watch: Fed looking to stand pat as Brexit and trade risks abate.
- Fixed income: Low yields, tight spreads.
- Equities: Cyclicals and eurozone stocks set to lead.
- Asset allocation: No big bets with valuations rich in most spots.
A phase-one trade deal is signed and sealed. Did it deliver for the U.S.?
After nearly two years of negotiations that included harsh rhetoric, temporary detentes, dampened hopes, finger pointing and—most of all—billions of dollars of tariffs on items ranging from tuna to tungsten, the U.S. and China agreed to a “phase-one” trade deal on January 15. The agreement, a relatively modest one considering the wide range of issues involved, ushers in a fragile truce at a time when both sides feared the economic and political damage from the ongoing trade tussle.
Under the deal’s terms, the U.S. will (1) cancel tariff increases on roughly $150 billion of Chinese goods that were originally set to take effect on December 15 and (2) cut in half the existing 15% tax on about $120 billion of China’s exports that had been imposed in September. Notably, full tariffs remain on a majority ($360 billion) of the Chinese goods sold in the U.S.
In exchange, China pledged to increase orders of U.S. farm products, manufactured goods, energy products and services by a combined $200 billion. China also loosely agreed to (1) provide U.S. companies with greater access to its financial services sector, (2) refrain from devaluing its currency in order to boost exports and (3) modestly enhance its protection of U.S. intellectual property.
With phase one concluded, negotiations for phase two will start ...at some point. National Economic Council Director Larry Kudlow believes the two sides will begin “immediately.” But according to China’s Global Times, talks may not happen “anytime soon.” Regardless of the time frame, thornier issues still need to be hashed out. These include China’s requirement that foreign firms partner with a state-run company if they want to do business there—an arrangement known as forced technology transfer.
President Trump refered to the deal as a “momentous step.” His Chinese counterpart, Xi Jinping, stated that “it is a good thing for the U.S., China, and the entire world.” What’s our take?
Aside from making loose promises on intellectual property and currency management, China isn’t vowing to do much that it wasn’t already doing in early 2018, before the trade war began. Tariffs will remain on most Chinese imports, continuing to hurt U.S. consumers and businesses. Here are some examples of the damage likely caused or exacerbated by the trade war:
- U.S. industrial production shrank 1.0% in 2019, the worst year-on-year drop since 2016.
- Manufacturing activity fell to a 10-year low in December, according to the ISM’s purchasing managers’ index.
- Investment detracted from U.S. GDP during the first three quarters of 2019. (We’ll get the full-year picture on January 30, when the government releases its advance estimate of fourth-quarter GDP growth.)10
All this seems like a steep price to pay for such modest concessions from both sides. Nonetheless, given a choice, we prefer this détente, which should reduce some of the uncertainty confronting businesses, over the prospect of continued escalating trade tensions.
Equities/fixed income: Emerging market opportunities, anyone
Now that a trade deal (however modest) is in the books, and hostilities between the U.S. and China are at a relative low point, investors may be considering adding to or beginning an allocation to emerging market (EM) equities and debt (EMD). Here are three reasons we’re currently favorable toward the EM environment:
- EM central banks take it easy. With inflation low across much of the developing world, EM central banks have been actively trimming interest rates, which has helped boost economic growth in these markets. According to Reuters, December marked the 11th consecutive month in which EM central banks, on net, delivered interest-rate cuts—the longest such stretch since 2013. And even in cases where they’re not lowering rates, some central banks are still in stimulus mode. The People’s Bank of China, for example, recently held rates steady while reducing the portion of deposits commercial banks are required to set aside as reserves, a move designed to spur lending.
- BRICs could do the trick. There’s evidence that EM central bank policy is having the desired growth effect. The JPMorgan Global Composite Purchasing Managers’ Index, which measures manufacturing and service-sector activity, rose to 51.7 in December, an eight-month high. (Readings above 50 indicate expansion.) Notably, Brazil, Russia, India, and China—the four major EM countries represented by the “BRIC” acronym—all experienced economic expansion last month. With the BRICs bringing momentum into the new year, the International Monetary Fund forecasts EM growth will accelerate from 3.9% in 2019 to 4.6% in 2020, more than double the pace of developed markets.
- Prospects for a weaker dollar. A pickup in EM growth, were it to occur, could lift EM bond yields while extending the rally in EM stocks. (This asset class surged 11.8% in the fourth quarter of 2019, outperforming the S&P 500 Index, and has gained 2.9% thus far in 2020.11) The potential scope of such market action could lure investors out of U.S. securities (and the dollar) and into EM assets and currencies. The resulting weaker greenback would make it cheaper for EM issuers to service and repay dollar-denominated debt, thereby broadly benefiting the economies of those countries.
We believe this attractive backdrop offers the opportunity for outperformance by EM equities, although their valuations are not especially compelling (compared to either the U.S. or their own recent history). In contrast, EM debt looks attractively priced next to U.S. high-yield bonds and is not particularly expensive in its own right versus historical valuations over the past decade or so.
And for income seekers in today’s low-yield world, EMD also merits consideration, in our view. As of January 17, the asset class offered a 4.73% yield, nearly 250 basis points (2.50%) above the broad U.S. investment-grade market, according to Bloomberg Barclays indexes.
Because of their unique characteristics, opportunities and risks, EM fixed income and equities are challenging asset classes in which to invest using passive strategies. Therefore, we believe active portfolio management is the best approach to these mandates.