Trader Thomas Ferrigno works on the floor of the New York Stock Exchange on May 17, 2019. The current level of asset prices does not reflect the increasing probability of a protracted trade war. Photo: AP
Nicholas Spiro
Nicholas Spiro

As the US-China trade war escalates, stock markets have been shaken but not stirred

  • A mere 3 per cent drop in the S&P 500 this month, despite the escalation in the US-China trade war, indicates that markets have not adequately grasped the risk that the conflict poses
How concerned are financial markets about the renewed escalation of the trade war? A cursory glance at some of the key gauges of market performance suggests that US President Donald Trump’s impulsive decision on May 6 to threaten to raise tariffs on all Chinese imports to 25 per cent, followed by the White House’s two-pronged attack on China’s Huawei Technologies – curbing its access to America’s market and placing the firm on a banned entity list – has rattled investors.

Since May 3, the MSCI Emerging Markets equity index has plunged nearly 8 per cent, reducing the gauge’s gains since the start of this year to 3.3 per cent. Chinese stocks, meanwhile, have fallen for the past four weeks, with the CSI 300 index of large-cap mainland-listed shares down 11.4 per cent since April 19.

What is more, the yuan – which Nordea, the Scandinavian financial services group, dubs “the most important gauge worldwide currently” – has slid 3.2 per cent against the US dollar since April 17 and is once again close to the psychologically important 7.0 mark.

More worryingly, the Trump administration’s offensive against Huawei has accentuated concerns about a “digital iron curtain”, dividing the world into two separate technological spheres.

The Philadelphia Semiconductor Index – a US equity gauge that tracks companies which design, distribute and manufacture semiconductors – has lost 13.5 per cent so far this month, putting it on course for its worst month since the global financial crisis. As recently as April 24, the index was trading at an all-time high.

The dramatic sell-off in semiconductor shares could be the canary in the coal mine. According to Bank of America Merrill Lynch’s latest fund manager survey published earlier this month, a “long”, or overweight, position in US tech stocks is the most popular trade in markets, thus providing ample scope for further price declines if Washington and Beijing fail to make significant headway in their negotiations by the end of June when the G20 summit in Osaka will be held.
Google CEO Sundar Pichai speaks during the annual Game Developers Conference in San Francisco, California in March. A recent fund manager survey found US tech stocks to be the most crowded trade. Photo: AFP

Still, broader sentiment in stock markets has held up surprisingly well, given the degree to which US-China relations have deteriorated and the dire consequences of a full-blown trade war for the global economy.

For all the escalation in trade tensions, the MSCI All-Country World Index – a leading gauge of stocks in developed and developing economies – has lost only 3.5 per cent so far this month, leaving the index less than 8 per cent shy of its record high set in January last year. The benchmark S&P 500 index, meanwhile, stands 3 per cent below its latest all-time high reached on April 30.

Volatility in equity markets, moreover, remains subdued, with the VIX Index – Wall Street’s so-called “fear gauge” which measures the anticipated volatility in the S&P 500 – currently standing below 15, only several points above its historical low.

As JPMorgan rightly noted in a report published last Friday, “the global market correction remains mild by the standards of this trade war”. The question is whether the current level of asset prices adequately reflects the increasing probability of a protracted, full-scale trade war.

It should be clear to investors by now that it patently does not. Even if one accepts the fact that the Federal Reserve’s decision earlier this year to put its interest-rate-hiking campaign on hold is helping shore up sentiment, markets are underpricing the severity of the geopolitical stand-off between America and China.
The Trump administration’s decision to aggressively target Chinese tech companies marks a new, more dangerous phase in the conflict that is fuelling long-held suspicions in Beijing that America’s real objective is to contain China. The Communist Party’s more defiant stance – notably its refusal to cede sovereignty over key elements of China’s industrial policy – shows that there is no room for compromise based on the terms demanded by the White House to end the trade war.
In a report published last week, US brokerage Academy Securities noted “there is reason to believe that the US has now crossed the Rubicon in terms of dealing with China”, adding that the Trump administration is now showing a “true commitment” to treating China as the “ strategic competitor” it had labelled it as.

Markets are so far unwilling to price in a long, all-out trade conflict, partly because investors are convinced it is in both countries’ interests to strike an agreement as soon as possible. Yet, even if an 11th-hour deal materialises, the geopolitical and commercial tensions between China and the US will persist.

For some time now, investors have struggled to gauge the market implications of a trade war, mainly because of Trump’s unpredictability. While traders were burnt at the end of last year by being overly pessimistic, a 3 per cent fall in the S&P 500 this month in the face of a rapidly intensifying economic conflict between America and China smacks of complacency.

Nicholas Spiro is a partner at Lauressa Advisory

This article appeared in the South China Morning Post print edition as: Are stock markets taking the conflict seriously enough?