If US trade war has made investing in financial markets feel like a trip to the dentist, it’s best to grin and bear it

Hannah Anderson says a pro-risk tilt in portfolios is still appropriate, despite recent volatility, given that market fundamentals remain solid

PUBLISHED : Friday, 13 July, 2018, 1:02pm
UPDATED : Friday, 13 July, 2018, 10:32pm

I make terrible decisions when I’m anxious. A trip to the dentist fills me with dread. Seeing an upcoming appointment, I am more likely to cancel than just get it over with. This provides temporary peace of mind, but negatively has an effect on my long-term health. 

Right now, investors are anxious – anxious about US policy changes, about the global business cycle, about market sentiment, and again, anxious about stability in China. But they should realise that taking a deep breath and going through some momentary discomfort is the better decision for their long-term health.

Despite recent volatility, a pro-risk tilt in portfolios is still appropriate. Fundamentals remain solid in most markets, judicious investor reactions to recent headlines are encouraging and the forthcoming earnings’ season should validate the views of equity optimists.

One of the biggest sources of volatility for global markets in recent months has been US actions on trade. Markets have grown increasingly anxious about how protectionism will reverberate through markets.

Investors should be aware it will take markets some time to fully and appropriately price in the impact of these policies – which is one reason that the reaction immediately after an announcement has borne little resemblance to market behaviour in the following days.

Over the past 18 months, a protectionist trade announcement has corresponded to a 0.3 per cent fall in the S&P 500 total return on the day of announcement, followed by a 1 percentage point cumulative recovery over the subsequent five trading days.

The impact of rising trade tensions is a much more company-specific question than it once was. The majority of the value in the imports the US has imposed tariffs on comes from other countries besides China – refracting their impact around the world, but scaling down the damage on any one market.

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The US has delivered specifics on plans to enact tariffs on US$250 billion of imports from China. These plans, and China’s retaliation, only amount to 2 per cent of US and 3.2 per cent of China’s 2017 GDPs. China has retaliated one for one to each new round of tariffs, but it will be unable to continue to do so if the US pushes ahead with its latest proposed tariffs on US$200 billion of imports; the US does not export US$250 billion of goods to China.

In addition to targeting the most politically sensitive US exports with its retaliatory tariffs, China is likely to aim to get US companies to intercede on its behalf with the US government

China will have to choose between raising the tariff rate it applies (so equal levels of tariff revenues are collected), applying tariffs to services imports, or pursing alternative strategies. China is most likely to begin targeting US businesses operating in China. In addition to targeting the most politically sensitive US exports with its retaliatory tariffs, China is likely to aim to get US companies to intercede on its behalf with the US government.

Another source of investor anxiety has been renewed worries about stability in China. Domestic conditions that have little to do with trade – a mid-cycle macroeconomic slowdown, regulation-driven liquidity constraints and narrowing yield differentials – have produced volatility in onshore markets.

After entering a bear market earlier this year, Chinese equities found their footing earlier this week, but the trade news sparked a downturn. In the early stages of a market recovery, anything that damages sentiment can highlight fragilities.

After a strong 2017, domestic policy changes to cool the property market and reform the financial system, data momentum has rolled over a bit. A rebound towards the end of the year is likely, especially given policymakers’ proactive stance. Chinese officials have continually reminded us that monetary policy will be “neutral and prudent”; right now, it’s more prudent than neutral as authorities continue to provide liquidity through several channels.

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Additionally, US actions that threaten “Made in China 2025” are certainly more politically sensitive for China than ordinary tariffs, but the initiative is about the future – it’s where China wants its economy to go, not where it is right now.

While Chinese policymakers may be more willing to step in to ameliorate any negative effects of US tariffs on these industries than they would be for others, the overall impact from US tariffs on China is likely to be modest.

Maintenance – like remembering to floss – should mean fewer trips to the dentist. Investors should take the same approach: active asset allocation maintenance in response to changing conditions won’t make it stress-free but it can result in less anxiety.

As the global business cycle ages, investors may want to start to trim riskier assets like equities, but volatility alone should not deter them from a pro-risk tilt, especially when fundamentals remain solid.

Hannah Anderson is a global market strategist at J.P. Morgan Asset Management