Even if Trump and Xi make up at G20 in Buenos Aires, don’t hold your breath for a meaningful market rally
- Nicholas Spiro says the declines across asset classes indicate that trade tariffs are just one of the factors depressing investor sentiment
Are US President Donald Trump and his Chinese counterpart about to offer some much-needed relief to financial markets?
The highly anticipated meeting between the two heads of state at the G20 leaders’ summit in Buenos Aires at the end of the week is fuelling speculation that even a temporary ceasefire, or at least a pledge to keep negotiating, could provide a fillip to sentiment at a time when the mood in markets is increasingly bleak.
While it has become difficult to untangle the complex web of factors that have contributed to this year’s dramatic falls in asset prices – there have been simultaneous declines in bonds and equities which, according to data from JPMorgan, have resulted in the broadest losses in markets since the stagflation episodes in the 1970s – the rapid escalation in trade tensions between the US and China is an obvious culprit.
Not only has the trade war contributed significantly to the global growth scare that has become more pronounced over the past few months, it has exacerbated the acute tensions between Beijing’s two-year-old deleveraging campaign and its efforts to shore up growth. The policy confusion in China, whose equity market is this year’s worst performing major benchmark, has infected the broader emerging market asset class. If one excludes Chinese stocks, equities in developing economies are still down more than 15 per cent this year, compared with a 22 per cent fall in the Shanghai Composite.
Yet, even in China, sentiment was deteriorating before the trade conflict escalated in mid-June when America imposed tariffs on US$50 billion of Chinese imports. By the end of May, the Shanghai Composite was down 14.5 per cent from its peak in late January. The yuan’s steep decline against the dollar, moreover, began in April. Markets have been fretting about slowing domestic demand in China since the beginning of this year and have viewed the deleveraging drive as a bigger threat to growth than the trade war.
In global markets, the role of trade tensions as a key determinant of sentiment has been even more ambiguous.
Equity markets were already tumbling in early February as the so-called “short volatility” trade – speculative bets that the long period of tranquillity in markets would persist – began to unwind, causing the FTSE All-World Index, a leading gauge of global stocks, to fall 9 per cent in the space of 10 days. This was the first of several signs throughout this year that markets have entered a new regime of higher volatility as the world’s leading central banks, led by the Federal Reserve, withdraw liquidity.
The most recent declines in asset prices, initially dubbed “Red October”, have shown the extent to which trade tariffs are merely one of a number of vulnerabilities responsible for what Morgan Stanley aptly calls a “rolling bear market”.
Since early October, more sectors and asset classes – some of which were still performing strongly when the trade war erupted during the summer – have come under strain. Even higher-quality assets have succumbed to the selling pressure that began in emerging markets earlier this year. The high-flying technology sector, which turbocharged the rally in US stocks, is now bearing the brunt of the sell-off as investors fret that corporate earnings have reached their peak. The shares of Apple have plummeted 25 per cent since hitting a record high on October 3, dragging down the broader equity market.
More worryingly, US corporate bonds – which hitherto had proved extremely resilient – have come under the cosh. Over the past fortnight, spreads, or the risk premium, on American investment grade and high-yield debt have widened the most since 2016, according to data from Bloomberg, with energy bonds hit hard by the 32 per cent fall in oil prices since early October.
While emerging market currencies and stocks have risen since the end of last month, partly on hopes that Trump and Xi will find common areas of agreement to help ease tensions, the fact that nearly all major asset classes are in the red shows that stresses in markets run much deeper than trade tariffs. As JPMorgan rightly noted in a report published on November 16, “in the context of G20 hopes that intuitively should support all risky markets, the declines in tech stocks, oil and high-yield [bonds] in recent weeks are notable”.
All this suggests that the bar for a meaningful rally is high. Even if the outcome of the Trump-Xi meeting exceeds investors’ expectations – a distinct possibility given how low they are to begin with – there are simply too many problems plaguing markets right now for sentiment to improve significantly.
While global bond and equity markets, which this year have suffered their sharpest combined loss since the 2008 financial crisis, are desperate for good news, it will take a lot more than conciliatory words in Buenos Aires to lift the spirits of investors.
Nicholas Spiro is a partner at Lauressa Advisory