Businesses shiver in the uncertain climate as US-China trade war tensions are renewed

The latest escalation in US-China trade war tension sheds light on two issues. First, while an agreement is still the more likely outcome in the medium term, the future is sure to be bumpy. Both sides have to balance the need to limit economic damage with not appearing weak in front of their domestic audiences.

Fundamental differences in political ideology, economic systems and structure will place these two superpowers on a path of confrontation for years. In particular, competition over technological development, such as 5G technology, as well as how to make use of big data and artificial intelligence, could be key flashpoints.

Second, the new round of tariffs has brought back uncertainties for businesses. Businesses around the world were just starting to feel more settled as negotiations between the two sides proceeded. This latest renewal of tensions could hurt sentiment again. Weaker corporate investment could delay the recovery in the global trade cycle and growth momentum.

This sense of deja vu sets up a more challenging investment environment as we approach the halfway point of 2019.

Looking back to the height of trade tensions, from April to November last year, different asset classes behaved in a variety of ways. Unsurprisingly, downbeat sentiment hurt northeast Asian equities the most, including China, Taiwan and South Korea. These economies are highly connected by the manufacturing supply chain.

Taiwan and South Korea were also hurt by the global electronic downcycle, which has yet to improve. Stock markets in Southeast Asia and India were relatively less affected, being further from the epicentre of the trade war and potential beneficiaries of diversification in the Asian supply chain away from China.

Meanwhile, in fixed income, emerging debt had a tough time last year. This probably had more to do with the US Federal Reserve engaging in policy normalisation, and the US dollar strengthening. Higher US Treasury yields put pressure on many countries. Many emerging market currencies depreciated significantly, forcing their central banks to raise interest rates to limit capital outflow and restore currency stability.

The trade tension backdrop seems to be reverting back to the 2018 scenario, but several differences now imply that the asset return outcome could be different.

As mentioned earlier, the Fed is content with the current level of interest rates. Should the trade war escalate further, the US economy could see higher inflation and weaker growth. The Fed is likely to focus more on the latter since inflation has been running below target for some time and is unlikely to be a material threat even with higher import costs.

A more patient Fed is also standing back as developed market and Asian central banks opt for rate cuts, such as India in April, and New Zealand, Malaysia and the Philippines in recent weeks. China has also done a policy U-turn compared to a year ago, shifting away from corporate deleveraging to supporting growth. More tariffs could mean more fiscal and monetary stimulus to protect domestic demand.

US-China trade tensions are likely to remain a source of market volatility in the months ahead, calling for a more diversified approach in asset allocation between equities and fixed income. Given the low cash-rate environment in Hong Kong, returns are likely to fall behind inflation.

In fixed income, despite more uncertainties facing the economy, the willingness of global central banks to keep monetary policy loose should prompt investors to continue to look for income. This would point towards global corporate debt and also Asian fixed-income products. For those who consider themselves very conservative, short-dated US government bonds offer interest rates of more than 2 per cent, with lower price volatility compared to corporate debt and equities.

Equities may not get much love in this environment, but there are some positive long-term stories to consider. US corporate earnings for the first quarter may seem slow, with only 4 per cent growth for the 90 per cent of S&P 500 companies that have reported so far. However, this is ahead of market expectations and a modest earnings forecast upgrade could help.

Meanwhile, in Asia, the structural growth story for many economies remains intact, and this requires a more active approach in sector and company selection. High-dividend stocks also provide some buffer against market volatility and more consistent cash flows contributing to returns.

Tai Hui is chief market strategist for the Asia-Pacific at JPMorgan Asset Management