AS THE TRADE WAR ESCALATES, GLOBAL DEMAND SLOWS
For a year now, global stocks have been highly sensitive to the US/China trade negotiations. This year the US/China trade saga has gone from looking optimistic through the 1st quarter, to an escalation of tariffs in May and, most recently, to a further hardening of attitudes to any agreement from both sides. It is this last development, coupled with the recent proposal of tariffs on Mexico, that caused us to reduce international stocks last week. US and Chinese leaders are determined not to show weakness, which is why the recent breakdown in talks is alarming. Someone is going to have to blink for progress to resume, and both leaders seem to have entrenched their hardline positions. Not surprisingly, global stock markets have fallen around 7% from their recent peak and have fallen below meaningful support levels, in our view (see chart, below).
From a fundamental perspective, economic data is softening all over the world as uncertainty over global trade is causing both consumers and businesses to reduce spending. This is especially true in Europe and Japan, where the major public companies are very sensitive to demand from China and the US.
Fundamental uncertainty is reflected in global stocks (as measured by the MSCI World Stock Index), which has broken below the 200-day moving average. The 1st quarter of this year saw the index recoup all of the losses from the 4th quarter and return to the highs of last September. Until the trade talks soured, it looked like the index might make it above the September high, but now it has broken below support at the bottom of our indicated decision box (blue horizontal lines, chart below), suggesting the recent weakness could persist. We think the next support for global stocks is around 480 (dotted line, chart below).
GLOBAL STOCKS BREAK BELOW THE BOTTOM OF A TRADING BAND
It’s not just the stock market that is worried about growth. Around the world, bond yields have been falling. Ten- year government bond yields in Germany and Japan are negative, and the yield on the 10-year US Treasury note has fallen by more than one percentage point, from 3.2% to 2.1% since last October, with half of that coming in just the last few months.
US 10-YEAR BOND YIELDS AT LOWEST LEVELS IN 18 MONTHS
The fixed income markets are telling the Fed that rate cuts are needed, because the yield on 3-month interest rates – which are highly dependent on expectations about Federal Reserve policy – are now slightly higher than 10-year yields.
RIVERFRONT REDUCING EXPOSURE TO INTERNATIONAL STOCKS
Our portfolio management teams have decided to lower overall exposure to international equities. In our shorter-horizon portfolios, we have left the proceeds in cash. In our longer-horizon portfolios, we have reallocated the proceeds back into US stocks, thus keeping our overall stock weighting approximately the same. Our base case remains that the world will avoid recession in the near-to-intermediate term, but complications as discussed above have caused us to lower our conviction level. Since mid-May, when we last wrote about trade (Weekly View, 5/13/19) there has been a series of rolling events that, in aggregate, have darkened the near-term outlook for international stocks. In our opinion, these include:
- Increased threat of a protracted, multi-front ‘trade war’ between the US, China and other trading partners. While we believe that the US and its partners have more to gain via an eventual cease-fire as opposed to a prolonged altercation, the longer this uncertainty drags on, the higher the probability of lasting damage to the global economy. Importantly, we believe this dynamic has the potential to impact earnings in both developed and emerging market economies should the trade war drag on.
- European political uncertainty. Following the departure of Theresa May as Prime Minister in the UK, the risks around a potential ‘no-deal’ Brexit have increased, though we still believe this to be a low-probability event. In general, the mixed results of the European Parliamentary elections last week have fractured established party politics in many major European nations and increased uncertainty, including around who may succeed Mario Draghi as head of the European Central Bank this fall.
- Continued deceleration in economic survey data in numerous developed and emerging market economies, which may challenge the global economic recovery.
As we discussed earlier, our technical analysis of global stocks – the ‘message of markets’ – is corroborating our increased near-term caution, suggesting international stocks have worse odds of positive absolute and relative returns versus the US over the next 3 months. We would note that the U.S. economy is still the strongest major economy, that the US still holds the upper hand in trade negotiations; thus, we continue to believe that a trade war will hit many international economics harder than the U.S.
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