iStock.com/DisobeyArt
There’s a party goin’ on right here
A celebration to last throughout the years
So bring your good times, and your laughter too
We gonna celebrate your party with you
Celebrate good times, come on! (Let’s celebrate)
Celebrate good times, come on! (Let’s celebrate)
– Kool & The Gang
The President has announced a trade deal with China referring to the agreement as phase 1 with more to follow. For well over a year, trade negotiations between the United States and China weighed on investor sentiment forcing many to the sidelines hoping to avoid the next tweet or headline that might rock the markets. October was already on shaky ground having started the month off down 3% in just the first few days. With many fearing another disappointment, last week’s negotiations suddenly turned into a love fest forcing shorts to cover and bulls to rejoice.
While heavy sell programs late in the day Friday knocked a couple of hundred points off the Dow most of the major indices closed up over 1%. The usual trade related stocks like Caterpillar [
Not So Fast
Before this party really gets out of control, let’s put down the glass and sober up. Let’s be clear. What we have is a truce. Warriors sometimes need a rest. Soldiers lay down their arms to recoup before heading into the next battle. Too any observer watching this unfold over the last couple of years the heavy lifting still lies ahead.
The October 15th tariff increase is gone while the December 15th tariffs still stand. In return for the lifting of the October deadline, China has agreed to about $50 billion in agricultural purchases along with currency transparency. In addition, they will open markets to U.S. Financial firms. Delayed to later phase negotiations are the tougher issues that really lie at the heart of the ongoing Trade War. The forced transfer of intellectual property, cyber security and a state-run economy that continues to thumb their nose at international trade norms won’t be addressed until later rounds. So, what’s really going on?
Political Imperative
There’s both a political and economic dynamic taking place that can’t be ignored for both sides of the conflict. Unlike his counterpart President Trump has the burden of an election cycle. 2020 is rapidly approaching at a time when the President’s signature barometer of performance, the U.S. stock market, has stalled in recent months. While stocks are enjoying a healthy year, the two-year performance isn’t all that impressive and as pointed out in previous posts, where U.S. markets trade one year from today, will be an important factor in the November 2020 election. Add the fact that impeachment proceedings are moving apace in the House, and the need to jump start a stalled negotiation process became a political imperative.
While Xi doesn’t face the same election burdens, he presides over an economy that is heading south and the inescapable fact that the math simply doesn’t work for him. The Chinese miracle has always been based on the promise that in exchange for access to 1 billion customers, U.S. corporations would agree to some of the draconian forced joint ventures along with outright theft of their intellectual property. Today, Americans on both sides of the political aisle are questioning that relationship believing the playing field hasn’t been level for some time and demand change. Senator Marco Rubio (R-FL) is urging Federal Retirement Thrift Investment Board to cease buying Chinese companies related to China’s 2025 plan. The revamp of the MSCI Index exposes U.S. Pension assets to increased investment in China listings. This could easily get bipartisan support in the months ahead complicating already strained relations with the world’s second largest economy.
At home Chinese citizens were willing to give up much of their freedom and agree to increased censorship to support the state-run economy on the promise that their standard of living would go up every year. When economic prosperity starts to falter or even decline suddenly the emperor has no clothes and political unrest starts to rise. Hong Kong may only be of the tip of the iceberg.
The China playbook is likely to go on for years and the chance of a grand deal seems remote. Hopefully companies will adjust, and CEOs will come to the realization that there is little chance of returning to the status quo. Already, CEOs are rethinking their supply chains. Along with the financial risk that lives with any investment, they are faced with an increasing political risk as both sides of the political aisle at home cast a wary eye on mainland China. Investment in a factory or supply chain can be in the $ billions and is often designed to last decades. Given the increased political uncertainty, every CEO will think long and hard before committing capital and will explore other alternatives.
Less than 36 hours after the so-called deal, analysts are questioning just how much progress has been made.
“While the negotiations do appear to have produced a fundamental understanding on the key issues and the broader benefits of friendly relations, the Champagne should probably be kept on ice, at least until the two presidents put pen to paper.” – China Daily
The above is a passage from the China Daily, a state-owned English newspaper. Sounds like they are setting the stage for disappointment down the road. Analysts at Morgan Stanley call it an uncertain arrangement at best, while Goldman puts the odds of the December hikes being lifted at just 60%. We’ve been down this road before, so skepticism is warranted. China remains an adversary in every sense of the word. This isn’t just about trade anymore. It’s difficult to resolve complex issues like intellectual property when you’re negotiating partner thinks of your IP as public domain. Already reports suggest that China would like more talks before signing phase 1.
Celebrate good times, come on! (Let’s celebrate.)
___
Equities Contributor: David Nelson, CFA CMT
Source: Equities News
