Since Trump’s tweets last Sunday threatening to impose new tariffs on China, the stock markets have fallen from levels close to their all-time highs, with the S&P 500 down 3.5% in the week. Although both technical factors and the volatility due to being in the middle of the earnings season may have had some influence, equity markets have clearly reacted negatively to these tweets, pricing in a higher likelihood of a lack of an agreement between the US and China.
Our main scenario continues to be that an agreement will finally be reached before the US elections next year, providing Pres. Trump with a very visible political victory to present to his electorate. Furthermore, we do not believe that the president is really willing to suffer the consequences of a full-fledged trade war with China, which would certainly imply a global recession and a bear market, in order to secure a long-term strategic gain for the US. (see our publication on the subject https://www.morawealth.com/trade-war-third-opium-war/)
Therefore, what we are witnessing these days is nothing more than a continuation of the negotiating tactics that Pres. Trump has used since the battle with China began (see chart below): as long as the US market continues its bullish path , and only China is affected by the tariffs, the pressure continues to increase. If, on the other hand, markets fall, one becomes conciliatory and offers a truce to negotiate. And given that the US economy posted a solid first quarter and the stock markets hit record highs, you had the weekend’s tweets.
The risk, as in the beginning of any war, is that there is a miscalculation and the result ends up causing great destruction on both sides. However, the risk is two-sided, since a resolution may be finally reached, and stocks markets may rally on the news. In this case, it is important to bear in mind that the economic impact of tariffs takes time to reveal, and that tariffs can be revoked as quickly as they are imposed. As we think that common sense will prevail in the end, we still assign a greater probability to the possibility of reaching an agreement.
Moreover, from a valuation standpoint, with prevailing interest rates and inflation levels, equity markets continue being relatively attractive and we see no reason to reduce our current allocation to risk assets.
Fernando de Frutos, MWM Chief Investment Officer
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