Published on Sep. 18, 2019
Equity Commentary | August 2019
The trade war between the US and China continued to be a focal point for capital markets during August. Early in the month, the Treasury Department formally labeled China a currency manipulator in response to the yuan’s recent depreciation. We believe that the act of formally labeling China a currency manipulator is largely a symbolic one, reflective of the deteriorating relations between the two countries, but of little consequence to the global economy or capital markets.
More significant, in our view, are the new tariffs that were announced by both countries over the last few weeks. In response to an earlier threat from President Trump for additional tariffs on Chinese imported goods, China announced their intention to levy about 5-10% tariffs on an incremental $75 billion of US imports. President Trump responded to China’s retaliation by increasing the current tariff rate on Chinese imports into the US by 5 percentage points. Similarly, tariffs on Chinese imports that had been scheduled to go into effect on December 15th at 10% are now planned to be levied at 15%. President Trump also sent out a tweet in which he appeared to order US companies to begin looking for alternatives to doing business with China. While this call to action is not a legally binding mandate, we believe it is another indication that the US-China trade dispute could persist for some time. We do expect a fluid back and forth of trade dispute news between the two countries until a compromise is made.
While we believe that much of the news on the trade war has been negative in recent weeks, there have been some positive indications. We note that some of the tariffs that were scheduled to go into effect on Chinese imported goods on Sept. 1st have been pushed out to Dec. 15th. These include consumer products such as cell phones, laptops, video game consoles, clothing and footwear. We would not be surprised to see these tariffs delayed again as we get closer to the holiday season. These products make up a significant portion of holiday sales and we therefore think it is likely that the administration will ultimately wait until the holiday shopping season is over before levying tariffs on these goods. Both China and the US have made additional conciliatory moves ahead of the scheduled trade meeting in October, and Chinese officials have suggested putting national security issues on a separate track so that other issues might have a better shot at being resolved. Finally, the deadline for the US decision on whether to allow domestic companies to supply certain technologies to Huawei has been extended for an additional three months. In the interim, US companies will continue to work with Huawei, which presumably should please the Chinese government and perhaps ease negotiations between the two countries.
Turning to the economy, activity appears to be slowing in the US. The Institute for Supply Management’s widely followed manufacturing survey missed estimates in August and came in below 50 for the 1st time in recent years, a level consistent with contraction in the sector. The University of Michigan’s consumer sentiment index also weakened in August, and its forward-looking expectations component showed a decline from the prior month’s survey. While the Conference Board’s measure of consumer confidence remained strong, in our opinion, its expectations component weakened. We think that the inherent uncertainty of the trade war has had a negative impact on these metrics. In our view, this has created a challenging environment for corporate executives and may be impacting investment and hiring decisions, although as of yet there is little evidence of weakness in the employment statistics we monitor. While the consumer has thus far been resilient, we have concerns that the sentiment indicators noted above may be flagging problems ahead for this all-important sector of the economy.
In addition to uneven data, some investors are pointing to the recent inversion of the yield curve as further evidence that the economic expansion may be nearing its cyclical end. We think that there are cogent arguments being made on both sides of this debate. When comparing 10-year Treasuries to 2-year notes, the spread is flat, while the 10-year Treasury spread to the Federal Funds rate is inverted, and therefore we think that it perhaps paints a more ominous picture of where the economy is heading. However, with the Fed and other major central banks having injected copious amounts of liquidity into the financial system in recent years, we think it is fair to question whether the yield curve has been distorted to the point where it is no longer a reliable recession indicator. In our view it remains to be seen how much predictive power the yield curve has in the current cycle, but we do believe that the flattening and inversions seen recently may have an influence on confidence and lending, which in turn can have a meaningful impact on economic activity.